Government & Public Finance

NODE 01

Role of Government

• Taxation, Expenditure, Regulation.
• Provision of public goods.
• Redistribution & Macro policy.
• Social protection.

NODE 02

Market & Government

• Markets coordinate via prices & incentives.
• But can produce inefficient outcomes.
• Market → Market Failure → Gov Intervention.

NODE 03

Market Failure

!

• Failure to allocate resources efficiently.
• Sources: Externalities, Public goods.
• Info asymmetry, Market power.

NODE 04

Public Goods

• Non-rivalry: Consumption doesn't reduce availability.
• Non-excludability: Costly to exclude non-payers.
• E.g., National defence, street lighting.

NODE 05

Private Goods

• Rivalry: One's use stops another's.
• Excludability: Can prevent non-payers.
• E.g., Food, clothing, cars.

NODE 06

Free Rider Problem

• Benefiting from a good without paying.
• Particularly impacts public goods.
• Private market provision becomes insufficient.

NODE 07

Externalities

• Economic activity affecting a third party.
• Negative: Creates a cost (Pollution).
• Positive: Creates a benefit (Education).

NODE 08

Pvt vs Social Cost

EXT

• Private Cost: Borne by decision-maker.
• External Cost: Imposed on third parties.
• Social Cost = Private + External Cost.

NODE 09

Pvt vs Social Benefit

EXT

• Social Benefit = Private + External Benefit.
• Society may benefit more than individual considers.

NODE 10

Gov Response

• Taxes, Subsidies, Regulation.
• Tradable permits, property rights.
• Depends on nature of externality.

NODE 11

Taxation

• Compulsory payment imposed by government.
• Major source of revenue.
• Tax → Revenue + Incentive effect.

NODE 12

Direct Tax

• Imposed directly on income/wealth.
• Not ordinarily shifted to another person.
• E.g., Income tax, Corporate tax.

NODE 13

Indirect Tax

BIZ

• Imposed on transactions/goods/services.
• Can be passed through prices.
• E.g., GST, excise duties.

NODE 14

Progressive Tax

• Tax burden rises as income rises.
• Income ↑ → average tax burden ↑.
• Associated with redistribution.

NODE 15

Proportional Tax

• Applies a constant tax rate.
• E.g., 10% at every income level.
• Average tax rate remains constant.

NODE 16

Regressive Tax

• Larger relative burden on lower-income groups.
• As a proportion of income.
• Indirect consumption taxes often regressive.

NODE 17

Tax Base

BASE

• Economic quantity to which tax applies.
• E.g., Income base, property value, transactions.

NODE 18

Tax Rate

%

• Amount of tax applied to the base.
• Liability = Base × Rate.
• Includes exemptions, deductions, thresholds.

NODE 19

Evasion vs Avoidance

• Evasion: Illegal concealment to avoid tax.
• Avoidance: Legal arrangement to reduce liability.
• The legal distinction matters.

NODE 20

Gov Revenue

• Tax revenue, non-tax revenue, capital receipts.
• Non-tax: fees, fines, dividends, interest.

NODE 21

Gov Expenditure

H

• Education, Healthcare, Defence.
• Infrastructure, Administration, Subsidies.

NODE 22

Revenue Expenditure

• Does NOT directly create long-term physical assets.
• Supports ongoing gov functions.
• E.g., Salaries, pensions, interest payments.

NODE 23

Capital Expenditure

• Creates/acquires assets or productive capacity.
• E.g., Roads, bridges, public buildings.
• Contributes to future economic potential.

NODE 24

Government Budget

• Statement of estimated receipts & expenditure.
• Usually for a financial year.
• Revenue → Expenditure → Deficit/Surplus.

NODE 25

Revenue Receipts

• Tax and Non-tax revenue.
• Do not create a liability to repay.
• Do not reduce government assets.

