Public finance is one of the old branches of economics which highlights the role

and functions of the government in economy. Government is a formal or

informal institution created by the people in a specific region to perform
various functions such as protection from external attacks, protection of
private property of the people, generation of employment, maintaining
internal law and orders, provision of social needs like education, health, etc...
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.
"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.
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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.

The following subdivisions form the subject matter of public finance.

1. Public expenditure
2. Public revenue
3. Public debt
4. Financial administration
5. Federal finance

Government expenditures

Economists classify government expenditures into three main types.

Government purchases of goods and services for current use are classed
as government consumption. Government purchases of goods and services
intended to create future benefits – such as infrastructure investment or
research spending – are classed as government investment. Government
expenditures that are not purchases of goods and services, and instead just
represent transfers of money – such as social security payments – are
called transfer payments.
  Government operations
Government operations are those activities involved in the running of a state or
a functional equivalent of a state (for example, tribes, secessionist movements
or revolutionary movements) for the purpose of producing value for
the citizens. Government operations have the power to make, and the
authority to enforce rules and laws within a
civil, corporate, religious, academic, or other organization or group

 Income distribution
α Income distribution – Some forms of government expenditure are
specifically intended to transfer income from some groups to others. For
example, governments sometimes transfer income to people that have
suffered a loss due to natural disaster. Likewise, public pension programs
transfer wealth from the young to the old. Other forms of government
expenditure that represent purchases of goods and services also have
the effect of changing the income distribution. For example, engaging in
a war may transfer wealth to certain sectors of society. Public education
transfers wealth to families with children in these schools. Public road
construction transfers wealth from people that do not use the roads to
those people that do (and to those that build the roads).
α Income Security
α Employment insurance
α Health Care
α Public financing of campaigns

Financing of government expenditures

Government expenditures are financed primarily in three ways:

 Government revenue
o Taxes
o Non-tax revenue (revenue from government-owned
corporations, sovereign wealth funds, sales of assets, or seigniorage)
 Government borrowing
 Money creation
How a government chooses to finance its activities can have important effects
on the distribution of income and wealth (income redistribution) and on the
efficiency of markets (effect of taxes on market prices and efficiency). The issue
of how taxes affect income distribution is closely related to tax incidence,
which examines the distribution of tax burdens after market adjustments are
taken into account. Public finance research also analyzes effects of the various
types of taxes and types of borrowing as well as administrative concerns, such
as tax enforcement.

 Taxes
Taxation is the central part of modern public finance. Its significance arises not
only from the fact that it is by far the most important of all revenues but also
because of the gravity of the problems created by the present day tax
burden. The main objective of taxation is raising revenue. A high level of
taxation is necessary in a welfare State to fulfill its obligations. Taxation is used
as an instrument of attaining certain social objectives, i.e., as a means of
redistribution of wealth and thereby reducing inequalities. Taxation in a
modern government is thus needed not merely to raise the revenue required
to meet its expenditure on administration and social services, but also to
reduce the inequalities of income and wealth. Taxation might also be needed
to draw away money that would otherwise go into consumption and cause
inflation to rise.
A tax is a financial charge or other levy imposed on an individual or a legal
entity by a state or a functional equivalent of a state (for
example, tribes, secessionist movements or revolutionary movements). Taxes
could also be imposed by a subnational entity. Taxes consist of direct
tax or indirect tax, and may be paid in money or as corvée labor. A tax may be
defined as a "pecuniary burden laid upon individuals or property to support the
government [ . . .] a payment exacted by legislative authority." A tax "is not a
voluntary payment or donation, but an enforced contribution, exacted
pursuant to legislative authority" and is "any contribution imposed by
government [ . . .] whether under the name of toll, tribute, tallage, gabel,
impost, duty, custom, excise, subsidy, aid, supply, or other name."

 There are various types of taxes, broadly divided into two heads – direct
(which is proportional) and indirect tax (which is differential in nature):
 Stamp duty, levied on documents
 Excise tax (tax levied on production for sale, or sale, of a certain good)
 Sales tax (tax on business transactions, especially the sale of goods and
services)
o Value added tax (VAT) is a type of sales tax
o Services taxes on specific services
 Road tax; Vehicle excise duty (UK), Registration Fee (USA), Regco (Australia),
Vehicle Licensing Fee (Brazil) etc.
 Gift tax
 Duties (taxes on importation, levied at customs)
 Corporate income tax on corporations (incorporated entities)
 Wealth tax
 Personal income tax (may be levied on individuals, families such as
the Hindu joint family in India, unincorporated associations, etc.)

