Public Finance 1

Public finance

refers to the activities carried out by the government associated with raising of finances and the spending of the finances raised (it is the study of how government collects revenue and how it spends it)

The components of public finance are;

i. Public revenue

ii. Public expenditure

iii. Public debt

i. Public revenue

refers to the revenues (income) and resources
received by the government from different sources.

ii. Public expenditure

refers to the resources spent by the government.

iii. Public debt-refers to the money and resources borrowed by the government.

Purpose of public finance

i. Provision of essential goods and services.

The government has a responsibility of providing its citizens with essential goods and services such as security,health,schools,drought control, law e.t.c such facilities and services may not be adequately covered by the private sector because of the high costs involved and risks.

ii. Encouraging consumption of certain commodities

The government may encourage consumption of certain commodities e.g. maize by subsidizing on their productions or lowering their taxes.

iii. Controlling consumption of certain commodities

The government may also encourage consumption of some commodities e.g. cigarettes and alcohol by imposing heavy taxes on them.

iv. Promotion of Balanced regional development

This may be done by initiating economic projects in areas that are under developed/lagging behind.

v. Wealth Redistribution

This is done by heavily taxing the rich and
using the money raised to provide goods and services that benefit the poor

vi. To promote economic stability

Economic instability may be caused by factors such as unemployment. Such problems can be solved through public expenditure in projects that generate employment such as ‘kazi
kwa vijana’

vii. Creation of a conducive Business Environment

Through public expenditure, the government may develop infrastructure such as roads, electricity, security e.t.c thereby creating a conducive environment for businesses to thrive in.

viii. To raise government revenue

Through public finance, the government raises revenue which it uses in provision of essential goods and services to the public.

ix. Improving balance of payment

This may be done by improving heavy taxes such as customs duty to discourage importation.

Sources of public finance

There are two major sources of public finance i.e.

i. Public revenue

ii. Public debt (government borrowing)

i. Public revenue

This is the income that the government gets from its citizens. The main sources of public revenue are:

a. Tax:

This is a compulsory payment levied by the government on individuals and firms without any direct benefit to the payer.

b. Fines and penalties

These are the charges imposed on individuals, firms and corporations who break the laws of the country.(offenders)

c. Fees;

These are the payments charged by the government for the direct services it renders to its people e.g. road licence fee, marriage certificate fee and import licence fee.

d. Rent and rates:

Charged on use of government properties e.g. game parks, forests e.t.c

e. Eschiats:

Income obtained from properties of persons who die without legal heirs or proper wills. Such people’s properties are taken over by the state.

f. Dividends and profits:

These are the income received from the government direct investments e.g. income/surplus from public corporations.

g. Interest from loans

This is the interest on loans advanced by the government to firms and

individuals through its agencies such as ICDc,AFC e.t.c.

h. Proceeds from scale of government property.

g.Public debt (Government borrowing)

This is the money that the government borrows when public revenue is insufficient to meet all its financial obligations.

Government borrowing is also referred to as national debt.

It includes all outstanding borrowing by the central government, local authorities and government corporations.

These are two majorly two sources of public debts:

a. Internal borrowing

b. External borrowing

a. Internal borrowing

This refers to borrowing by government from firms and individuals within the country.

This may be done through:

Open market operation;

The government sells its securities such as treasury bonds and treasury bills.

This however has a disadvantage of causing ‘crowding out effect’ where the government leaves the private investors with little to borrow from.

b. External borrowing

This refers to government borrowing from external sources. It may either be on a bilateral or multilateral basis.

Bilateral borrowing is where the government borrows directly from another country.

Multilateral borrowing

Is where the government borrows from international financial institutions such as international monetary fund (IMF).

World Bank, African Development bank e.t.c.such bodies get finances from various sources which they lend to their member countries who are in need of such funds.
Generally, external borrowing has strings attached.

The borrowing country is expected to meet some set conditions, sometimes adversely affecting some sectors of the economy.

The total internal borrowing (internal debt) added to the total external borrowing (external debt) constitutes the national debt.

Classes of public (National debt)

These are two classes of national debt:

i. Reproductive debt

ii. Dead-weight debt.

i. Reproductive debt

This is borrowed money used to finance project(s) that can generate revenue.

Such projects, once started may become self sustaining and may contribute towards servicing/repaying the debt. E.g. money used to finance irrigation schemes, electricity production e.t.c.

ii. Dead-weight debt

This is borrowed money that is used to finance activities that do not generate any revenue.

Examples are money used to finance recurrent expenditure e.g. payment of salaries or for famine relief e.t.c.

Dead-weight debt is a burden to members of the public since they are the ones who are expected to contribute towards its repayment.

Factors to consider before the government decides whether to borrow

internally or externally

This refers to how the government spends the finances it has raised on behalf of its citizens.

Categories of government expenditure

a) Recurrent expenditure

b) Development expenditure

c) Transfer payments.

a. Recurrent expenditure

This refers to government spending that takes place regularly e.g. payments of salaries to civil servants, fuelling of government vehicles e.g.

Every financial year, the government must allocate funds to meet such expenditure.Recurrent expenditure is also known as consumption expenditure.

b. Development expenditure

This is also referred to as capital expenditure .It is government spending on projects that facilitate economic development.

Such projects includes construction of railway lines, roads, airports, rural electrification e.t.c
Once completed expenditure on such projects ceases and may only require maintenance.

c. Transfer payments

This is expenditure on things/people who do not directly contribute to a country’s national income.

Such expenditure include money spent on famine relief, pension, bursaries e.t.c

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