Public Finance – SS2 Economics Lesson Note (Third Term)

Public finance is the aspect of economics which deals with the financial activities related to income, expenditure and national debt operations, with their overall effects on the economy. That is, it is the management and control of government income and expenditure to achieve the government’s policy objectives. It involves a detailed analysis of the sources from which the government derives its income (revenue), the items on which it spends its money and the impact of that spending on different aspects of the economy.

Behavioural objectives

By the end of the lesson, students should be able to:

1. define public finance and state its objectives;
2. explain fiscal policy and state the economic objectives of government on fiscal policy;
3. classify government revenue and list its main sources;
4. classify government expenditure and give examples of each class;
5. state the reasons for the increase in government expenditure and its effects.

What are the objectives of public finance?

1. It performs equitable distribution of resources among individuals, tiers of government and the various sectors of the economy.
2. It is used to achieve and maintain a favourable balance of payments and economic development.
3. It provides a general parameter for monitoring the economy in terms of growth and stability.
4. It is used to achieve the economic objectives of the government.
5. It is used to ensure good fiscal policy for the regulation of the economy.
6. It is used to generate employment avenues for the people.
7. It ensures the satisfaction of the needs of the people through the provision of funds for transfer payments, e.g. pension fund, unemployment benefits, subsidies etc.

What is fiscal policy?

Fiscal policy is a government plan of action concerning the raising of revenue through taxation and other means, and deciding the pattern of expenditure to be applied.

Fiscal policy therefore involves the use of government income and expenditure instruments to regulate the economy and achieve set economic objectives.

The economic objectives of the government on fiscal policy include:

1. Maintenance of stable prices/control of inflation and deflation.
2. Equitable distribution of wealth.
3. Efficient allocation of resources.
4. Provision of full employment.
5. Stability in the exchange rate of the national currency.
6. Maintenance of favourable balance of payments.

What is government revenue?

Government revenue is the total income that accrues to all levels of administration or government from various sources.

Classification of public revenue

Government revenue can be classified as:

1. Recurrent revenue: This is the total amount of revenue collected by the government of a country on a regular or yearly basis, e.g. taxation, fees, licences, fines etc.
2. Capital revenue: This is revenue from irregular or extraordinary sources. It is used for meeting expenditure on heavy capital projects, e.g. grants or loans collected by the government to build a project such as a railway line.

Sources of government revenue

The main sources of government revenue are:

1. Taxes: These are major sources of revenue to governments all over the world. Taxes may be direct or indirect.
2. Royalties: This is the money paid to the government by companies engaged in mining activities, for the right to search for and exploit mineral resource deposits.
3. Earnings (income) from government investments, e.g. interest, rent, dividends and profits from government-owned business property.
4. Grants and aid from individuals and institutions at home, and from foreign governments and international organisations.
5. Borrowing: This could be internal or external borrowing, e.g. sale of government securities or loans from the African Development Bank, IMF, World Bank, Paris Club etc.
6. Fees, licences, charges and fines, e.g. vehicle licence fees, liquor licence fees, firearms licence fees, international passport fees, court fines, Road Safety Commission fines etc.
7. Other sources, e.g. tolls, rates etc.

What is government expenditure?

Government expenditure is the total expense incurred by public authorities at all levels of administration in the country. It includes money spent by the government on building roads, bridges, schools, hospitals, corporations and other permanent investments.

Classification of public expenditure

Government expenditure can be classified as:

1. Recurrent expenditure: These are expenditures incurred in running the day-to-day activities of the government. They recur within a fiscal year, i.e. they are items or expenses that last for less than a year, e.g. wages, salaries, stationery, fuel for official cars, cost of maintaining roads, repair expenses on dams etc.
2. Capital expenditure: These are expenditures (investments) on projects that last for more than one year. They are used to acquire permanent assets, e.g. construction of roads, bridges and government buildings, and purchase of cars. In most cases, recurrent expenditure is spent on maintaining capital projects.

Objectives of government expenditure

The main items of government expenditure are meant to achieve the following objectives:

1. Defence or national security: The government provides for the Army, Air Force, Navy and the Police to maintain law and order and defend the country from external aggression.
2. General administration: The government spends money on maintaining the Civil Service and the various officers of the government in the ministries, agencies, corporations, parastatals and departments.
3. Providing social amenities: The government spends money to provide educational facilities, pipe-borne water, roads, bridges, ports, telecommunication, power and electricity etc.
4. Servicing national debt: The government spends money on the repayment of the principal and interest of both internal and external debts, including payment of pensions.
5. Direct productive service: The government sometimes participates directly by organising the production of some commodities to promote economic activities and services.

Reasons for the increase in government expenditure

Government expenditure has increased greatly. Some of the reasons are:

1. Population explosion: An increase in population leads to higher administration costs.
2. Inflation: Inflation (a general increase in the price level) raises the cost of projects undertaken by the government.
3. Devaluation: The devaluation (depreciation) of the naira leads to high expenditure because the Nigerian economy is largely import-dependent.
4. Administrative cost: The cost of maintaining democratic institutions and a large number of political structures, i.e. states, local governments and their officials, keeps increasing.
5. Social amenities: There is greater demand for social and economic infrastructure, and a cost of maintaining existing ones.
6. Economic development: The government’s economic development programme requires a lot of capital outlay to import the needed equipment and machines.
7. Rise in national debts: The cost of servicing the country’s huge stock of internal and external debt has kept increasing because of interest capitalisation.
8. Bribery and corruption: Corruption is highly prevalent, and government officials and politicians over-invoice the cost of projects.
9. Defence and security expenses: Higher spending on defence and security increases government expenditure.
10. Unemployment: Attempts by the government to combat unemployment also increase government expenditure.
11. Poverty: Efforts by the government to alleviate poverty often lead to high expenditure.

Effects of public expenditure

1. Some government expenditures help to redistribute the income of the people.
2. Government expenditure on industrial investment helps to generate employment for people.
3. Government expenditure helps to allocate certain resources to certain areas, which enhances the even distribution of resources.
4. Government expenditure helps to stabilise the prices of goods and services.
5. Government expenditure in industries helps to increase productivity and income for individuals, with a rise in their purchasing power.

Evaluation

1. Define public finance.
2. What is fiscal policy?
3. List four sources of government revenue.
4. Distinguish between recurrent expenditure and capital expenditure, giving two examples of each.
5. State four reasons for the increase in government expenditure.

Assignment

1. Which of the following is not an item of capital expenditure?
   (a) Building of dams (b) Supply of electricity (c) Payment of interest on loans (d) Building of harbours.
2. Public expenditure on education and health is known as the expenditure of
   (a) general services (b) social services (c) commercial services (d) economic services.
3. Which of the following is an item of recurrent expenditure?
   (a) Construction of highways (b) Building of dams (c) Payment of salaries and wages (d) Building of a new university.
4. Which of the following items cannot be classified as essential government expenditure?
   (a) Construction of roads (b) Servicing of external debts (c) Maintenance of public hospitals (d) Importation of luxury consumer goods.
5. Which policy is used to adjust government revenue and expenditure to produce a desirable effect on the economy?
   (a) monetary (b) business (c) physical (d) fiscal.