 Debt
 Governments, like any other legal entity, can take out loans, issue bonds,
and make financial investments. Government debt (also known as public
debt or national debt) is money (or credit) owed by any level
of government; either central or federal government, municipal
government, or local government. Some local governments issue bonds
based on their taxing authority, such as tax increment bonds or revenue
bonds.
 As the government represents the people, government debt can be seen
as an indirect debt of the taxpayers. Government debt can be
categorized as internal debt, owed to lenders within the country,
and external debt, owed to foreign lenders. Governments usually borrow
by issuing securities such as government bonds and bills. Less
creditworthy countries sometimes borrow directly from commercial
banks or international institutions such as the International Monetary
Fund or the World Bank.
 Most government budgets are calculated on a cash basis, meaning that
revenues are recognized when collected and outlays are recognized
when paid. Some consider all government liabilities, including
future pension payments and payments for goods and services the
government has contracted for but not yet paid, as government debt.
This approach is called accrual accounting, meaning that obligations are
recognized when they are acquired, or accrued, rather than when they
are paid. This constitutes public debt.
Government revenue

Government revenue or national revenue is money received by

a government from taxes and non-tax sources to enable it to undertake public
expenditure. Government revenue as well as government spending are
components of the government budget and important tools of the
government's fiscal policy. The collection of revenue is the most basic task of a
government, as revenue is necessary for the operation of government,
provision of the common good (through the social contract in order to fulfill
the public interest) and enforcement of its laws; this necessity of revenue was a
major factor in the development of the modern bureaucratic state.
Government revenue is distinct from government debt and money creation,
which both serve as temporary measures of increasing a government's money
supply without increasing its revenue.

 Sources

There are a variety of sources from which government can derive revenue. The
most common sources of government revenue have varied in different places
and time periods. In modern times, tax revenue is typically the primary source
of revenue for a government. Types of taxes recognized by the OECD include
taxes on income and profits (including income taxes and capital gains
taxes), social security contributions, payroll taxes, property
taxes (including wealth taxes, inheritance taxes, and gift taxes), and taxes on
goods and services (including value-added taxes, sales taxes, excises,
and duties). Besides, lotteries can also bring in considerable revenue for the
government. In early 2009, the Australian government used lotteries to boost
spending, generating more than $60m in additional tax revenue for state
governments.
Non-tax revenue includes dividends from government-owned
corporations, central bank revenue, fines, fees, sale of assets, and capital
receipts in the form of external loans and debts from international financial
institutions. Foreign aid is often a major source of revenue for developing
countries, and for some developing countries it's the primary source of
revenue. Seignorage is one of the ways a government can increase revenue, by
deflating the value of its currency in exchange for surplus revenue, by saving
money this way governments can increase the prices of goods.
Under a federalist system, sub-national governments may derive some of their
revenue from federal grants.

Government debt

A country's gross government debt (also called public debt, or sovereign debt)
is the financial liabilities of the government sector. Changes in government
debt over time reflect primarily borrowing due to past government deficits. A
deficit occurs when a government's expenditures exceed revenues.
Government debt may be owed to domestic residents, as well as to foreign
residents. If owed to foreign residents, that quantity is included in the
country's external debt.
In 2020, the value of government debt worldwide was $87.4 US trillion, or 99%
measured as a share of gross domestic product (GDP). Government debt
accounted for almost 40% of all debt (which includes corporate and household
debt), the highest share since the 1960s. The rise in government debt since
2007 is largely attributable to the global financial crisis of 2007–2008, and
the COVID-19 pandemic.
The ability of government to issue debt has been central to state formation and
to state building. Public debt has been linked to the rise of democracy,
private financial markets, and modern economic growth

Measuring government debt

Government debt is typically measured as the gross debt of the general

government sector that is in the form of liabilities that are debt instruments.
A debt instrument is a financial claim that requires payment of interest and/or
principal by the debtor to the creditor in the future. Examples include debt
securities (such as bonds and bills), loans, and government employee pension
obligations.
International comparisons usually focus on general government debt because
the level of government responsible for programs (for example, health care)
differs across countries and the general government comprises central, state,
provincial, regional, local governments, and social security funds. The debt of
public corporations (such as post offices that provide goods or services on a
market basis) is not included in general government debt, following the
International Monetary Fund's Government Finance Statistics Manual
2014 (GFSM), which describes recommended methodologies for compiling
debt statistics to ensure international comparability.
The gross debt of the general government sector is the total liabilities that are
debt instruments. An alternative debt measure is net debt, which is gross debt
minus financial assets in the form of debt instruments. Net debt estimates are
not always available since some government assets may be difficult to value,
such as loans made at concessional rates.
Debt can be measured at market value or nominal value. As a general rule,
the GFSM says debt should be valued at market value, the value at which the
asset could be exchanged for cash. However, the nominal value is useful for a
debt-issuing government, as it is the amount that the debtor owes to the
creditor. If market and nominal values are not available, face value (the
undiscounted amount of principal to be repaid at maturity) is used.
A country's general government debt-to-GDP ratio is an indicator of its debt
burden since GDP measures the value of goods and services produced by an
economy during a period (usually a year). As well, debt measured as a
percentage of GDP facilitates comparisons across countries of different size.
The OECD views the general government debt-to-GDP ratio as a key indicator
of the sustainability of government finance.
While government borrowing may be desirable at times, a "deficits bias" can
arise when there is disagreement among groups in society over government
spending. To counter deficit bias, many countries have adopted balanced
budget rules or restrictions on government debt. Examples include the "debt
anchor" in Sweden; a "debt brake" in Germany and Switzerland; and
the European Union's Stability and Growth Pact agreement to maintain a
general government gross debt of no more than 60% of GDP.

To concluse:
Public finance plays a major role in resource distribution and promoting
stable growth and income distribution. In order for public finance to maintain
the ability to respond flexibly in this era of declining birth rates and aging of the
population, the efficiency of the government sector must be improved.