Role of Public Finance In Economic Development

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Public finance is the branch that deals with the government’s revenue and expenditure. Public Finance plays an essential role in stabilizing the supply, allocating the resources, and distribution and development of the state.

Let us learn more about this topic.

Public Finance and its role in the market economy

Public Finance in Market Economy

We can divide the public finance into five sections which are-

  1. Public Revenue
  2. Public Expenditure
  3. Public Department
  4. Fiscal Policy
  5. Financial Administration

The Public Department functions under the direct control of the Chief Secretary and deals with important matters that concern the General Administration of the State.

Public administrators are the public employees who are working in public departments and agencies, at different levels of government.

The fiscal policy helps the government in collecting revenue and expenditure to influence a country’s economy.

A fiscal administration exhibits the reality of the government and the public organization in their provision of public goods or services for the citizens of the country.

Role of Public Finance in Stabilizing the Supply

The economy continues to face blooms and depression. This causes instability in the market. To cope up with incapability, public finance is one of the tools.

The policies like deficit budgeting and surplus budgeting during the time of depression and bloom respectively help to achieve economic stability.

Deficit spending is when the amount spent exceeds the revenue at a particular time. A budget surplus is when the income or the receipts are more than the expenditures or the outlays.

Role of Public Finance in the Allocation of Resources

The economy has two types of goods, known as private goods and public goods. Private goods are exclusive, this means that the person buying them will get the benefits from it.

However, public goods are non-exclusive in nature and anyone and everyone get the benefit of them.

Public finance deals with allocating the public funds in such a way that everyone gets the benefit of them, equally and without any discrimination. The government looks after maintaining the law and order, defense against foreign attacks, building infrastructure, and more.

Role of Public Finance in Distribution and Development

There are large disparities in income and wealth. This disparity sows the seed of crime in society.

Public finance works on cutting down these disparities by its distributing function. It helps in the corrective distribution by charging high taxes from the rich and paying subsidies to the poor, by using the technique of progressive taxation, or by imposing high taxes on the luxury goods.

It helps the economy to grow as a whole and promote development in the areas that have been earlier left behind.

Sources of Government Revenue

Government revenue is the money that the government receives through the taxes and the non-tax sources to undertake government expenditures. The revenue receipts are recurring in nature.

A receipt is a revenue receipt if –

  1. It does not create any liability for the government.
  2. It should not lead to a fall in the assets of the government.

The revenue receipts are non-redeemable and can be further classified into the tax revenue and non-tax revenue.

Revenue Receipts

Forms of Taxes and Subsidies

A tax is a compulsory payment that the people do to the government. There is a further division of taxes into direct taxes and indirect taxes.

Direct Taxes

Direct taxes are those taxes imposed on the property and the income of an individual or a company. This type of tax is directly paid to the government. Direct tax affects both the income level and the purchasing power of the customer.

These systems can be either progressive, regressive, or proportional. Examples of direct taxes are property tax, income tax, value-added tax, estate tax, gift tax, and more.

Indirect Taxes

These types of taxes impose on goods and services and are compulsory payments. These taxes affect the income and the property of an individual through their consumption expenditures. Examples of indirect taxes are sales tax, entertainment tax, excise duty, and more.

Non Tax Revenue

However, taxes are not the only medium for the government to earn revenue. There are some sources other than taxes, which are called the Non-Tax revenue. Some of the major sources of the non-tax revenue are –

a. License Fee

The license fee includes the fees charged for the attainment of the license from various industries like petroleum, communication services, broadcasting, and more.

b. Fines and Penalties

Fines and Penalties include the revenue that the government collects from the people or the organization who have violated the law of order in one way or the other.

c. Interests

This is the interest on the loans that the government has given to different states of the union territories across the country. The states and the UTs borrow loans to implement a plan or policy.

d. Power Supply Fees

It includes the fee received by the Central Electricity Authority from the power supply under the act of electricity supply.

e. Fees for Communication Services

These fees come under the subhead of the license fees. It includes the fees that are collected from the communication services companies or the telecom operators.

f. Escheats

It is a common law doctrine which transfers the real property of a person who has died without heirs to the State.

Subsidy

A subsidy is a financial aid that the government provides to an economic sector. This is to promote economic and social policy. A subsidy can be either a direct subsidy or an indirect subsidy. Cash grants and interest-free loans are examples of direct subsidy.

Insurance, low-interest loans, tax breaks, etc are examples of an indirect subsidy.

There are various types of subsidies. Some of them are listed below:

various types of subsidies

a. Production Subsidy

This subsidy helps to encourage the suppliers to increase the output of a particular product by helping them cut their costs. It helps to expand the production of goods, which will promote the market and at the same time, not increase the price of the goods for the consumers.

b. Consumption Subsidy

The consumption or the consumer subsidy helps to encourage consumer behavior. This subsidy is very common in developing countries. As to promote consumer wellbeing, the government subsidizes water, electricity, living, and more.

c. Export Subsidy

An export subsidy is the support of the government, that is extended for the products that are exported. However, this subsidy is known for being abused.

d. Import Subsidy

An import subsidy is a support from the government for the products that get imported. It helps in reducing the price of the products that are imported. It can also lead to the redistribution of income.

e. Employment Subsidy

Employment subsidy helps to promote job opportunities in the market. With the promotion of job opportunities, it also helps to cut down the unemployment rate in the country.

f. Transport Subsidy

Transport subsidies extend to the rail and bus service sectors. It helps in decreasing the pollution caused to the environment and also helps to reduce congestion on the roads.

g. Oil Subsidy

Oils subsidies help in cutting down the price of the oil for the consumers. This also leads to an increase in the demand for oil in the market.

Crowding-Out Effect

Crowding Out Effect

When the increased interest rates lead to a fall in the private investment spending in such a way that it depresses the initial increase of the total investment spending, it is known as the crowding-out effect.

It happens when the government raises the taxes to fund the introduction of new welfare programs or the expansion of the existing ones. Due to higher taxes, the individuals and businesses are left with lesser discretionary income to spend.

Public Expenditure and its Effects

Public Expenditure and its effects

There are several effects of public expenditure on the economy. Some of them are listed below –

1. Effect on Production

Public expenditure increases production capacity. Income savings also increase and create a beneficial effect on investment and capital formation. However, sometimes it also ends up bringing adverse effects on people’s willingness to work and save.

2. Effect on Distribution

The main aim of the government is to maximize the social benefit and the objective of social welfare can be attained by the help of government expenditure. Its purpose is to collect the excess income from the rich in the form of taxes and spread it into the hands of the poor in the form of subsidies.

This can also be stated as the redistribution of income.

3. Effect on Consumption

This expenditure helps to redistribute the income in the favor of the poor. With that, it promotes consumption and other economic activities. It further helps to strengthen the capacity to save and consume.

4. Effect on Economic Stability

Public expenditure is a tool to strengthen economic stability in times of depression, recession, or inflation.

5. Effect on Economic Growth

Keeping in mind the growth prospects, the government allocates the funds to various departments like industry, agriculture, transport, education, and more. This helps to promote the idea of balanced growth and makes sure no sector is behind.

Conclusion

It is important to acknowledge the fact the economy cannot stay stable throughout the year and it needs a backup mechanism to help it through whenever the things go down the line.

Public Finance helps to maintain this stability and sets the economy through all the ups and downs. Tax and Subsidies are also some of the mechanisms of public finance. They help in allocating the resources, redistributing the income, and maintaining stability.

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1 Response

  1. REHEMA says:

    I really appreciate, your tutorial to up to standard

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