PUBLIC FINANCE

1. PUBLIC FINANCE SUBIR MAITRA Associate professor subirmaitra.blogspot.in simplyeconomix.blogspot.in

2. Aim of the course • To discuss the role of the public sector in modern economies, • To examine the economic rationale for government intervention, • To discuss the effects of government’s actions in terms of efficiency and equity

3. Course outline (as per CU Syllabi) • Introduction to public economics : The nature, scope and significance of public economics • Forms and Functions of Government : Different forms of government – unitary and federal. Tiers of government in the federal form- Central, State, Local (Introductory discussion with examples).

4. Course outline (as per CU Syllabi) • Functions of Government: Economic functions -allocation, distribution and stabilization. Regulatory functions of the Government and its economic significance • Federal Finance Federal Finance: Different layers of the government, Inter governmental transfer— horizontal vs. vertical equity. Grants—merits and demerits of various types of grants — unconditional vs. conditional grants, tied grants, matching grants.

5. Course outline (as per CU Syllabi) • Public Goods and Public Sector Concept of public goods—characteristics of public goods, national vs. local public goods, determination of provision of public good Externality, concept of social versus private costs and benefits, merit goods, club goods. Provision versus production of public goods. Market failure and public provision. Pricing of public goods—vertical summation • Government Budget and Policy Government budget and its structure – Receipts and expenditure – concepts of current and capital account, balanced, surplus, and deficit budgets, concept of budget deficit vs. fiscal deficit, functional classification of budget. Concept of Revenue Deficit. Budget, government policy and its impact. Budget multipliers.

6. Course outline (as per CU Syllabi) • Revenue Resources Concept of tax, types of tax – direct tax and indirect tax, canons of taxation, subsidy, transfer policy. Principles of taxation -Ability to Pay principle (brief discussion), Benefit Approach (Actual Examples) Tax Design - introduction – truth seeking mechanism. • Tax Structure Effects of income tax on work effort, saving and risk bearing (just brief ideas). Excess burden of indirect taxes VAT, Goods and Services Tax (pros and cons). Non-tax revenue resources-earnings from public undertakings, interest on loans.

7. Course outline (as per CU Syllabi) • Distribution and Stabilization Instruments for stabilization Public Debt---internal and external. Public Finance and Public Choice: The Role of State. • Readings 1. Musgrave and Musgrave: Public Finance in Theory and Practice (Fifth Edition). 2. H.L. Bhatia. Public Finance. (Fifteenth Revised Edition). 3. AmareshBagchi (ed.). Readings in Public Finance. Oxford University Press. 4. Misra and Puri. Indian Economy.

8. Introduction to Public Economics • Government or Public intervention: Circular Flow of Income • Government as the provider of goods and services: Health, education, defence, environment, infrastructures, etc. • Government as the framer of the rules and regulation: Legal structure and property rights, environmental regulation and protection of natural resources, safety regulations, employment regulations, etc.

9. Introduction to Public Economics • Government ensuring a stable economic environment: Budget/Fiscal Deficit, Deficit Financing • Government financing its activities with taxation: and this affects the agents’ decisions on labour demand and supply and on consumption.

10. Nature and scope of public economics • Role of the government in market economies, the rationale of its intervention and the economic and social effects in terms of the efficiency and equity trade offs. • When should the government intervene in the economy? • How should the government intervene? • What are the effects of public intervention? • How social choices are made?

11. When should the government intervene in the economy? • The public sector has different roles in market economies: • Allocation of resources (efficiency goal) • Income (re)Distribution (equity goal) • Stabilisation for the economic cycle

12. When and how to intervene/1 Allocation role (efficiency) • The ALLOCATION ROLE is to provide efficiently (increasing the size of the pie) goods and services when the market is not able to produce them efficiently (market failures) through: • The production ofpublic goods or the public financing of private provision: i.e. all those goods and services which are not produced (or would be produced inefficiently) by the market, due to market failures; • The regulation of market activities to support market competition (property rights, legal system, restrictions ) • Taxes and subsidieswhich change the market price of goods/services

13. When and how to intervene/2 Redistributive role • The aim is to foster equity correcting the distribution of resources resulting from market mechanisms by shifting resources from some groups in society to others and/or by changing initial endowments through: • Monetary transfers (such as welfare benefits to support the income of the poor or the unemployed) • Transfers in kind (provisions of public services such as education, health services, social services) • Taxes/subsidies (for example with progressive taxation or exemptions)

14. When and how to intervene/3Stabilisation role • Smoothing over the business cycle and external shocks, supporting full employment and controlling inflation through: • Fiscal policy (transfers and taxation, automatic stabilizers, public expenditures) • Support to productive activities

15. What are the effects of government intervention: The analysis of government failures • Behind public intervention in modern market economies is the need to correct actual or perceived market failures (efficiency goal) and to ensure and equitable distribution of resources (equity goal) • However government intervention may also produce negative direct and/or indirect effects (government failures) due to: • Limited information • Limited control on private markets responses to public intervention • Limited control over the public bureaucracy • Limitations imposed by the political process

16. What are the effects of public intervention • Need to consider direct and indirect effects of public intervention on individuals and markets: • Direct effects are those expected assuming that the behaviour of economic agents do not change as a consequence of government intervention • Indirect effects are those that arise because agents change their behaviour in response of the intervention (for example increasing taxation may reduce labour supply) • Difficult to measure impacts and especially to establish causation (see Gruber ch.3 if interested)

17. How decisions are taken?The analysis of social choices • Political economy studies how the political decision making process produces decisions that affect individuals and the economy • This part of public economics analyses how socially desiderable goals are chosen • Socially desiderable goals relate to: - the capacity to support socio-economic growth - the capacity to guarantee adequate living conditions to citizens - the capacity to guarantee equality in opportunities for all

18. Key economic questions in public economics • Efficiency: • What is produced, how it is produced and how much it is produced (public vs private goods/services): given available resources make the pie as large as possible • Equity • For whom it should be produced and who should pay for it: distribute the pie in the most equitable way • How are decisions taken? • Trade offs: • an efficient outcome could be not equitable • an equitable outcome could be inefficient

19. Theoretical tools needed for Public Economics (Stiglitz ch.3,5; Gruber ch.2) • Consumer theory (constrained utility maximization) • Production theory • Equilibrium and social welfare theory