Public finance
Encyclopedia
Public finance is the revenue and expenditure of public authorities
The purview of public finance is considered to be threefold: governmental effects on (1) efficient allocation of resources, (2) distribution of income, and (3) macroeconomic stabilization
.
.
"Market failure
" occurs when private markets do not allocate goods or services efficiently. The existence of market failure provides an efficiency-based rationale for collective or governmental provision of goods and services. Externalities, public good
s, informational advantages, strong economies of scale, and network effects can cause market failures. Public provision via a government or a voluntary association, however, is subject to other inefficiencies, termed "government failure."
Under broad assumptions, government decisions about the efficient scope and level of activities can be efficiently separated from decisions about the design of taxation systems (Diamond-Mirlees separation). In this view, public sector
programs should be designed to maximize social benefits minus costs (cost-benefit analysis), and then revenues needed to pay for those expenditures should be raised through a tax
ation system that creates the fewest efficiency losses caused by distortion of economic activity as possible. In practice, government budgeting or public budgeting
is substantially more complicated and often results in inefficient practices.
Government can pay for spending by borrowing (for example, with government bond
s), although borrowing is a method of distributing tax burdens through time rather than a replacement for taxes. A deficit is the difference between government spending and revenues. The accumulation of deficits over time is the total public debt
. Deficit finance allows governments to smooth tax burdens over time, and gives governments an important fiscal policy
tool. Deficits can also narrow the options of successor governments.
Public finance is closely connected to issues of income distribution
and social equity. Governments can reallocate income through transfer payments or by designing tax systems that treat high-income and low-income households differently.
The Public Choice approach to public finance seeks to explain how self-interested voters, politicians, and bureaucrats actually operate, rather than how they should operate.
Public Finance Management (PFM) basically deals with all aspects of resource mobilization and expenditure management in government. Just as managing finances is a critical function of management in any organization, similarly public finance management is an essential part of the governance process. Public finance management includes resource mobilization, prioritization of programmes, the budgetary process, efficient management of resources and exercising controls. Rising aspirations of people are placing more demands on financial resources. At the same time, the emphasis of the citizenry is on value for money, thus making public finance management increasingly vital.
s.
or a functional equivalent of a state (for example, tribe
s, secessionist movements or revolutionary
movements) for the purpose of producing value
for the citizens. Government operations have the power to make, and the authority to enforce rules and laws within a civil, corporate
, religious, academic, or other organization
or group. In its broadest sense, "to govern" means to rule over or supervise, whether over a state, a set group of people, or a collection of people.
Government expenditures are financed in two ways:
How a government chooses to finance its activities can have important effects on the distribution of income and wealth (income redistribution) and on the efficiency of markets (effect of taxes on market prices and efficiency
). The issue of how taxes affect income distribution is closely related to tax incidence
, which examines the distribution of tax burdens after market adjustments are taken into account. Public finance research also analyzes effects of the various types of taxes and types of borrowing as well as administrative concerns, such as tax enforcement.
A tax is a financial charge or other levy
imposed on an individual or a legal entity by a state
or a functional equivalent of a state (for example, tribe
s, secessionist movements or revolutionary
movements). Taxes could also be imposed by a subnational entity. Taxes consist of direct tax
or indirect tax
, and may be paid in money
or as corvée
labor. A tax may be defined as a "pecuniary burden laid upon individuals or property to support the government [ . . .] a payment exacted by legislative authority." A tax "is not a voluntary payment or donation, but an enforced contribution, exacted pursuant to legislative authority" and is "any contribution imposed by government [ . . .] whether under the name of toll, tribute, tallage, gabel, impost, duty, custom, excise, subsidy, aid, supply, or other name."
s, issue bonds
and make financial investments. Government debt (also known as public debt or national debt) is money
(or credit
) owed by any level of government
; either central or federal government
, municipal government or local government
. Some local governments issue bonds based on their taxing authority, such as tax increment bond
s or revenue bond
s.
As the government represents the people, government debt can be seen as an indirect debt of the tax
payers. Government debt can be categorized as internal debt
, owed to lenders within the country, and external debt
, owed to foreign lenders. Governments usually borrow by issuing securities
such as government bond
s and bills. Less creditworthy countries sometimes borrow directly from commercial bank
s or international institutions such as the International Monetary Fund or the World Bank.
