Public finance
Public finance is the study of the role of the government in the economy.[1] It is the branch of economics that assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achieve desirable effects and avoid undesirable ones.[2] The purview of public finance is considered to be threefold, consisting of governmental effects on:[3]
"Public Finance" redirects here. For the magazine, see Public Finance (magazine).Economist Jonathan Gruber has put forth a framework to assess the broad field of public finance.[4] Gruber suggests public finance should be thought of in terms of four central questions:
Overview[edit]
One of the more traditional subfields of economics, public finance emphasizes the function and role of government in the economy. A region's inhabitants established a formal or informal entity known as the government to carry out a variety of tasks, including providing for social requirements like education and healthcare as well as protecting the populace's private property from outside threats.
The proper role of government provides a starting point for the analysis of public finance. In theory, under certain circumstances, private markets will allocate goods and services among individuals efficiently (in the sense that no waste occurs and that individual tastes are matching with the economy's productive abilities). If private markets were able to provide efficient outcomes and if the distribution of income were socially acceptable, then there would be little or no scope for government. In many cases, however, conditions for private market efficiency are violated. For example, if many people can enjoy the same good (the moment that good was produced and sold, it starts to give its utility to every one for free) at the same time (non-rival, non-excludable consumption), then private markets may supply too little of that good. National defense is one example of non-rival consumption, or of a public good.[8]
"Market failure" occurs when private markets do not allocate goods or services efficiently. The existence of market failure provides an efficiency-based rationale for collective or governmental provision of goods and services.[9] Externalities, public goods, informational advantages, strong economies of scale, and network effects can cause market failures. Public provision via a government or a voluntary association, however, is subject to other inefficiencies, termed "government failure."
Under broad assumptions, government decisions about the efficient scope and level of activities can be efficiently separated from decisions about the design of taxation systems (Diamond-Mirrlees separation). In this view, public sector programs should be designed to maximize social benefits minus costs (cost-benefit analysis), and then revenues needed to pay for those expenditures should be raised through a taxation system that creates the fewest efficiency losses caused by distortion of economic activity as possible. In practice, government budgeting or public budgeting is substantially more complicated and often results in inefficient practices.
Government can pay for spending by borrowing (for example, with government bonds), although borrowing is a method of distributing tax burdens through time rather than a replacement for taxes. A deficit is the difference between government spending and revenues. The accumulation of deficits over time is the total public debt. Deficit finance allows governments to smooth tax burdens over time and gives governments an important fiscal policy tool. Deficits can also narrow the options of successor governments. There is also a difference between public and private finance, in public finance the source of income is indirect, e.g., various taxes (specific taxes, value added taxes), but in private finance sources of income is direct.[10]
History[edit]
Although public finance only began to be viewed as a body of knowledge no more than a century and a half ago, there is evidence of principles common to public finance as early as the bible with discussions of Sunday-trade, slavery regulations, and compassion for the poor. Public finance, although not explicitly named, is often the subject of much of political philosophy.
These concepts can be seen in ancient greece as well, although it was split into two categories there: on one hand the government was to provide for a theater in every city and works of art in the country side. On the other hand, the government was to provide financing for war. Unemployment in ancient Greece was virtually non-existent as Greek economic rule equated heavily to slavery. Greek economic development as per the governmental duties extended to growth, equity, and employment.
The Romans later popularized systemic bodies of law. They guaranteed freedom of contract and property, as well as reasonable price and value. They also developed a well-maintained system of roads and colonies which led to one of the first real tax systems. Their system was tbased on two types of taxes: tributa and vectigalia. The former included the land tax and a poll tax, while the latter was made up of another poll tax, an inheritance tax, a sales tax, and a postage tax. Other taxes depended entirely on the city and were usually temporary. These taxes were used among other things to fund the military, establish trade routes, and fund the cursus publicum. Each region had a set amount to pay which would be collected by aristocrats. Who paid taxes was determined by local officials. The romans employed a regressive tax system wherein the lower income levels paid higher taxes and the wealthier enjoyed reduced taxation.[11]
During feudalism lacking communication led to issues with pre-existing tax systems. Taxation was organized based on what "men spend" in hopes of encouraging investment and savings. Since the government was meant to take care of those who would otherwise turn to charity or crime by means of an allowance provided by a public tax, it is one of the first concepts of what could be considered a negative income tax. Additionally, in England at the time, the main taxes paid were land taxes, a tax that was collected in order to pay for mercenaries. The first mention of a tax in Anglo-Saxon England dates back to the 7th century where it’s specified that fines resulting from judicial cases should be paid to the king. Later something known as food rent was introduced, wherein regions would pay acertain amount of their foodstuffs to the king periodically.
This food rent was not too dissimilar from the taxes imposed on serfs in Russia in the middle ages wherein they were to pay most of their produce and goods to the local lord. In 1550 serfs were instructed to pay another tax called za povoz, which was imposed on those who refused to deliver the harvest from their fields to their master. Later in the eighteenth and nineteenth century lords began having to pay a per capita tax for each of their peasants and were responsible for their well-being during times of famine.
Toward this time, public finance and interest in how governments were to utilize the money earned from taxes as well as how to provide for their state became increasingly common.
The laissez-faire approach first became popular toward the middle of the 17th century, popularized especially by Charles Davenant. The laissez-faire attitude was especially common with Physiocrats in France (as opposed to the classical school in Britain). They maintained a "laissez-faire, laisser-passer" attitude, with one of the central ideas being that the government’s central role should be to guarantee private property, and the maintenance of one single tax, namely the produit net, which encompassed the farmer’s surplus.
Adam Smith also advocated for the laissez-faire attitude, but also claimed that the government would need to take a more proactive role in protection, justice, and public works. He first proposed the idea of a public good, as he believed that a good could provide a value to society as whole that would exceed the value it would provide to only one individual. Adam Smith also maintained that a government should maintain a properly regulated money flow and banking system, patents as well as copyrights, and provide public education and transport. For him public projects always needed to yield a profit that would be greater to society than the individual. One of the most pivotal works on taxation, Adam Smith’s Canons of Taxation gave further criteria for taxation, namely equality, certainty, convenience, and economy.
Following Adam Smith, several economists expanded on his ideas, or transformed them as in the case of Thomas Robert Malthus, who believed that tax-financed public works would be most effective, so long as it created greater demand for labor and commodities.
Public finance as a field began becoming more well-known and independently recognized around this time, with John Ramsay McCulloch writing many pivotal works in the field.[12]