Public financePublic finance Dr. AlshihaDr. Alshiha

IntroductionIntroductionPublic FinancePublic Finance

Dr. Adnan AlshihaDr. Adnan Alshiha

What Is Public Finance?What Is Public Finance? Public FinancePublic Finance , field of economics , field of economics

concerned with how governments raise concerned with how governments raise money, how that money is spent, and the money, how that money is spent, and the effects of these activities on the economy effects of these activities on the economy and on society and on society

What Is Public Finance?What Is Public Finance? Public f inancePublic f inance studies how studies how

governments at all levels—national, state, governments at all levels—national, state, and local—provide the public with desired and local—provide the public with desired services and how they secure the financial services and how they secure the financial resources to pay for these services. resources to pay for these services.

What Is Public Finance?What Is Public Finance? In many industrialized countries, spending In many industrialized countries, spending

and taxation by the government form a and taxation by the government form a large portion of the nation's total economic large portion of the nation's total economic activity. activity.

For example, total government spending For example, total government spending in the United States equals about 40 in the United States equals about 40 percent of the nation's gross domestic percent of the nation's gross domestic productproduct

Why Public Finance Is Why Public Finance Is Needed?Needed?

Governments provide Governments provide public goodspublic goods——government-financed items and services government-financed items and services such as roads, military forces, lighthouses, such as roads, military forces, lighthouses, and street lights. and street lights.

Private citizens would not voluntarily pay Private citizens would not voluntarily pay for these services, and therefore for these services, and therefore businesses have no incentive to produce businesses have no incentive to produce them.them.

Why Public Finance Is Why Public Finance Is Needed?Needed?

Public finance also enables governments Public finance also enables governments to correct or offset undesirable side effects to correct or offset undesirable side effects of a market economy. of a market economy.

These side effects are called These side effects are called spilloversspillovers or or externalities.externalities.

Example: households and industries may Example: households and industries may generate pollution and release it into the generate pollution and release it into the environment without considering the environment without considering the adverse effect pollution has on others. adverse effect pollution has on others.

Why Public Finance Is Why Public Finance Is Needed?Needed?

Pollution is a spillover because it affects Pollution is a spillover because it affects people who are not responsible for it. people who are not responsible for it.

To correct a spillover, governments can To correct a spillover, governments can encourage or restrict certain activities. encourage or restrict certain activities.

For example, governments can sponsor For example, governments can sponsor recycling programs to encourage less recycling programs to encourage less pollution, pass laws that restrict pollution, pollution, pass laws that restrict pollution, or impose charges or taxes on activities or impose charges or taxes on activities that cause pollution.that cause pollution.

Why Public Finance Is Why Public Finance Is Needed?Needed?

Public finance provides government Public finance provides government programs that moderate the incomes of programs that moderate the incomes of the wealthy and the poor. the wealthy and the poor.

These programs include social security, These programs include social security, welfare, and other social programs. welfare, and other social programs.

For example, some elderly people or For example, some elderly people or people with disabilities require financial people with disabilities require financial assistance because they cannot work. assistance because they cannot work.

Why Public Finance Is Why Public Finance Is Needed?Needed?

Governments redistribute income by Governments redistribute income by collecting taxes from their wealthier collecting taxes from their wealthier citizens to provide resources for their citizens to provide resources for their needy ones. needy ones.

The taxes fund programs that help support The taxes fund programs that help support people with low incomes.people with low incomes.

Public SpendingPublic Spending

Each year national, Provincial, and local Each year national, Provincial, and local governments create a budget to determine governments create a budget to determine how much money they will spend during how much money they will spend during the upcoming year. the upcoming year.

The budget determines which public The budget determines which public goods to produce, which spillovers to goods to produce, which spillovers to correct, and how much assistance to correct, and how much assistance to provide to financially disadvantaged provide to financially disadvantaged people. people.

Public SpendingPublic Spending The chief administrator of the government—such The chief administrator of the government—such

as the prime minister, governor, or mayor—as the prime minister, governor, or mayor—proposes the budget. proposes the budget.

The legislature—such as the parliament, The legislature—such as the parliament, Provincial council, or Municipality council—Provincial council, or Municipality council—ultimately must pass the budget. ultimately must pass the budget.

The legislature often changes the size and The legislature often changes the size and composition of the budget, but it must not make composition of the budget, but it must not make changes that the chief administrator will reject changes that the chief administrator will reject and veto.and veto.

Government SpendingGovernment Spending Government spending takes two forms: Government spending takes two forms: Exhaustive spendingExhaustive spending Transfer spending.Transfer spending.

Government SpendingGovernment Spending Exhaustive spending:Exhaustive spending: refers to refers to

purchases made by a government for the purchases made by a government for the production of public goods. production of public goods.

For example, to construct a new harbor For example, to construct a new harbor the government buys and uses resources the government buys and uses resources from the economy, such as labor and raw from the economy, such as labor and raw materials. materials.

Government SpendingGovernment Spending Transfer spendingTransfer spending when government when government

transfers income to people to help them support transfers income to people to help them support themselves. themselves.

Transfers can be one of two kinds: Transfers can be one of two kinds: cashcash or or in-kind.in-kind. Cash transfersCash transfers are cash payments, such as are cash payments, such as

social security checks and welfare payments. social security checks and welfare payments. In-kind transfersIn-kind transfers involve no cash payments involve no cash payments

but instead transfer goods or services to but instead transfer goods or services to recipients. Examples of in-kind transfers include recipients. Examples of in-kind transfers include food stamp coupons and Medicare. food stamp coupons and Medicare.