Most government budgets are calculated on a cash basis, meaning that revenues are recognized when collected and outlays are recognized when paid. Some consider all government liabilities, including future pension
payments and payments for goods and services the government has contracted for but not yet paid, as government debt. This approach is called accrual accounting, meaning that obligations are recognized when they are acquired, or accrued, rather than when they are paid.
derived from the issuing of currency
. It arises from the difference between the face value
of a coin
or bank note and the cost of producing, distributing and eventually retiring it from circulation. Seigniorage is an important source of revenue for some national banks
, although it provides a very small proportion of revenue for advanced industrial countries.
In market-oriented economies with substantial state enterprise, such as in Venezuela, the state-run oil company PSDVA provides revenue for the government to fund its operations and programs that would otherwise be profit for private owners. In various mixed economies, the revenue generated by state-run or state-owned enterprises are used for various state endeavors; typically the revenue generated by state and government agencies goes into a sovereign wealth fund
. An example of this is the Alaska Permanent Fund
and Singapore's Temasek Holdings
.
Various market socialist systems or proposals utilize revenue generated by state-run enterprises to fund social dividends, eliminating the need for taxation altogether.
The GFSM 2001 addresses the institutional complexity of government by defining various levels of government. The main focus of the GFSM 2001 is the general government sector defined as the group of entities capable of implementing public policy through the provision of primarily nonmarket goods and services and the redistribution of income and wealth, with both activities supported mainly by compulsory levies on other sectors. The GFSM 2001 disaggregates the general government into subsectors: central government, state government, and local government (See Figure 1). The concept of general government does not include public corporations
. The general government plus the public corporations comprise the public sector (See Figure 2).
The GFSM 2001 framework is similar to the financial accounting of businesses. For example, it recommends that governments produce a full set of financial statements including the statement of government operations (akin to the income statement
), the balance sheet
, and a cash flow statement
. Two other similarities between the GFSM 2001 and business financial accounting are the recommended use of accrual accounting
as the basis of recording and the presentations of stocks of assets and liabilities at market value
. It is an improvement on the prior methodology - Government Finance Statistics Manual 1986 – based on cash flows and without a balance sheet statement.
Government finance statistics should offer data for topics such as the fiscal architecture, the measurement of the efficiency and effectiveness of government expenditures, the economics of taxation, and the structure of public financing. The GFSM 2001 provides a blueprint for the compilation, recording, and presentation of revenues, expenditures, stocks of assets, and stocks of liabilities. The GFSM 2001 also defines some indicators of effectiveness in government’s expenditures, for example the compensation of employees as a percentage of expense. The GFSM 2001 includes a functional classification of expense as defined by the Classification of Functions of Government (COFOG) .
This functional classification allows policy makers to analyze expenditures on categories such as health, education, social protection, and environmental protection.
The financial statements can provide investors with the necessary information to assess the capacity of a government to service and repay its debt, a key element determining sovereign risk, and risk premia. Like the risk of default of a private corporation, sovereign risk is a function of the level of debt, its ratio to liquid assets, revenues and expenditures, the expected growth and volatility of these revenues and expenditures, and the cost of servicing the debt. The government’s financial statements contain the relevant information for this analysis.
The government’s balance sheet presents the level of the debt; that is the government’s liabilities. The memorandum items of the balance sheet provide additional information on the debt including its maturity and whether it is owed to domestic or external residents. The balance sheet also presents a disaggregated classification of financial and non-financial assets.
These data help estimate the resources a government can potentially access to repay its debt. The statement of operations (“income statement”) contains the revenue and expense accounts of the government. The revenue accounts are divided into subaccounts, including the different types of taxes, social contributions, dividends from the public sector, and royalties from natural resources. Finally, the interest expense account is one of the necessary inputs to estimate the cost of servicing the debt.
The purview of public finance is considered to be threefold: governmental effects on (1) efficient allocation of resources, (2) distribution of income, and (3) macroeconomic stabilization
Macroeconomics
Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...
.
Overview
The proper role of government provides a starting point for the analysis of public finance. In theory, under certain circumstances private markets will allocate goods and services among individuals efficiently (in the sense that no waste occurs and that individual tastes are matching with the economy's productive abilities). If private markets were able to provide efficient outcomes and if the distribution of income were socially acceptable, then there would be little or no scope for government. In many cases, however, conditions for private market efficiency are violated. For example, if many people can enjoy the same good at the same time (non-rival, non-excludable consumption), then private markets may supply too little of that good. National defense is one example of non-rival consumption, or of a public goodPublic good
In economics, a public good is a good that is non-rival and non-excludable. Non-rivalry means that consumption of the good by one individual does not reduce availability of the good for consumption by others; and non-excludability means that no one can be effectively excluded from using the good...
