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What is Public Finance?

by GBAF mag

Public finance is simply the study of government’s role in the economy. It is also the branch of economic science that evaluates the state of government revenue expenditure and governmental budget of the nation and the long-term adjustment of either or both to attain desirable political effects and avoid undesired ones. This branch also attempts to shed light on the effect of policy changes on economic activities. In fact, public finance gives great importance to economic growth, which is essential for a country’s progress and prosperity.

The scope of public finance revolves around macroeconomics. However, for many of us who are relatively less acquainted with the field, there exists an easy way of putting things together. Public finance theory basically speaks about the relationship between fiscal policy and monetary policy.

Basically, public finance focuses on the idea that taxation should be used to redistribute wealth. Thus, the goal of taxing is not to accumulate wealth but to use it in ways that benefit the public. For instance, if taxes are raised, then the poor will get some help from the revenues. On the other hand, when taxes are lowered, then those at the top of the scale will also get a benefit through the increased tax revenues.

By doing this, the public sector is made less dependent on the speculative instincts of private markets. This prevents over-correction of market failures. Over-correction in the public sector may lead to public sector fragility. Over-correction can occur when government interventions make the market “sticky” or do not change prices fast enough.

Public finance theory also looks into the effect of interest rates on government debt. The logic of this is that high interest loans create additional government expenditure because private lenders charge higher interest rates than government banks. If interest rates become too high, then there will be less demand for bank financing leading to less government revenue. In addition, when the public sector does not take up more bank financing, then there will be pressure to monetize assets via interest rates, thus causing economy-wide inflation.

The concern with public finance is that there are economic fluctuations because of general macroeconomic conditions such as GDP growth and employment growth. When unemployment is high, public spending may be encouraged to increase to pay for rising unemployment. Consequently, if the interest rate is too low, then tax revenues are likely to decline leading to lower government debt. This can result in public dissatisfaction with public sector deficits and lead to higher interest rates overall.

The concern with public finance in practice is that excessive deficits can lead to economic devaluation. A balanced approach to public finance would involve reducing budget deficits, increasing national debt, and cutting government spending. Cutting government spending can be difficult as most people prefer to spend their money on items that make them feel better about the nation. Reducing the deficit is difficult because most households receive a large portion of their income from wages and salaries. Similarly, reducing government debt reduces the national debt since the amount of debt owed by the Federal government is greater than the amount of money currently available in the system to repay it.

There is a problem of inadequate information if only a portion of public finance activity is focused on budgeting and taxation. Public officials should make sure that they are able to accurately identify revenue sources and expenditure, as well as work out long term plans for expenditure. Governments should also consider whether current laws need to be changed to accommodate changes in tax and revenue practices. Finally, if public finance officials are unable to implement effective policies, this may mean that revenue will decline and government debt will rise.

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