( 6 ) Basic working principles of public or government finance
Governments spend a lot of taxpayers' money in recurrent expenses as well as capital or infrastructure projects. The government budget is of direct relevance to our financial position and that of society as a whole. Citizens are very often asked to pay their share of these spendings through the increase of personal income tax or other indirect taxes such as sales tax or GST ( goods & services tax ). Incorrect ways of spending public funds will both do great damages to the economy and will result in great injustice.
Just as in accounting there are some basic philosophies involved in this specialised branch of economics. Let us have a brief look a few more important ones. Before doing so, however, we need to learn about some special characteristics of public finance. The concepts of external economies and diseconomies very often come up in connection with government spending because the government is responsible for many branches of social services. Here the terms economies and diseconomies refer to conditions and effects and not systems as such. A particular economic activity is said to produce an external economy when it can create benefits for other people who are not the intended target of that activity. Take the radio air wave for example. If the government sets up a radio station for its military service everyone else can also enjoy its programs without extra costs on the government. Again, if the government constructs a freeway to make it more convenient for citizens in the outlying areas to get into the city the freeway will also benefit those living along its route. The improved convenience will also lead to the increase in the value of properties in its vicinity. These are extra benefits to be reaped by society.
On the other hand, some economic activities can create external diseconomies. For example, an electric power station that runs on coal will give rise to air pollution and will adversely affect the health of citizens living in its vicinity. Besides the moral issue the costs of the resultant long-term health care problems will be ultimately borne by society while the electric company simply makes the profit without bearing the full social costs. Nowadays, social accounting is becoming popular in some countries to find out the ultimate costs of to society. The fundamental lessons to be learned on these special characteristics of public projects are three fold. First, the decision to go ahead with such projects must be based not just on immediate or direct costs and benefits but on all external economies and diseconomies. Secondly, many projects with such special characteristics are very often more suited to public sector management because profit is not the sole consideration for the government. Thirdly, if it is decided that it is more efficient for private corporations to handle such projects strict control must be in place to ensure that costs of external diseconomies if any must be paid for by the private enterprise undertaking the project. Otherwise, corporate greed will again lead to some social costs being passed on by the private enterprise to the taxpayer. However, it must also be borne in mind that others things being equal first consideration should be given to allowing the private sector to take up the project under a market oriented economy to give priority to economic efficiency. The existing size of the public sector must also be considered so as to keep down government's share in the total economy to a reasonable proportion such as below 20 % of GDP ( gross domestic product ).
Very often there is some dilemma facing government in connection with the operation of many public services such as health care and social welfare. How much should the government charge citizens for using such services. If they are completely free then such services may be abused by those who may not really need them. Thus, it will lead to a waste of precious economic resources. On the other hand, if the charges are too expensive it will be unfair to the the underprivileged sector of society who may not be able to afford them thus creating a burden on the poor. Due to the special characteristics of such essential services the strict rules of the price system ( or money vote and by supply and demand ) under capitalism cannot work properly. Here again we encounter situations that cannot be satisfactorily handled by a strict application of the price system ( prices to be determined freely by supply and demand ) which is considered to be a sacred institution under capitalism. So, economists have come up with two useful principles that are quite handy in such tricky situations. They are called the ability to pay and benefits received principles in public finance. These two principles are not mutually exclusive but can be used in a certain mix to achieve the optimum balance on fairness and efficent use of economic resources.
The “ ability to pay “ principle requires that due consideration must be given to any hardship that may affect the user's ability to pay for the essential services while the “ benefits received “ principles specifies that users have the basic obligation to pay for any services they receive unless special circumstances warrant otherwise. Applying the above principles to use of the emergency ward of public hospitals an appropriate way to
The “ ability to pay “ principle requires that due consideration must be given to any hardship that may affect the user's ability to pay for the essential services while the “ benefits received “ principles specifies that users have the basic obligation to pay for any services they receive unless special circumstances warrant otherwise. Applying the above principles to use of the emergency ward of public hospitals an appropriate way to
strike a balance between fairness and efficient use of the emergency facilities would be to charge a fee that will deter non-urgent users ( benefits received principle ) but the charge can be waived by the health authority or borne by the social welfare department in case of citizens already on the welfare system ( ability to pay principle ).
The government's budget can be used very effectively to achieve many economic goals such as creating employment ( through fiscal spending ), redistribution of income on a more equitable basis ( through taxation ), keeping down the inflation rate by a surplus budget ( withdrawing more resources from the economy than putting back into it ) and stimulating consumption in the private sector through a deficit budget ( injecting more into the economy than withdrawing from it ). There is usually no serious problem with a surplus budget except public criticism against the government for not taking better care of the underprivileged sector. However, if a surplus budget is called for to dampen an over heated economy by withdrawing resources from it the foregoing criticism will not stand. On the other hand, there can be a lot of controversey over a deficit budget ( spending more than the amount of revenue raised during a financial year ). This is because a deficit must be properly funded.
