Public Finance – Tax, Inflation, Government Expenditure explained

Taxation effects, government expenditures, deficit financing, and public borrowing in an economy constitutes the theory of public finance.

Public Finance

Public finance is the study of the government’s role in an economy. It is the branch of economics that deals and assesses the revenue and expenditures of the government. In public finance, we study the finance of the public or governments. It deals with the questions on how governments revenues are being generated in the economy to meets its daily expenditures. It is concerned with the income and expenditures of public authorities.

Taxation effects, government expenditures, deficit financing, and public borrowing in an economy constitutes the theory of public finance. It studies the effect of the achievements of the major economic objects like growth, efficiency, and stability.

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What is public finance

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What is the reason for public finance?

Public finance helps the government on:

  • Efficient allocation of resources
  • Macroeconomic stabilization
  • Distribution of income

The government gets revenues in different ways to meet their day to day expenditure. Some of the ways revenue are generated for expenditures are:

  • Tax
  • Government borrowing
  • Grants and aids
  • Inflation
  • Revenue from government own corporations


The main objective of taxation is to raise funds and revenues for the government. Taxes can be defined as the specific amount of money levied on an individual or firm to be paid to the government for goods sold or bought. Taxation on the other hand is the act of imposing a tax on an individual or firm.

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There are different types of tax, we have the direct tax and the indirect tax.

The direct tax is paid directly into the government account by the firms and individuals and this is proportional. The indirect tax has been paid immediately after a good or service is purchased. The person the goods are purchased from will be the one to pay the tax which takes us back to the direct tax.

Indirect tax is differential in nature. There are also other categories of tax which are stamp duty, excise duty for production for sale, the sales tax levied on the business transaction (value-added tax and service tax), road tax, gift tax, duties, wealth tax, personal income tax.

Government borrowing

The government borrows money from other countries or World Bank to get revenues. The money borrowed is invested by buying bonds and selling them to the public to get money for the economic expenditure.


This is the continuous increase in the price level of goods and services without a corresponding increase in the value of money. The government tries to ingest money into circulation, consequently, the price of goods increases leaving the value of money to decline. 

What does finance mean

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It includes all government spending on investment, income distribution, transfer payments, and government consumption. Government final consumption on expenditure is the acquisition by governments, of goods and services for current use, to directly satisfy the individual or collective needs of the is the purchase from national accounts of goods and services directly satisfying individual needs.

Transfer payments

Transfer payments in Public Finance deal with government expenditure that is not the acquisition of goods and services and instead just represents the payments of money such as social security payments. These payments are considered to be wastage as they do not add to the government but rather absorb resources from the governments. They are paid without any exchange of goods and services an example is a payment of welfare (financial aid) government giving subsidies on certain products to certain people or to the public at large (fuel subsidy).

Income distribution

This is a form of government expenditure that is intended for the transfer of money from groups to others. An example is a government transferring money to people involved in a natural disaster. Others are public pension transferred from the young to the old, income insecurity, employment insurance, health care, public finance for the campaign during the election. They also help in grants and aids by giving aids to countries suffering from the economic crisis.

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Infrastructure and investment (gross fixed capital formation)

This is intended to create future benefits. Infrastructure investment or research spending is called gross fixed capital formation. Acquisition of goods and services is derived through production by the government. Or through purchases of goods and services from market producers. The government can buy bonds from the public and resell them at a higher rate to get income for the government. Some infrastructure produced by the government is the construction of the railway, construction of the overhead bridge.

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Harish is the editor at howto Finance. Here we publish high quality trending news topics on Business, Finance, Loans and Credit-Cards etc. Our editorial includes worldwide topics.

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