.
"Market failure
Market failure
Market failure is a concept within economic theory wherein the allocation of goods and services by a free market is not efficient. That is, there exists another conceivable outcome where a market participant may be made better-off without making someone else worse-off...
" occurs when private markets do not allocate goods or services efficiently. The existence of market failure provides an efficiency-based rationale for collective or governmental provision of goods and services. Externalities, public good
Public good
In economics, a public good is a good that is non-rival and non-excludable. Non-rivalry means that consumption of the good by one individual does not reduce availability of the good for consumption by others; and non-excludability means that no one can be effectively excluded from using the good...
s, informational advantages, strong economies of scale, and network effects can cause market failures. Public provision via a government or a voluntary association, however, is subject to other inefficiencies, termed "government failure."
Under broad assumptions, government decisions about the efficient scope and level of activities can be efficiently separated from decisions about the design of taxation systems (Diamond-Mirlees separation). In this view, public sector
Public sector
The public sector, sometimes referred to as the state sector, is a part of the state that deals with either the production, delivery and allocation of goods and services by and for the government or its citizens, whether national, regional or local/municipal.Examples of public sector activity range...
programs should be designed to maximize social benefits minus costs (cost-benefit analysis), and then revenues needed to pay for those expenditures should be raised through a tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
ation system that creates the fewest efficiency losses caused by distortion of economic activity as possible. In practice, government budgeting or public budgeting
Public budgeting
Public Budgeting is a field of Public Administration and a discipline in the academic study thereof. Budgeting is characterized by its approaches, functions, formation, and type....
is substantially more complicated and often results in inefficient practices.
Government can pay for spending by borrowing (for example, with government bond
Government bond
A government bond is a bond issued by a national government denominated in the country's own currency. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country...
s), although borrowing is a method of distributing tax burdens through time rather than a replacement for taxes. A deficit is the difference between government spending and revenues. The accumulation of deficits over time is the total public debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
. Deficit finance allows governments to smooth tax burdens over time, and gives governments an important fiscal policy
Fiscal policy
In economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....
tool. Deficits can also narrow the options of successor governments.
Public finance is closely connected to issues of income distribution
Income distribution
In economics, income distribution is how a nation’s total economy is distributed amongst its population.Income distribution has always been a central concern of economic theory and economic policy...
and social equity. Governments can reallocate income through transfer payments or by designing tax systems that treat high-income and low-income households differently.
The Public Choice approach to public finance seeks to explain how self-interested voters, politicians, and bureaucrats actually operate, rather than how they should operate.
Public finance management
Collection of sufficient resources from the economy in an appropriate manner along with allocating and use of these resources efficiently and effectively constitute good financial management. Resource generation, resource allocation and expenditure management (resource utilization) are the essential components of a public financial management system.Public Finance Management (PFM) basically deals with all aspects of resource mobilization and expenditure management in government. Just as managing finances is a critical function of management in any organization, similarly public finance management is an essential part of the governance process. Public finance management includes resource mobilization, prioritization of programmes, the budgetary process, efficient management of resources and exercising controls. Rising aspirations of people are placing more demands on financial resources. At the same time, the emphasis of the citizenry is on value for money, thus making public finance management increasingly vital.
Government expenditures
Economists classify government expenditures into three main types. Government purchases of goods and services for current use are classed as government consumption. Government purchases of goods and services intended to create future benefits--- such as infrastructure investment or research spending--- are classed as government investment. Government expenditures that are not purchases of goods and services, and instead just represent transfers of money--- such as social security payments--- are called transfer paymentTransfer payment
In economics, a transfer payment is a redistribution of income in the market system. These payments are considered to be exhaustive because they do not directly absorb resources or create output...
s.