NODE 26

Capital Receipts

→

• Borrowings, recovery of loans.
• Disinvestment / sale of assets.
• Affect government liabilities or assets.

NODE 27

Fiscal Deficit

GAP

• Total Exp − Total Receipts (excluding borrowings).
• Measures total borrowing requirement.

NODE 28

Revenue Deficit

• Revenue Expenditure − Revenue Receipts.
• Indicates shortfall in meeting daily expenses.

NODE 29

Primary Deficit

FD − INT

• Fiscal Deficit − Interest Payments.
• Current fiscal gap excluding past debt burden.

NODE 30

Budget Surplus

• Government receipts > expenditure.
• Balanced budget = Receipts equal Expenditure.

NODE 31

Gov Borrowing

• Funding deficits via securities, T-bills, external debt.
• Provides financing but creates future obligations.

NODE 32

Public Debt

• Accumulated stock of government borrowing.
• Deficit = flow, Debt = stock.

NODE 33

Debt & Interest

• Borrowing creates future interest obligations.
• Large debt constrains future fiscal choices.
• Depends on growth, rates, and debt composition.

NODE 34

Subsidies

• Financial support lowering effective cost.
• E.g., Food, fertiliser, energy.
• Pursues social goals but has fiscal costs.

NODE 35

Transfer Payments

• Income provided without direct exchange of goods.
• E.g., Pensions, social assistance.
• Important for redistribution.

NODE 36

Redistribution

• Via progressive taxation, transfers, public services.
• Reduces poverty and inequality.

NODE 37

Allocation Function

• Intervening to improve resource allocation.
• Corrects market failures, provides public goods.

NODE 38

Distribution Function

• Influencing distribution of income/opportunities.
• Via taxes, education, healthcare.

NODE 39

Stabilisation Function

• Using policy to influence macro stability.
• Counter-cyclical spending/taxes.

NODE 40

Fiscal Policy

• Decisions on taxation and expenditure.
• Expansionary: Spend ↑ / Tax ↓.
• Contractionary: Spend ↓ / Tax ↑.

NODE 41

Automatic Stabilisers

• Mechanisms that auto-respond to activity.
• Progressive taxes, unemployment transfers.
• Cushions household disposable income.

NODE 42

Crowding Out

• Public borrowing reduces private investment.
• Raises financing costs if near capacity.

NODE 43

Crowding In

• Gov spending encourages private investment.
• E.g., Infrastructure lowers transport costs.

NODE 44

Fiscal Multiplier

• Initial spending generates larger overall output.
• Repeated rounds of spending and income.

NODE 45

Government Failure

• Intervention is not automatically efficient.
• Bureaucratic inefficiency, rent-seeking.
• Regulatory capture, political distortions.

NODE 46

Regulation

• Standards, licensing, price rules.
• Alters behavior without direct ownership.

NODE 47

Public–Private

• Public: Gov-owned/controlled.
• Private: Privately owned firms.
• Mixed economy contains both.

NODE 48

Merit Goods

• Socially beneficial beyond private choice.
• E.g., Education, healthcare.
• Gov subsidises/provides to increase access.

NODE 49

Demerit Goods

X

• Impose social costs / considered harmful.
• Gov uses taxes, regulation, restriction.

NODE 50

Cost–Benefit Thinking

• Projects involve Social Benefits vs Social Costs.
• E.g., Highway = Connectivity vs Pollution.

NODE 51

Gov Budget Structure

• Receipts (Tax, Capital) vs Spending (Rev, Cap).
• Results in Surplus/Deficit.
• Requires Financing (Borrowing).

NODE 52

Three Functions of Public Finance

STA ALL DIS

• Allocation: Correct market failures.
• Distribution: Redistribute income.
• Stabilisation: Macroeconomic control.

NODE 53

Master Gov Chain

• Market Economy → Market Failures → Gov Intervention.
• Tax + Spend + Regulate → Alloc, Dist, Stab.
• Must beware of Government Failure.