Public Revenue Public Revenue Governments must have funds, or Governments must have funds, or

revenue, to pay for their activities. revenue, to pay for their activities. Governments generate some revenue by Governments generate some revenue by

charging fees for the services they charging fees for the services they provide, such as entrance fees at national provide, such as entrance fees at national parks or tolls for using a highway. parks or tolls for using a highway.

However, most government revenue However, most government revenue comes from taxes, such as income taxes, comes from taxes, such as income taxes, capital taxes,capital taxes, and and salessales and and excise taxes.excise taxes.

Public Revenue Public Revenue

An important source of tax revenue in most An important source of tax revenue in most industrialized countries is the income or payroll industrialized countries is the income or payroll tax, also known as the tax, also known as the personal income tax.personal income tax.

Income taxes are imposed on labor or activities Income taxes are imposed on labor or activities that generate income, such as wages or that generate income, such as wages or salaries. salaries.

In the United States, income taxes account for In the United States, income taxes account for about half of the total revenue of local, state, about half of the total revenue of local, state, and federal governments combined. and federal governments combined.

Public Revenue Public Revenue Another important source of government revenue Another important source of government revenue

is the capital tax. is the capital tax. Capital includes items or facilities that generate Capital includes items or facilities that generate

profits, such as factories, business machinery, profits, such as factories, business machinery, and real estate. and real estate.

Some types of capital taxes are known as Some types of capital taxes are known as “profits” taxes. “profits” taxes.

One kind of capital tax used by the federal One kind of capital tax used by the federal government in the United States is the government in the United States is the corporate corporate income tax.income tax.

A A property taxproperty tax is a capital tax used by state and is a capital tax used by state and local governments. Property taxes are levied on local governments. Property taxes are levied on items such as houses or boats.items such as houses or boats.

Public Revenue Public Revenue

Sales and excise taxes are also a major source Sales and excise taxes are also a major source of government tax revenue. of government tax revenue.

Many state and local governments levy a sales Many state and local governments levy a sales tax on the purchase of certain items. tax on the purchase of certain items.

Consumers usually pay a percentage of the Consumers usually pay a percentage of the sales price as the tax. sales price as the tax.

Excise taxes are used by all levels of Excise taxes are used by all levels of government. government.

An excise tax is levied on a specific product, An excise tax is levied on a specific product, such as alcohol, cigarettes, or gasoline. such as alcohol, cigarettes, or gasoline.

In Canada and many European, South In Canada and many European, South American, and Asian countries, a American, and Asian countries, a value-added value-added tax (VAT)tax (VAT) provides significant revenue. provides significant revenue.

The VAT is levied on the value added to a The VAT is levied on the value added to a product during production as its components are product during production as its components are assembled into final goods. assembled into final goods.

For example, a clothing manufacturer might For example, a clothing manufacturer might spend $500 on fabric, thread, zippers, and other spend $500 on fabric, thread, zippers, and other goods required to make dresses. The goods required to make dresses. The manufacturer then adds $1000 to cover the manufacturer then adds $1000 to cover the costs of labor and the use of machines and costs of labor and the use of machines and equipment and sells the dresses for a total of equipment and sells the dresses for a total of $1500. The value-added tax is paid on this $1500. The value-added tax is paid on this $1000.$1000.

How Public Finance How Public Finance Affects the Economy?Affects the Economy?

Government spending and taxation directly Government spending and taxation directly affect the overall performance of the economy. affect the overall performance of the economy.

For example, if the government increases For example, if the government increases spending to build a new highway, construction of spending to build a new highway, construction of the highway will create jobs. Jobs create income the highway will create jobs. Jobs create income that people spend on purchases, and the that people spend on purchases, and the economy tends to grow. economy tends to grow.

The opposite happens when the government The opposite happens when the government increases taxes. Households and businesses increases taxes. Households and businesses have less of their income to spend, they have less of their income to spend, they purchase fewer goods, and the economy tends purchase fewer goods, and the economy tends to shrink. to shrink.

Fiscal PolicyFiscal Policy A government's fiscal policy is the way the A government's fiscal policy is the way the

government spends and taxes to influence government spends and taxes to influence the performance of the economy.the performance of the economy.

Government Deficits Government Deficits When the government spends more than it When the government spends more than it

receives, it runs a receives, it runs a deficit.deficit. Governments finance deficits by borrowing Governments finance deficits by borrowing

money. money. Deficit spending—that is, spending funds Deficit spending—that is, spending funds

obtained by borrowing instead of taxationobtained by borrowing instead of taxation—can be helpful for the economy. —can be helpful for the economy.

ExampleExample when unemployment is high, the government when unemployment is high, the government

can undertake projects that use workers who can undertake projects that use workers who would otherwise be idle. would otherwise be idle.

The economy will then expand because more The economy will then expand because more money is being pumped into it. money is being pumped into it.

However, deficit spending also can harm the However, deficit spending also can harm the economy. economy.

When unemployment is low, a deficit may result When unemployment is low, a deficit may result in rising prices, or inflation. The additional in rising prices, or inflation. The additional government spending creates more competition government spending creates more competition for scarce workers and resources and this for scarce workers and resources and this inflates wages and pricesinflates wages and prices