Government operations
Government operations are those activities involved in the running of a stateState (polity)
A state is an organized political community, living under a government. States may be sovereign and may enjoy a monopoly on the legal initiation of force and are not dependent on, or subject to any other power or state. Many states are federated states which participate in a federal union...
or a functional equivalent of a state (for example, tribe
Tribe
A tribe, viewed historically or developmentally, consists of a social group existing before the development of, or outside of, states.Many anthropologists use the term tribal society to refer to societies organized largely on the basis of kinship, especially corporate descent groups .Some theorists...
s, secessionist movements or revolutionary
Revolutionary
A revolutionary is a person who either actively participates in, or advocates revolution. Also, when used as an adjective, the term revolutionary refers to something that has a major, sudden impact on society or on some aspect of human endeavor.-Definition:...
movements) for the purpose of producing value
Value (economics)
An economic value is the worth of a good or service as determined by the market.The economic value of a good or service has puzzled economists since the beginning of the discipline. First, economists tried to estimate the value of a good to an individual alone, and extend that definition to goods...
for the citizens. Government operations have the power to make, and the authority to enforce rules and laws within a civil, corporate
Corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...
, religious, academic, or other organization
Organization
An organization is a social group which distributes tasks for a collective goal. The word itself is derived from the Greek word organon, itself derived from the better-known word ergon - as we know `organ` - and it means a compartment for a particular job.There are a variety of legal types of...
or group. In its broadest sense, "to govern" means to rule over or supervise, whether over a state, a set group of people, or a collection of people.
Income distribution
- Income distributionIncome distributionIn economics, income distribution is how a nation’s total economy is distributed amongst its population.Income distribution has always been a central concern of economic theory and economic policy...
- Some forms of government expenditure are specifically intended to transferTransfer paymentIn economics, a transfer payment is a redistribution of income in the market system. These payments are considered to be exhaustive because they do not directly absorb resources or create output...
income from some groups to others. For example, governments sometimes transfer income to people that have suffered a loss due to natural disaster. Likewise, public pensionPensionIn general, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment. Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum.The terms retirement...
programs transfer wealth from the young to the old. Other forms of government expenditure which represent purchases of goods and services also have the effect of changing the income distribution. For example, engaging in a warWarWar is a state of organized, armed, and often prolonged conflict carried on between states, nations, or other parties typified by extreme aggression, social disruption, and usually high mortality. War should be understood as an actual, intentional and widespread armed conflict between political...
may transfer wealth to certain sectors of society. Public educationPublic educationState schools, also known in the United States and Canada as public schools,In much of the Commonwealth, including Australia, New Zealand, South Africa, and the United Kingdom, the terms 'public education', 'public school' and 'independent school' are used for private schools, that is, schools...
transfers wealth to families with children in these schools. Public road construction transfers wealth from people that do not use the roads to those people that do (and to those that build the roads). - Income SecuritySocial securitySocial security is primarily a social insurance program providing social protection or protection against socially recognized conditions, including poverty, old age, disability, unemployment and others. Social security may refer to:...
- Employment insurance
- Health CareHealth careHealth care is the diagnosis, treatment, and prevention of disease, illness, injury, and other physical and mental impairments in humans. Health care is delivered by practitioners in medicine, chiropractic, dentistry, nursing, pharmacy, allied health, and other care providers...
- Public financing of campaigns
Financing of government expenditures
Government expenditures are financed in two ways:
- Government revenueGovernment revenueGovernment revenue is revenue received by a government. Its opposite is government spending. Government revenue is an important part of fiscal policy....
- TaxTaxTo tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
es - Non-tax revenueNon-tax revenueNon-tax revenue or non-tax receipts are government revenue not generated from taxes. Examples include:* Aid from another level of government - for example, in the United States, federal grants may be considered non-tax revenue to the receiving states, and equalization payments* Aid from abroad *...
(revenue from government-owned corporationGovernment-owned corporationA government-owned corporation, state-owned company, state-owned entity, state enterprise, publicly owned corporation, government business enterprise, or parastatal is a legal entity created by a government to undertake commercial activities on behalf of an owner government...
s, sovereign wealth fundSovereign wealth fundA sovereign wealth fund is a state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other financial instruments. Sovereign wealth funds invest globally. Some of them have grabbed attention making bad investments in several Wall Street financial...
s, sales of assets, or SeigniorageSeigniorageSeigniorage can have the following two meanings:* Seigniorage derived from specie—metal coins, is a tax, added to the total price of a coin , that a customer of the mint had to pay to the mint, and that was sent to the sovereign of the political area.* Seigniorage derived from notes is more...
)
- Tax
- Government borrowingGovernment debtGovernment debt is money owed by a central government. In the US, "government debt" may also refer to the debt of a municipal or local government...
