Lecture 1 Public Finance Cpa

8/12/2019 Lecture 1 Public Finance Cpa

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PUBLIC FINANCE(PF)

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THE NATURE OF PUBLIC FINANCE

Public finance is one of those subjects which

lie on the border line between economics and

politics. It is concerned with the income and

expenditure of public authorities, and with theadjustment of the one to the other. The."

Principles of Public Finance" are the general

principles which may be laid down with regard to

these matters.


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In modern civilised communities the income

and expenditure of public authorities consist,

almost exclusively, of money receipts and

money payments. The word " finance"signifies " money matters" and their

management, and public finance in its

modern sense presupposes the existence of a

money economy.


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The main division in public finance is between public incomeand public expenditure, which form two symmetricalbranches of the subject. Some writers have excludedpublic expenditure from the scope of public finance, butthis is clearly illogical. Public debts are often treated as aseparate branch of the subject and this is convenient,

since they give rise to a number of special problems. Onthe other hand, receipts from \ public borrowings formpart of public income, while . payments of interest on,and repayments of the principal ' of, public debts formpart of public expenditure. \Similarly receipts frompublic assets, whether in the shape of annual income or of

the proceeds of sales, form part of public income, whilepayments in respect of public assets, whether in theshape of expenses of management, or initial expenses,of acquisition, form part of public expenditure. And thesequestions are related to the problem of balancing thebudget.


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PUBLIC FINANCE -DEFINED

used or applied to the packages of those policyproblems, which involve the use of tax and

expenditure measures. As a subject, public finance is

a study of public sector economics. It is about the

revenue, expenditure and debt operations of the

government and the impact of these measures to the

society. Public Finance is, therefore, about fiscal

institutions, that is the tax systems, expenditure

programs, and budget procedures, stabilization

instruments, debt issues, level of government etc.


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PUBLIC FINANCE -DEFINED

Public Finance-is the study of the financial activities of governments and public

authorities. It describes and analyzes the expenditures of

government and the techniques used by governments to finance

its expenditures.

-It interest in studying the institution and decision making process

that help mold the observed behavior of people acting through

government.

-It deals with the economic role of government as a response to

market failures, its limitation in responding to such failures, the

design and evaluation of expenditure and tax program, and short

& long term consequences of the deficit in the economy.


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WHYDOWENEEDAPUBLICSECTOR?

From the economic point of view government

intervention is necessary because of what is known

as Market failurein such functions as allocation of

resources, distribution of income and

stabilization of the economy.

Market Failures- These are market inadequacies or

areas that the market or private sector of the

economy fails to address and fail to satisfy all theneeds of the society. For instance;


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1. Market failure in providing the societys

desired set of goods and services.

2. Market failures in the distribution of income

and poverty.

3. Market failure in achieving stability in

employment and prices. Reduces fluctuation

in economic activities (business cycles, boom,

peak, recession, and depression).


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The need for public sector:

(a) Allocation Function:

The provision of social goods or the process by

which total resources used is divided betweenprivate and social goods and which chooses the

mix of social goods. This provision of social goods

is what is known as the allocation function. Market

failure in the provision of social goods is chosen.

This provision of social goods is what is known asthe allocation function.


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Market failure in the provision of social goods arises

because of the presence of public goods. These are

goods we consume collectively and therefore one

person who purchased the good can exclude no one

from the benefits arising from consumption of suchgoods. To put id differently the benefits derived by

anyone consuming a social good are externalities

in that they become available to all others. In case of

private goods the benefits of consumption areinternalized with a particular consumer whose

consumption excludes military defence, Law and

Order (The Police), Judiciary, Air clearing etc.


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The market mechanism is well suited for theprovision of private goods. It is based on exchange,

and exchange can occur only where there is an

exclusive title to the property, which is to be

exchanged. Application of the exclusion principle

tends to be inefficient solution. This is not the casefor social goods, as it will be inefficient to exclude

anyone consumer from partaking in the benefits,

when such participation would not reduce

consumption by anyone else. For instance, you maycross the Salender Bridge as much as you can but

this does not reduce the possibility available to others

to use the bridge.


