Bihar Public Finance & Fiscal Policy | BPSC Preparation: All subjects - BPSC (Bihar) PDF Download

Basic Understanding of Public Finance

1. as a practical activity of all components of public administration an
2. As a theoretical area.

• The term “public finance“ may be defined as the identification of specific financial relationships and functions running between public administration bodies and institutions (i.e. public sector entities – the state) as one party and in mutual interaction with other entities of the economic system as the other party (i.e. private entities – households and companies).
• These relationships and functions may be considered special as they include:
  1. Procuring public goods (production and provision);
  2. arranging and funding various transfers (particularly in the social area);
  3. Directing entities existing in the economy towards socially desirable behaviours; for instance through taxes, penalties, subsidies and other stimuli and charges.
• In order to arrange the funding of the above-mentioned areas, there is a fiscal system (public budgeting system) whose aim is to collect the required amount of public revenue. Public revenue serves, at various levels of public budgets (governmental, regional and local), to fund public expenditures.
• Public expenditures, public revenue and particularly taxes may be considered to be the fundamental elements of public finance. Important terms derived from these three elements include deficit, public debt, budgetary policy and fiscal policy.
• The development of public finance is connected with economic mechanisms that should ideally lead to the effective and fair allocation of limited resources.

Public Finance – Causes of Development

• The reason for developing public funding is the state intention to soften the drawbacks resulting from economic decisions made by individual entities (households and companies). It uses fiscal tools (public revenue and expenditure) to accomplish this.
• Certain behaviour is classified as the “quasi-fiscal funding principle”, where publiclaw goods are funded from off-budgetary resources (e.g. the public-law television in the Czech Republic is funded from television licence fees).
• Another important term that relates to public finance, and that is also a strong argument for its development, is market failure.
• The market system follows supply and demand through the price mechanism. It is a system that has developed itself, and that has strong ties with the interactions between people and companies.
• All these entities strive to maximize their benefit (welfare). The greatest benefit is strongly interconnected with reaching the economic optimum condition.
• A system that reaches the optimum is considered, in the neoclassical economics concept, to be efficient, fair and stable.
• The ideal condition is called the Pareto optimum. This exists in an economy when none of the involved entities can improve its position without worsening another entity’s position. If any of the entities intends to improve its position, it is possible for it to do so only to the detriment of another entity. The existence of perfect competition is a necessary requirement for reaching the optimum.
• The three above-mentioned elements (efficiency, stability and fairness) are connected with microeconomics from the viewpoint of efficiency, connected with macroeconomics from the viewpoint of stability, and connected with sciences outside economics from the viewpoint of fairness. The perception of fairness is investigated by other social sciences, and is closely linked to ethics, etc.
• If no conditions exist for reaching a market-efficient solution, or the conditions are simply violated for any reason, market failure will ensue.
• It consists of the following:
  1. The allocation of resources is not efficient,
  2. The economy in the area of macroeconomics indicators oscillates around the desired values and
  3. The distribution of wealth and income may diverge from the consensus on fairness.
• It is then up to the state to perform its fiscal function (the public finance function) in those three areas in order to preferably eliminate or at least reduce market failure. Specifically, those are microeconomic failures from the allocation function perspective, macroeconomic failures from the stabilization function perspective, and the redistribution function then falls into the area of market failure caused by outside economies.
• If the conditions for perfect competition are not met, a malfunction in the price mechanism will arise, which disturbs the allocation mechanism. Some failures can be eliminated without public finance intervention through auto-regulation (the internalization of externalities). However, others are part of the government’s allocation function and its fiscal tools (taxes and governmental purchases or transfers).
• Macroeconomic failure is indicated by instability in the economic system that usually suffers from cyclical inflation, a high rate of unemployment, low or even negative growth of production or problems in the foreign trade balance, etc.
• The above-mentioned macroeconomic cases of instability are why governments perform the state stabilization functions (stabilization fiscal functions).

• The state uses several tools to perform the stabilization function. The basic classification is a division into monetary and fiscal tools. The monetary tools include open market operations, the setting of basic interest rates, determining the level of mandatory minimum reserves, etc. Fiscal tools may include public expenditure, public revenue and ways of funding deficits.

• The causes of market failure outside the economy relate to reaching fairness in society through the distribution of wealth and income. With the distribution of wealth, the market does not practically perceive fairness. In this case, the state performs a redistributive role with 5h3 principles of solidarity, social conscience, charity, etc. based on the social consensus.

• The state performs the redistribution function through two basic categories of tools. The first includes revenue (tax) and the other expenditures (transfers, grants and subsidies).

First, a tax transfer mechanism may be implemented through a combination of progressive taxation of high incomes and transfers (subsidies) in favour of low income households.

Secondly, this can occur through the taxation of luxury goods combined with subsidies on goods for the low-income population.

Fiscal Policy Meaning

• Arthur Smithies defines fiscal policy as “a policy under which the government uses its expenditure and revenue programmes to produce desirable effects and avoid undesirable effects on the national income, production and employment.”
• Though the ultimate aim of fiscal policy in the long-run stabilisation of the economy, yet it can be achieved by moderating short-run economic fluctuations.
• In this context, Otto Eckstein defines fiscal policy as “changes in taxes and expenditures which aim at short-run goals of full employment and price-level stability.

Objective of Fiscal Policy

• To maintain and achieve full employment.
• To stabilise the price level.
• To stabilise the growth rate of the economy
• To maintain equilibrium in the balance of payments.
• To promote the economic development of underdeveloped countries.

Deficits, Debts and FRBM Targets for 2017-18

• The Fiscal Responsibility and Budget Management (FRBM) Act, 2006 of the state provides annual targets to progressively reduce the outstanding liabilities, revenue deficit and fiscal deficit of the state government.
• Revenue deficit: It is the excess of revenue expenditure over revenue receipts. A revenue deficit implies that the government needs to borrow in order to finance its expenses which do not create capital assets. However, the budget estimates a revenue surplus of Rs 14,556 crore (or 2.3 % of GSDP) in 2017-18. This implies that revenue receipts are expected to be higher than the revenue expenditure, resulting in a surplus. The estimate indicates that the state is meeting the target of eliminating revenue deficit, as prescribed by the 14th Finance Commission.
• Fiscal deficit: It is the excess of total expenditure over total receipts. This gap is filled by borrowings by the government, and leads to an increase in total liabilities of the government. A high fiscal deficit may imply a higher repayment obligation for the state in the future. In 2017-18, fiscal deficit is estimated to be Rs 18,112 crore, which is 2.9% of the GSDP. This is within the limit prescribed by the 14th Finance Commission.
• Outstanding Liabilities: It is the accumulation of borrowings over the years. In 2017-18, the outstanding liabilities are expected at 19.78% of GSDP.