How a government chooses to finance its activities can have important effects on the distribution of income and wealth (income redistribution) and on the efficiency of markets (effect of taxes on market prices and efficiency
Effect of taxes and subsidies on price
Taxes and subsidies change the price of goods and, as a result, the quantity consumed.- Tax impact :A marginal tax on the sellers of a good will shift the supply curve to the left until the vertical distance between the two supply curves is equal to the per unit tax; when other things remain equal,...
). The issue of how taxes affect income distribution is closely related to tax incidence
Tax incidence
In economics, tax incidence is the analysis of the effect of a particular tax on the distribution of economic welfare. Tax incidence is said to "fall" upon the group that, at the end of the day, bears the burden of the tax...
, which examines the distribution of tax burdens after market adjustments are taken into account. Public finance research also analyzes effects of the various types of taxes and types of borrowing as well as administrative concerns, such as tax enforcement.
Taxes
Taxation is the central part of modern public finance. Its significance arises not only from the fact that it is by far the most important of all revenues but also because of the gravity of the problems created by the present day heavy tax burden. The main objective of taxation is raising revenue. A high level of taxation is necessary in a welfare State to fulfill its obligations. Taxation is used as an instrument of attaining certain social objectives i.e. as a means of redistribution of wealth and thereby reducing inequalities. Taxation in a modern Government is thus needed not merely to raise the revenue required to meet its ever-growing expenditure on administration and social services but also to reduce the inequalities of income and wealth. Taxation is also needed to draw away money that would otherwise go into consumption and cause inflation to rise.A tax is a financial charge or other levy
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
imposed on an individual or a legal entity by a state
State (polity)
A state is an organized political community, living under a government. States may be sovereign and may enjoy a monopoly on the legal initiation of force and are not dependent on, or subject to any other power or state. Many states are federated states which participate in a federal union...
or a functional equivalent of a state (for example, tribe
Tribe
A tribe, viewed historically or developmentally, consists of a social group existing before the development of, or outside of, states.Many anthropologists use the term tribal society to refer to societies organized largely on the basis of kinship, especially corporate descent groups .Some theorists...
s, secessionist movements or revolutionary
Revolutionary
A revolutionary is a person who either actively participates in, or advocates revolution. Also, when used as an adjective, the term revolutionary refers to something that has a major, sudden impact on society or on some aspect of human endeavor.-Definition:...
movements). Taxes could also be imposed by a subnational entity. Taxes consist of direct tax
Direct tax
The term direct tax generally means a tax paid directly to the government by the persons on whom it is imposed.-General meaning:In the general sense, a direct tax is one paid directly to the government by the persons on whom it is imposed...
or indirect tax
Indirect tax
The term indirect tax has more than one meaning.In the colloquial sense, an indirect tax is a tax collected by an intermediary from the person who bears the ultimate economic burden of the tax...
, and may be paid in money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
or as corvée
Corvée
Corvée is unfree labour, often unpaid, that is required of people of lower social standing and imposed on them by the state or a superior . The corvée was the earliest and most widespread form of taxation, which can be traced back to the beginning of civilization...
labor. A tax may be defined as a "pecuniary burden laid upon individuals or property to support the government [ . . .] a payment exacted by legislative authority." A tax "is not a voluntary payment or donation, but an enforced contribution, exacted pursuant to legislative authority" and is "any contribution imposed by government [ . . .] whether under the name of toll, tribute, tallage, gabel, impost, duty, custom, excise, subsidy, aid, supply, or other name."
- There are various types of taxes, broadly divided into two heads - direct (which is proportional) and indirect tax (which is differential in nature):
- Stamp dutyStamp dutyStamp duty is a tax that is levied on documents. Historically, this included the majority of legal documents such as cheques, receipts, military commissions, marriage licences and land transactions. A physical stamp had to be attached to or impressed upon the document to denote that stamp duty...
, levied on documents - ExciseExciseExcise tax in the United States is a indirect tax on listed items. Excise taxes can be and are made by federal, state and local governments and are far from uniform throughout the United States...
tax (tax levied on production for sale, or sale, of a certain good) - Sales taxSales taxA sales tax is a tax, usually paid by the consumer at the point of purchase, itemized separately from the base price, for certain goods and services. The tax amount is usually calculated by applying a percentage rate to the taxable price of a sale....