There are basically three way of funding a budget deficit. First, the government can simply print more money. This is the worst and most irresponsible way because putting more money into the economy without a corresponding increase in the production of goods and services will simply lead to a higher price inflation which is will lead to hardship for the fixed income earners and reduce the competitive edge of the country as compared to other trading partners. Unfortunately, irresponsible and dictatorial governments such as Zimbabwe are doing exactly that. It had led to a hyper inflation rate of over 231,000,000% in Zimbabwe in July 2008 as compared to the previous year. The same tragic scenario also occurred in Germany after the First World War. The second wayis to raise more taxes which will be a direct burden on the taxpayer and will be unpopular. The third way is to borrow from its citizens and outsiders ( other countries and international corporations ) by issuing government bonds ( national debt ).
There are some particularly tricky problems connected with the question of national debts. First and foremost, borrowing too much will subject the government to the influence of the creditors especially if these are foreign countries or international financing giant corporations. There is always the political consideration that these creditors can put undue pressure on the government to carry out policies to the advantage of the creditors. In extreme cases of excessive national debt the sovereignty of the national may be threatened. In the case of excessive national debt owed to its own citizens there will be a problem of adversely affecting a fair distribution of income. Those citizens who are most likely to buy government bonds are the rich people. Interest payment on bonds will ultimately be financed from taxation. This means that the rich will become richer at the expense of the poor. While only the rich receive interest payment on the government bonds they hold as investment every citizen ( even the less well off ) must be bear the tax burden in respect of that portion raised for the purpose of financing government bond interest payments. The rich are getting richer while the poor have less to spend due to a higher tax burden resulting from the need to pay interest on government bonds.
Then there is the problem with the intergeneration transfer of national debt burden. As many types of government bonds have very long maturity periods this will imply that a substantial amount of money raised by government bonds during the period of their issue will not be due for repayment until becades into thefuture. As mentioned above in section ( 4 ) in connection with the working of the financial market some US treasury bonds have up to 99 years before they are due for repayment. This created the situation of the national debt burden being transferred to future generations while the borrowed funds have been used in the current generation. Therefore, to be fair to future taxpayers long term government bonds should only be issued to finance long term infrastructure capital projects such as roads and bridges which have enduring benefits that will extend to future generations. This is the accounting principle of matching capital expenditure ( capital assets ) with long term loans ( or long term liability ) which is also applicable in social accounting to ensure fairness to all citizens. This treatment also reflects the benefits received principle in public finance. By the same token, short term government bonds should be issued to cover a short fall in revenue in a deficit budget for the increased current expenses of a revenue nature.
The government's budget can be used very effectively to achieve many economic goals such as creating employment ( through fiscal spending ), redistribution of income on a more equitable basis ( through taxation ), keeping down the inflation rate by a surplus budget ( withdrawing more resources from the economy than putting back into it ) and stimulating consumption in the private sector through a deficit budget ( injecting more into the economy than withdrawing from it ). There is usually no serious problem with a surplus budget except public criticism against the government for not taking better care of the underprivileged sector. However, if a surplus budget is called for to dampen an over heated economy by withdrawing resources from it the foregoing criticism will not stand. On the other hand, there can be a lot of controversey over a deficit budget ( spending more than the amount of revenue raised during a financial year ). This is because a deficit must be properly funded.
There are basically three way of funding a budget deficit. First, the government can simply print more money. This is the worst and most irresponsible way because putting more money into the economy without a corresponding increase in the production of goods and services will simply lead to a higher price inflation which is will lead to hardship for the fixed income earners and reduce the competitive edge of the country as compared to other trading partners. Unfortunately, irresponsible and dictatorial governments such as Zimbabwe are doing exactly that. It had led to a hyper inflation rate of over 231,000,000% in Zimbabwe in July 2008 as compared to the previous year. The same tragic scenario also occurred in Germany after the First World War. The second wayis to raise more taxes which will be a direct burden on the taxpayer and will be unpopular. The third way is to borrow from its citizens and outsiders ( other countries and international corporations ) by issuing government bonds ( national debt ).
There are some particularly tricky problems connected with the question of national debts. First and foremost, borrowing too much will subject the government to the influence of the creditors especially if these are foreign countries or international financing giant corporations. There is always the political consideration that these creditors can put undue pressure on the government to carry out policies to the advantage of the creditors. In extreme cases of excessive national debt the sovereignty of the national may be threatened. In the case of excessive national debt owed to its own citizens there will be a problem of adversely affecting a fair distribution of income. Those citizens who are most likely to buy government bonds are the rich people. Interest payment on bonds will ultimately be financed from taxation. This means that the rich will become richer at the expense of the poor. While only the rich receive interest payment on the government bonds they hold as investment every citizen ( even the less well off ) must be bear the tax burden in respect of that portion raised for the purpose of financing government bond interest payments. The rich are getting richer while the poor have less to spend due to a higher tax burden resulting from the need to pay interest on government bonds.
