Public finance is the management of a country’s revenue, expenditures, and debt load through various government and quasi-government institutions. This guide provides an overview of how public finances are managed, what the various components of public finance are, and how to easily understand what all the numbers mean. A country’s financial position can be evaluated in much the same way as a business’ financial statements.
Components of Public Finance
The main components of public finance include activities related to collecting revenue, making expenditures to support society, and implementing a financing strategy (such as issuing government debt). The main components include:
Tax collection is the main revenue source for governments. Examples of taxes collected by governments include sales tax, income tax (a type of progressive tax), estate tax, and property tax. Other types of revenue in this category include duties and tariffs on imports and revenue from any type of public services that are not free.
The budget is a plan of what the government intends to have as expenditures in a fiscal year. In the U.S., for example, the president submits to Congress a budget request, the House and Senate create bills for specific aspects of the budget, and then the President signs them into law. Read a copy of 2017 Budget of the U.S. government, as published by the Office of Management and Budget.
Expenditures are everything that a government actually spends money on, such as social programs, education, and infrastructure. Much of the government’s spending is a form of income or wealth redistribution, which is aimed at benefiting society as a whole. The actual expenditures may be greater than or less than the budget.
If the government spends more then it collects in revenue there is a deficit in that year. If the government has less expenditures than it collects in taxes, there is a surplus.
If the government has a deficit (spending is greater than revenue), it will fund the difference by borrowing money and issuing national debt. The U.S. Treasury is responsible for issuing debt, and when there is a deficit, the Office of Debt Management (ODM) will make the decision to sell government securities to investors.
Managing Public Finance
Let’s take a closer look at how taxes, expenditures, and the deficit work. Below is a diagram of how the three are connected, and how the government determines how much financing it needs in a given fiscal year.
Total government revenue or tax collection is represented by the blue bar. This is a source of cash for the government.
Expenditures are a use of cash, and to the extent that they are greater than revenue, there is a deficit.
The difference between revenue and expenditures is the deficit (or surplus) that is funded with national debt.
2017 U.S. Figures
Now that the concept has been illustrated, let’s look at a real public finance example with the U.S. government in 2017.