(tax on business transactions, especially the saleSalesA sale is the act of selling a product or service in return for money or other compensation. It is an act of completion of a commercial activity....
of goods and servicesGoods and servicesIn economics, economic output is divided into physical goods and intangible services. Consumption of goods and services is assumed to produce utility. It is often used when referring to a Goods and Services Tax....
)- Value added taxValue added taxA value added tax or value-added tax is a form of consumption tax. From the perspective of the buyer, it is a tax on the purchase price. From that of the seller, it is a tax only on the "value added" to a product, material or service, from an accounting point of view, by this stage of its...
(VAT) is a type of sales tax - Services taxes on specific services
- Value added tax
- Road taxRoad taxRoad tax, known by various names around the world, is a tax which has to be paid on a motor vehicle before using it on a public road.-Australia:...
; Vehicle excise dutyVehicle excise dutyVehicle Excise Duty is a vehicle road use tax levied as an excise duty which must be paid for most types of vehicle which are to be used on the public roads in the United Kingdom...
(UK), Registration Fee (USA), Regco (Australia), Vehicle Licensing Fee (Brazil) etc. - Gift taxGift taxA gift tax is a tax imposed on the gratuitous transfer of ownership of property. The United States Internal Revenue Service says a gift is "Any transfer to an individual, either directly or indirectly, where full consideration is not received in return."When a taxable gift in the form of cash,...
- DutiesDuty (economics)In economics, a duty is a kind of tax, often associated with customs, a payment due to the revenue of a state, levied by force of law. It is a tax on certain items purchased abroad...
(taxes on importation, levied at customsCustomsCustoms is an authority or agency in a country responsible for collecting and safeguarding customs duties and for controlling the flow of goods including animals, transports, personal effects and hazardous items in and out of a country...
) - Corporate income tax on corporations (incorporatedIncorporation (business)Incorporation is the forming of a new corporation . The corporation may be a business, a non-profit organisation, sports club, or a government of a new city or town...
entities) - Wealth taxWealth taxA wealth tax is generally conceived of as a levy based on the aggregate value of all household holdings actually accumulated as purchasing power stock , including owner-occupied housing; cash, bank deposits, money funds, and savings in insurance and pension plans; investment in real estate and...
- Personal income tax (may be levied on individuals, families such as the Hindu joint familyHindu joint familyA Hindu Joint Family or Joint Family is an extended family arrangement prevalent among Hindus of the Indian subcontinent, consisting of many generations living under the same roof. All the male members are blood relatives and all the women are either mothers, wives, unmarried daughters, or widowed...
in India, unincorporated associationsVoluntary associationA voluntary association or union is a group of individuals who enter into an agreement as volunteers to form a body to accomplish a purpose.Strictly speaking, in many jurisdictions no formalities are necessary to start an association...
, etc.)
Debt
Governments, like any other legal entity, can take out loanLoan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
s, issue bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
and make financial investments. Government debt (also known as public debt or national debt) is money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
(or credit
Credit (finance)
Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...
) owed by any level of government
Government
Government refers to the legislators, administrators, and arbitrators in the administrative bureaucracy who control a state at a given time, and to the system of government by which they are organized...
; either central or federal government
Central government
A central government also known as a national government, union government and in federal states, the federal government, is the government at the level of the nation-state. The structure of central governments varies from institution to institution...
, municipal government or local government
Local government
Local government refers collectively to administrative authorities over areas that are smaller than a state.The term is used to contrast with offices at nation-state level, which are referred to as the central government, national government, or federal government...
. Some local governments issue bonds based on their taxing authority, such as tax increment bond
Tax increment financing
Tax Increment Financing, or TIF, is a public financing method which has been used as a subsidy for redevelopment and community improvement projects in many countries including the United States for more than 50 years...
s or revenue bond
Revenue bond
A revenue bond is a special type of municipal bond distinguished by its guarantee of repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds, rather than from a tax...
s.
As the government represents the people, government debt can be seen as an indirect debt of the tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
payers. Government debt can be categorized as internal debt
Internal debt
Internal debt is the part of the total debt in a country that is owed to lenders within the country. Internal debt's complement is external debt....
, owed to lenders within the country, and external debt
External debt
External debt is that part of the total debt in a country that is owed to creditors outside the country. The debtors can be the government, corporations or private households. The debt includes money owed to private commercial banks, other governments, or international financial institutions such...
