Public Economics: Public Revenue and Expenditure

Meaning of public economics (public finance)

Public economics (traditionally called public finance) is the branch of economics that studies the income and expenditure of public authorities — the central government, state governments (including the Government of Andhra Pradesh) and local bodies — and their effects on the economy. Unlike a private individual, who adjusts spending to income, a government can and often does adjust its revenue (through taxation and borrowing) to match planned expenditure, particularly when the Keynesian objective is to influence the level of aggregate demand.

Sources of public revenue

Public revenue is broadly classified into tax revenue and non-tax revenue.

Tax revenue is compulsory, non-quid-pro-quo payments to the government, and is of two kinds:

• Direct taxes — levied on income or wealth and paid directly by the person on whom they are imposed (e.g. income tax, corporate tax); their burden cannot easily be shifted to someone else.
• Indirect taxes — levied on goods and services and collected through an intermediary, so the burden can be shifted to the final consumer (e.g. Goods and Services Tax, customs duty).

Non-tax revenue includes fees (payment for a specific service rendered, e.g. registration fees), fines and penalties, profits and dividends from public sector undertakings, interest receipts on loans given by the government, and grants-in-aid received from other governments or agencies.

Canons of taxation

Adam Smith, in The Wealth of Nations, laid down four classic canons (principles) of taxation that a good tax system should satisfy:

1. Canon of Equity — the burden of tax should be distributed fairly, broadly in proportion to a person's ability to pay.
2. Canon of Certainty — the tax payer should know with certainty how much, when and in what manner a tax is to be paid; it should not be arbitrary.
3. Canon of Convenience — the tax should be levied and collected in a manner and at a time that is convenient to the tax payer.
4. Canon of Economy — the cost of collecting a tax should be as small as possible relative to the revenue it yields.

Later economists added further canons — productivity (a tax should yield adequate revenue), elasticity (revenue should be able to expand as the economy grows) and simplicity — but Smith's original four remain the foundation taught across Indian intermediate/PUC economics courses, including the AP Intermediate first-year syllabus.

Public expenditure and its classification

Public expenditure is generally classified in two overlapping ways:

• Revenue expenditure vs. Capital expenditure — revenue expenditure is spending that neither creates an asset nor reduces a liability (e.g. salaries, pensions, interest payments, subsidies); capital expenditure either creates a durable physical or financial asset or reduces the government's liabilities (e.g. building roads and schools, repayment of loans, investment in public enterprises).
• Developmental vs. Non-developmental expenditure — developmental expenditure directly promotes economic growth (agriculture, industry, infrastructure, education, health); non-developmental expenditure covers general administration, defence and debt-servicing that do not directly add to productive capacity, though they remain essential functions of the state. …