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However, in cases where benefits are available to all,consumers will not voluntarily offer payments to supplierof social goods. Hence, no voluntary payment is madeespecially where many consumers are involved. Thelinkage between producer and consumer is broken and

the government must step in to provide for such goods.

Summary - Allocation

Government increase efficiency by promotingcompetition, curving externalities like pollution andproviding basic public goods.

*Efficiency- denotes the most effective use ofsociety resources in satisfying peoples wants andneeds


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(b) Distribution Function:

Again, the government has to intervene in order toadjust the distribution of incomeand wealth to ensureconference with what society considers a fair or juststate of distribution of income and wealth. This fair or

just distribution of income cannot be achieved under themarket mechanism. Under the market mechanism, thedistribution of income and wealth depends first of all onthe distribution of factor endowment and thendetermined by the process of factor endowment andthen determined by the process of factor pricing, which

in a competitive market, sets factor returns equal to thevalue of marginal product. The distribution of incomeamong individuals thus depends on their factor suppliesand the prices which they fetch in the market.


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Earning abilities differ, so does factor endowment,

this distribution of income may or may not be in line

with what society considers fair and just. It involves

a substantive degree of inequality especially in the

distribution of capital income, and through views on

distributional income justice differ, most wouldagree that some adjustments are required.

Among various fiscal devices, redistribution is

implemented most directly by:

(i) A tax scheme which combines progressiveincome taxation of high income households

with a subsidy to low income households.


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(ii) Alternatively, redistribution may be implemented byprogressive income taxes used to finance public servicesespecially those such as public housing scheme,

hospitals and other health care schemes,

education schemes etc which particularly benefit

low income households.

(iii) A combination of taxes on goods purchased largely

by high income consumers with subsidies to other

goods, which are chiefly used by low-income earners.

Summary- Distribution

Government promotes equity by using tax and

expenditure programs to redistribute income

towards particular groups.


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(c) Stabilization Function

Fiscal policy has to be designed by the government to

maintain or achieve the goals of high employment, a

reasonable degree of price level stability, soundness

of foreign accounts and an acceptable rate of

economic growth.

Fiscal policy is needed for stabilization of the

economy. Full employment and stability do not come

about automatically in a market economy but require

public policy guidance. Without it, the economy tendsto be subject to substantial fluctuations, and it may

suffer firm sustained periods of unemployment or/and

inflation.


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Summary - Stabilization

Government fosters macroeconomics stability and

growth. Reducing unemployment and inflation while

encourages growth.


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THE DIFFERENCE BETWEEN MARKET ACTION AND GOVERNMENT

ACTION

The private sector (markets) and the public sector

(government) may simply be thought of as twoalternative institutions that can be used to allocate

scarce resources in an economy.

In a market economy, characterized by private

ownership, it is important to remember that theseresources are not owned collectively by society, but

rather are owned privately by individuals. The market

process that allocates these resources works through

the voluntary, uncoerced specialization and exchangeundertaken by individual owners.


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THE DIFFERENCE BETWEEN MARKET ACTION AND

GOVERNMENT ACTION

In contrast, collective action undertaken through thepublic sector uses the coercive powers of

government to alter the choices of individual owners.

This is the first of two fundamental differences between

market action and government actionthe reliance on

voluntary choice versus coercion to allocate resources.

When market exchange occurs it is clear that both

parties have been made better off (or were both

expecting to be made better off), while with government

action it is frequently the case that some parties havebeen made better off while others have been made

worse off.


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GOVERNMENT ACTION

The second fundamental difference between market

action and government action rests in the nature of

planningand cho ice. In the public sector planning is

done central ly, while in private markets planning is

done indiv idual ly.

Government intervention can thus be thought of as

replacing individual planning with central planning. In

markets, individuals are left to make choices based

on the personal costs and benefits they face accordingto their individual preferences.