, owed to foreign lenders. Governments usually borrow by issuing securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
such as government bond
Government bond
A government bond is a bond issued by a national government denominated in the country's own currency. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country...
s and bills. Less creditworthy countries sometimes borrow directly from commercial bank
Commercial bank
After the implementation of the Glass–Steagall Act, the U.S. Congress required that banks engage only in banking activities, whereas investment banks were limited to capital market activities. As the two no longer have to be under separate ownership under U.S...
s or international institutions such as the International Monetary Fund or the World Bank.
Most government budgets are calculated on a cash basis, meaning that revenues are recognized when collected and outlays are recognized when paid. Some consider all government liabilities, including future pension
Pension
In general, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment. Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum.The terms retirement...
payments and payments for goods and services the government has contracted for but not yet paid, as government debt. This approach is called accrual accounting, meaning that obligations are recognized when they are acquired, or accrued, rather than when they are paid.
Seigniorage
Seigniorage is the net revenueRevenue
In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover....
derived from the issuing of currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
. It arises from the difference between the face value
Face value
The Face value is the value of a coin, stamp or paper money, as printed on the coin, stamp or bill itself by the minting authority. While the face value usually refers to the true value of the coin, stamp or bill in question it can sometimes be largely symbolic, as is often the case with bullion...
of a coin
Coin
A coin is a piece of hard material that is standardized in weight, is produced in large quantities in order to facilitate trade, and primarily can be used as a legal tender token for commerce in the designated country, region, or territory....
or bank note and the cost of producing, distributing and eventually retiring it from circulation. Seigniorage is an important source of revenue for some national banks
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
, although it provides a very small proportion of revenue for advanced industrial countries.
Public finance through state enterprise
Public finance in centrally planned economies has differed in fundamental ways from that in market economies. Some state-owned enterprises generated profits that helped finance government activities. The government entities that operate for profit are usually manufacturing and financial institutions, services such as nationalized healthcare do not operate for a profit to keep costs low for consumers. The Soviet Union relied heavily on turnover taxes on retail sales. Sales of natural resources, and especially petroleum products, were an important source of revenue for the Soviet Union.In market-oriented economies with substantial state enterprise, such as in Venezuela, the state-run oil company PSDVA provides revenue for the government to fund its operations and programs that would otherwise be profit for private owners. In various mixed economies, the revenue generated by state-run or state-owned enterprises are used for various state endeavors; typically the revenue generated by state and government agencies goes into a sovereign wealth fund
Sovereign wealth fund
A sovereign wealth fund is a state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other financial instruments. Sovereign wealth funds invest globally. Some of them have grabbed attention making bad investments in several Wall Street financial...
. An example of this is the Alaska Permanent Fund
Alaska Permanent Fund
The Alaska Permanent Fund is a constitutionally established permanent fund, managed by a semi-independent corporation, established by Alaska in 1976, primarily by the efforts of then Governor Jay Hammond...
and Singapore's Temasek Holdings
Temasek Holdings
Temasek Holdings is an investment company owned by the government of Singapore. With an international staff of 380 people, it manages a portfolio of about S$193 billion at end of March 2011, focused primarily in Asia...
.
Various market socialist systems or proposals utilize revenue generated by state-run enterprises to fund social dividends, eliminating the need for taxation altogether.
Government Finance Statistics and Methodology
Macroeconomic data to support public finance economics are generally referred to as fiscal or government finance statistics (GFS). The Government Finance Statistics Manual 2001 (GFSM 2001) is the internationally accepted methodology for compiling fiscal data. It is consistent with regionally accepted methodologies such as the European System of Accounts 1995 and consistent with the methodology of the System of National Accounts (SNA1993) and broadly in line with its most recent update, the SNA2008.Challenges in measuring government
The size of governments, their institutional composition and complexity, their ability to carry out large and sophisticated operations, and their impact on the other sectors of the economy warrant a well-articulated system to measure government economic operations.The GFSM 2001 addresses the institutional complexity of government by defining various levels of government. The main focus of the GFSM 2001 is the general government sector defined as the group of entities capable of implementing public policy through the provision of primarily nonmarket goods and services and the redistribution of income and wealth, with both activities supported mainly by compulsory levies on other sectors. The GFSM 2001 disaggregates the general government into subsectors: central government, state government, and local government (See Figure 1). The concept of general government does not include public corporations
Government-owned corporation
A government-owned corporation, state-owned company, state-owned entity, state enterprise, publicly owned corporation, government business enterprise, or parastatal is a legal entity created by a government to undertake commercial activities on behalf of an owner government...
