importance of public finance essay

importance of public finance essay

The Importance of Public Finance

1. Introduction

Public finance needs to be managed properly. Proper management will give economic and social development to the country, whereas improper management will result in social and economic problems and the emergence of fiscal stress. A good government has administrative qualities, public minds, and financial management skills in this particular area, finance public officers, and public finance.

Public finance is the branch of economics that studies the financial activities of businesses and public governments. It includes financial activities that influence financing, spending, taxation, and borrowing, resulting in efficient allocation of resources for citizens and government organizations.

Private finance deals with financial transactions mainly in private life. For example, student loans, car loans, mortgages, working capital, and others.

Two different accounts namely: A) Public finance and B) Private finance have existed.

Public finance is crucial to the functioning of any economy. It involves all aspects of resource allocation and includes government taxing and spending, budgeting, borrowing and debt management, and fiscal management. If public finance is not managed effectively, economies can be put under stress. Therefore, it becomes imperative to learn and understand public finance. The contribution of the government to national income is known as public finance. The study of finance takes place under the theory of economics.

2. Role of Public Finance in Economic Development

The role of public finance in economic development is not only the relative importance of the public sector in mobilizing and aiding the means of multiple types of investment, external, aggregate and modernization investment and their uses (e.g. irrigation, roads, power, hydraulic power, etc.), are too important to the percent of the gross national product. The government is also responsible for providing a very large amount of money for the establishment and growth of a large exclusive sector and activities in important fields like defense, civil aviation, telecoms, etc. It is clear, therefore, that the efficient functioning of the public sector – the performance of the government budget and the associated matters of the role of public goods and the provision of reliable political and social infrastructure – is most crucial for economic development.

Public finance plays a very important role in modern economies. While in the large non-competitive state-owned sector, the government exercises a far greater degree of control over investments in the economy. Analysis shows that poor selection of public investment projects, their slow pace of implementation and delays in their completion all have detrimental effects on the economy. The first effect slows down the growth of capital formation; the second and third effects slow down the progress of cumulative causations and intensify the problem of accelerated inflation which is normal in a scheme of economy-led growth.

3. Ensuring Fiscal Responsibility and Stability

Many practical questions and problems also arise. How is fiscal discipline defined? How can fiscal constraints be evaluated and enforced? The importance that the Stability and Growth Pact has acquired is indicative of the increasing interest in these matters. Yet, if we look at EMU countries, it is clear that the pact may have had some successes, but also a number of important failures. Such failures, however, only show that maintaining governments within rigid control systems is especially difficult. It is certainly a challenge because those who decide have to follow restrictive requirements in managing public finance, which have to be interpreted, implemented, and observed not in isolation but in relation to various fiscal policy decisions set in line with the appropriate requirements of the different countries in the EMU.

Any fiscal rule, on its own, regardless of its features, cannot ensure that public finance is kept under control or on a sustainable path. This requires, first of all, political will. The implementation of an effective, transparent, and flexible fiscal policy is therefore primarily dependent on the existence of strong specific political conditions and institutions that offer sufficient protection against temptations to use public finance for political goals. An effective method of controlling such temptations is the participation of ordinary citizens in democratic procedures. It is now generally accepted that fiscal policy and transparency regarding the determinants of public finance and needs are essential to prevent government intervention from becoming arbitrary and subjective, in line with national economic objectives, and to avoid negative consequences for the growth of the private sector economy and the overall economic well-being.

4. Funding Public Goods and Services

When agricultural economies were dominant and manufacturing was relatively unimportant, governments had limited options for raising the revenue. A land tax on food production, consumption and import duties, and seigniorage were the primary sources of government revenue: some of these are still with us (or with other countries). The goal of these early studies in public finance was to decide who and what to tax, and whether the proceeds were appropriate. Of course, tax systems are almost always used to redistribute income across individuals and, to a somewhat lesser extent, regions. The benefits expected from the proceeds of special tax instruments were therefore generally evaluated by the nature of the final payments, including their effects on income distribution.

The ultimate goal of government at all levels should be to provide the public goods and services that would be underproduced or completely neglected if left entirely to individuals and/or the private sector. The lack of markets for these goods and services is the primary reason for government intervention, but these same characteristics create serious problems associated with public finance: understanding their significance and complexity is the main goal of this course. The first models and theories of public finance, developed in the 18th and 19th centuries, helped governments decide who to tax, on what basis to tax them, and whether particular tax policies were redistributive. The tools derived from these early models remain useful even today. Many of the phenomena observed in modern public economics continue to evolve around old issues such as income distribution and personal preferences: these studies are relatively straightforward applications of these very issues.

5. Addressing Income Inequality through Progressive Taxation

Progressivity means that a larger proportion of taxes is paid by those citizens who have the greatest ability to pay and who, in relative terms, have profited most from economic development. Both the income tax and the transfer system play a role in making a tax system progressive. It is essential to remember this when assessing the reform projects that are annually announced, for instance, in the German coalition government. Genuine progressivity requires the system to also be subject to inheritance tax. This is because both the economic situation – insofar as savings or inherited or gifted assets are being passed on – as well as the initial endowment of households are reflected in the assets of households relative to earned income. An estate tax is also progressive. For the tax policy to convince is the best tax policy is not the magnitude of individual tax components or the level of tax revenue, but how well the tax policy harmonizes the need for fair income distribution and macroeconomic objectives.

Inequality of income and wealth is not an economic phenomenon, but a social one. However, to the extent that it is driven by market imperfections, such as insufficient competition or unequal access to quality education, it is a problem for the economy, and one that also needs to be addressed through its fiscal system. In this respect, the Commission must not only safeguard but also promote progressive taxation.