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GOVERNMENT ACTION

When action is done through the public sector, thechoices and decisions must be made collectively.

Collective choice is a much more difficult process than

individual choice as it requires a mechanism for

aggregating the preferences of many diverse

individuals. To make good collective choices requires

registering or knowing a vast amount of information

about individual preferences.


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GOVERNMENT ACTION

In modern market based economies, democraticvoting procedures, rather than the selection of a

know ledgeable central planner, is generally used

as the process to make collective choices. These

voting rules, however, inherently have problems

with registering the intensity of preferences, getting

individuals to truthfully reveal their preferences, and

providing enough incentive for voters to become

well informed about the choices they must make.


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GOVERNMENT ACTION

Models of public sector intervention in cases of market

failure have historically modeled government as being

represented by a socially benevolent dictator who had all

the information necessary to make changes that would

improve the efficiency of resource allocation. Modern dayeconomic analysis, however, generally models the

process of collective choice as one dominated by rationally

ignorant voters, powerful special interest groups, vote

maximizing elected officials, and budget maximizingbureaucrats.


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GOVERNMENT ACTION

It should be apparent that this has important

implications for government intervention, both to

correct market failure and to achieve normative

equity goals. Interest groups and bureaucrats will

tend to cloak their self-interested demands fortransfers, budgets, and legislation as policies to

address market failures or equity goals, even when

that is not the true intention of the policy. For this

reason, stringent constraints on governmentintervention and regulation appear necessary.


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THE CONCEPT OF ECONOMIC EFFICIENCY

Within the neoclassical economic paradigm,economic efficiency is the benchmark by which both

market outcomes and government intervention

are judged. Economic efficiency (or pareto) requires

two conditions be met:(1) all actions generating more social benefits

than costs should be undertaken, and

(2) no actions generating more social costs thanbenefitsshould be undertaken.


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If both of these conditions are met, a ParetoOptimal allocation will be attainedthat is, one in

which it is impossible to reallocate resources in such a

way to make at least one person better off without

harming another person.

Whenmarket exchange occursit is clear that both

parties have been made better off, while when

government action occursit is frequently the casethat some parties have been made better off while

others have been made worse off.


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If all parties to an exchange benefit it is clear that the

action is consistent with efficiency. In cases where

government intervention benefits some parties and harms

others, the efficiencyimplications are not so obvious.

The traditional metric by which such actions are judged is

the potentialPareto criterion.

The potential Pareto criterion is met if enough benefits

are generated such that it would be hypothetically

possible for the winners to completely compensate

the losers.


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In essence, the potential Pareto criterion amounts

to a co st/benefi t test for government intervention.

It is important to note that substantial issues arise

with a strict application of this rule.

For example, if the benefits of building a road

exceed the losses to property owners from takingtheir property for use in construction, the potential

Pareto criterion would justify taking the property for

public use regardless of whether any compensation

was paid to the owners at all.


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Almost exclusively in public finance, the eff ic iency

cr i ter ion is applied to whether the quantity ofsome economic activity is the efficient quantity, and

the benchmark efficient quantity is generally

derived or illustrated in a supp ly and demand

diagram in which the supp ly curvemeasures themarginal social cost of the activity, while the

demand curve measures the marginal socia l

benefi t of that activity. This is illustrated in Figure 1

where MBsand MC

sare the marginal social benefit

and marginal social cost respectively


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Figure 1.Market Efficiency

Price(P)

Supply=MCs

Demand=MBs

Q* Quantity


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In Figure 1, Q* corresponds to the efficient

output level. All units up to Q* satisfy condition (1)

listed above because they all generate more

social benefitsthan costs. Units beyond Q* should not be produced given

condition (2) listed above because they generate

less social benefits than costs.


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NEEDS FOR PF:

Demand and supply of:

Water

Health public goods

Security

Education

i.e. public goods


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DIVISION OF PF.