. The general government plus the public corporations comprise the public sector (See Figure 2).
The GFSM 2001 framework is similar to the financial accounting of businesses. For example, it recommends that governments produce a full set of financial statements including the statement of government operations (akin to the income statement
Income statement
Income statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...
), the balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
, and a cash flow statement
Cash flow statement
In financial accounting, a cash flow statement, also known as statement of cash flows or funds flow statement, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing...
. Two other similarities between the GFSM 2001 and business financial accounting are the recommended use of accrual accounting
Comparison of Cash Method and Accrual Method of accounting
The two primary accounting methods of the cash and the accruals basis are used to calculate US public debt, as well as taxable income for U.S. federal income taxes and other income taxes...
as the basis of recording and the presentations of stocks of assets and liabilities at market value
Market value
Market value is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with open market value, fair value or fair market value, although these terms have distinct definitions in different standards, and may differ in some...
. It is an improvement on the prior methodology - Government Finance Statistics Manual 1986 – based on cash flows and without a balance sheet statement.
Users of GFS
The GFSM 2001 recommends standard tables including standard fiscal indicators that meet a broad group of users including policy makers, researchers, and investors in sovereign debt.Government finance statistics should offer data for topics such as the fiscal architecture, the measurement of the efficiency and effectiveness of government expenditures, the economics of taxation, and the structure of public financing. The GFSM 2001 provides a blueprint for the compilation, recording, and presentation of revenues, expenditures, stocks of assets, and stocks of liabilities. The GFSM 2001 also defines some indicators of effectiveness in government’s expenditures, for example the compensation of employees as a percentage of expense. The GFSM 2001 includes a functional classification of expense as defined by the Classification of Functions of Government (COFOG) .
This functional classification allows policy makers to analyze expenditures on categories such as health, education, social protection, and environmental protection.
The financial statements can provide investors with the necessary information to assess the capacity of a government to service and repay its debt, a key element determining sovereign risk, and risk premia. Like the risk of default of a private corporation, sovereign risk is a function of the level of debt, its ratio to liquid assets, revenues and expenditures, the expected growth and volatility of these revenues and expenditures, and the cost of servicing the debt. The government’s financial statements contain the relevant information for this analysis.
The government’s balance sheet presents the level of the debt; that is the government’s liabilities. The memorandum items of the balance sheet provide additional information on the debt including its maturity and whether it is owed to domestic or external residents. The balance sheet also presents a disaggregated classification of financial and non-financial assets.
These data help estimate the resources a government can potentially access to repay its debt. The statement of operations (“income statement”) contains the revenue and expense accounts of the government. The revenue accounts are divided into subaccounts, including the different types of taxes, social contributions, dividends from the public sector, and royalties from natural resources. Finally, the interest expense account is one of the necessary inputs to estimate the cost of servicing the debt.
Fiscal Data Using the GFSM 2001 Methodology
GFS can be accessible through several sources. The International Monetary Fund publishes GFS in two publications: International Financial Statistics and the Government Finance Statistics Yearbook. The World Bank gathers information on external debt. On a regional level, the Organization for Economic Co-operation and Development (OECD) compiles general government account data for its members, and Eurostat, following a methodology compatible with the GFSM 2001, compiles GFS for the members of the European Union.See also
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- Functional financeFunctional financeFunctional finance is an economic theory proposed by Abba P. Lerner, based on effective demand principle and chartalism. It states that government should finance itself to meet explicit goals, such as taming the business cycle, achieving full employment, ensuring growth and low inflation.-...
- Government budgetGovernment budgetA government budget is a legal document that is often passed by the legislature, and approved by the chief executive-or president. For example, only certain types of revenue may be imposed and collected...
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- Harris School of Public Policy StudiesHarris School of Public Policy StudiesThe Irving B. Harris Graduate School of Public Policy Studies is the public policy school of the University of Chicago in Chicago, Illinois, USA. It is one of the top policy schools in the United States. It is located on the University's main campus in Hyde Park...
External links
- Taxation and Public Finance course at the Harris School of Public Policy Studies
- State and Local Public Finance course at the Harris School of Public Policy Studies
- IMF--Dissemination Standards Bulletin Board-- Subscribing ... (see "fiscal sector")
- The IMF's Public Financial Management Blog
- Other Public Financing Resource
- US Debt Clock.org - Real Time U.S. Debt Clock
- Canadian Governments Compared