Then there is the problem with the intergeneration transfer of national debt burden. As many types of government bonds have very long maturity periods this will imply that a substantial amount of money raised by government bonds during the period of their issue will not be due for repayment until becades into thefuture. As mentioned above in section ( 4 ) in connection with the working of the financial market some US treasury bonds have up to 99 years before they are due for repayment. This created the situation of the national debt burden being transferred to future generations while the borrowed funds have been used in the current generation. Therefore, to be fair to future taxpayers long term government bonds should only be issued to finance long term infrastructure capital projects such as roads and bridges which have enduring benefits that will extend to future generations. This is the accounting principle of matching capital expenditure ( capital assets ) with long term loans ( or long term liability ) which is also applicable in social accounting to ensure fairness to all citizens. This treatment also reflects the benefits received principle in public finance. By the same token, short term government bonds should be issued to cover a short fall in revenue in a deficit budget for the increased current expenses of a revenue nature.
It will be recalled that there are four major economic goals for the government to achieve. To refresh the readers' memory, these are fullemployment, low flation, healthy economic growth ( i.e. increase in living standards over time ) and a fair distribution of national income ( a major proportion of the population being in the average income and wealth bracket ). There is now an urgent fifth goal of environmental protection. The most ideal conditions for the the economy is full employment with an acceptably low rate of inflation together with a healthy rate of growth, little disparity between the rich and poor plus a good and sustainable environment. Unfortunately, some of these economic objectives are not totally compatible. For example, an increase in fiscal spending can create more employment but it will also lead to a higher rate of inflation. Similarly, to achieve a higher rate of growth in a shorter period of time involves higher levels of spending ( both in the public and private sectors ) that will lead to a higher rate of inflation. Of course, the ideal way to achieve a higher rate of economic growth without too much addiional spending is to increase personal productivity ( working more efficiently ). Then, a more progressive rate of taxation will lead to a more equitable distribution of national income but it may sometimes reduce the incentive for more personal efforts. Political considerations will also come into play. For example, the best way for the world as a whole to achieve the most efficient use of resources is total free trade to promote competition and higher productivity or efficiency. However, tradeunions in many countries where a democratic political system is at work will dictate minimum wage levels and working conditions which can make the work force of that country less competitive. The result is that trade unions in that country will call for more protection ( such as quotas or import tariff ) against cheap labour producer countries. The conflict arises because of different working and remuneration standards between the advanced and developing countries. This is a major problem confronting members of the WTO ( World Trade Organisation ) which was formed to promote free trade on a global basis ( or more popularly known as Globalisation ). A skilful and fine balance must be struck by a capable government to achieve reasonable progress in all five economic goals the latest one of which is environmental protection.
Just one word of reminder regarding government spending in relation to the capitalistic rationale of “ big economy, small government “. In case it is necessary to support a declining economy this can be done fiscally by either increasing public spending or a reduction in taxes. Everything being equal the above capitalistic rationale warrants that cutting taxes should be given priority because the private section is supposed to be more efficient in deciding what to do with the extra money resulting from a tax cut. The public sector, on the other hand, is usually more wasteful because the government does not need to make a profit on its operations. Furthermore, a freedom of choice for the citizens to spend the extra cash from the tax cut in their own chosen way is consistent with the democratic principle.
Having acquainted themselves with the basic working principles of public finance the readers will now be more confident in assessing government policies
Just one word of reminder regarding government spending in relation to the capitalistic rationale of “ big economy, small government “. In case it is necessary to support a declining economy this can be done fiscally by either increasing public spending or a reduction in taxes. Everything being equal the above capitalistic rationale warrants that cutting taxes should be given priority because the private section is supposed to be more efficient in deciding what to do with the extra money resulting from a tax cut. The public sector, on the other hand, is usually more wasteful because the government does not need to make a profit on its operations. Furthermore, a freedom of choice for the citizens to spend the extra cash from the tax cut in their own chosen way is consistent with the democratic principle.
Having acquainted themselves with the basic working principles of public finance the readers will now be more confident in assessing government policies
proposed or taken to combat the the E&F T 2008. Hopefully, everyone will become an informed citizen to have a say in these public policies through the vote which all citizens of a democratic country posses to make a difference towards the recovery process.
The above is an extract from my economic essay which covers all aspects of basic principles in the proper and equitable running of an economy the link to which is set out below :- http://jkhcforum.blogspot.com.au/2013/05/the-2008-economic-financial-tsunami.html
JKHC
http://jkhcforum.blogspot.com.au/2013/05/the-2008-economic-financial-tsunami.html
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