PF have divided into threedivision

Public expenditure (PE)

Public income (PI)

Public debt national debt /National debt

(PN/ND)


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PUBLIC EXPENDITURE (PE)

It deals with the various types of expenditures of the

government required for its proper functioning. Economists classify government expenditures into

three main types. Government purchases of goodsand services for current use are classed asgovernment consumption.

Government purchases of goods and servicesintended to create future benefits---such asinfrastructure investment or research spending---areclassed as government investments.

Government expenditures that are not purchases ofgoods and services, and instead just representtransfers of money--- such as social securitypayments--- are called transfer payments.


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Tanzanian Government Expenditures

In Tanzania, the Government expenditures are divided into

two main categories depending on the type and nature ofexpenditures.

There are statutory expenditures, recurrent expenditures

and development expenditures.


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Recurrent / Supply Expenditures. These are

expenditures necessary to furnish the day-to-day

operations of the government. This type of

expenditure has probably assumed nomenclature

because of its recurring nature. The expendituresitems falling under this category include salaries

and wages for Government employees, office

expenses, travelling, maintenance and running

expenses of plants and vehicles and equipments,e.t.c


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Development expenditures

These are expenditures relating to development

projects of the government. They include

infrastructure development and long-term projects.

Examples of such expenses are construction of

roads and bridges, school /colleges/ university

buildings, acquisition of plants, equipments and

vehicles, etc.


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Causes for growth of PE.

Population growth

Unanticipated calamities e.g. / Flood, hunger.

Wars

Inflation / deflation etc


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PUBLIC INCOME (PI)

Is the revenue which obtains by government fromdifferent sources so as to finance public expenditure

(a) Recurrent Expenditure

(b) Development expenditure.

The government raises much of its finance through taxation.

Taxation is the most preferred sources of revenue among

governmentsworldwide. Apart from ensuring constant and

uninterrupted flow of revenue to government revenue,taxation serves other fiscal policy objectives as well.


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PUBLIC INCOME (PI)

SOURCES OF PUBLIC INCOME / REVENUE

Tax Revenue(Taxation)

Non Tax Revenue(e.g. fine)

Authority to collect revenue. The government of Tanzania shall

levy no taxes unless the Parliament has passed an Act to allow

such imposition of taxes. This is accordance with section 138 of

the Const: URT of 1977 as amended time to time. Taxation

system in Tanzania is consolidated through the TRA.


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PUBLIC INCOME (PI)

Other Sources of Government Revenue include:

Borrowing:The government may borrow funds from both internal and externalsources. Internal sources include all financial institutions such asBanks, Insurance companies and social Security institutions.

External sources include bilateral (between governments)

multilateral sources such as IMF, World Bank etc.

Grants and Aids:

Grants are funds given to the government for a specific purpose,e.g. construction of road, purchase of rice etc. An aid is a generalmonetary assistance given to the government with a donor country

not specifying its particular use.

Dividends from its corporations:

The government may own shares in various corporations fromwhich it may receive cash dividend.


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PUBLIC INCOME (PI)

User Charges:

These include port and airport services charges.

Fines imposed as punishment or damages for

contravening various Laws enacted by thegovernment. For instance driving a defective motorvehicle may attract payment of a certain amount ofmoney to the government as fine.

Licenses and other fees.

Sale of government bonds and securities.


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PUBLIC DEBT/NATIONAL DEBT

The government revenue is not sufficient to

finance development programs or social services

so that the government borrows some money

from inside or outside the country.The unpaid amount borrowed by the government

is called public debt or national debt.


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PUBLIC DEBT/NATIONAL DEBT

TYPES OF PUBLIS DEBT/NATIONAL DEBT

External debt EG. i.e., World Bank, Foreign

countries, U.N Agency

INTERNAL DEBT e.g. Treasury Bonds, Treasury

Bills, Banking institutions and Non Banking

institutions and Credit creation Process.

Documents

Lecture 1 Public Finance Cpa