PUBLIC FINANCE - KCSE BUSINESS STUDIES NOTES, AUDIOVISUALS, QUESTION AND ANSWER

OBJECTIVES

PUBLIC FINANCE ​

SPECIFIC OBJECTIVES

​By the end of the topic, the learner should be able to:

1. explain the meaning and purpose of public finance
2. describe the various sources of public finance
3. categorize government expenditure
4. explain the principles of government expenditure
5. explain the meaning and purpose of taxation
6. explain the principles of taxation
7. classify taxes
8. explain the merits and demerits of each type of tax.

COURSE OUTLINE

CONTENT

1. Meaning and purpose of public finance
2. Sources of public finance
3. Categories of Government expenditure
4. Principles of Government expenditure
5. Meaning and purpose of taxation
6. Principles of taxation
7. Classification of taxes
8. Merits and demerits of each type of tax

PUBLIC FINANCE

Public finance refers to the activities carried out by the government associated with raising of finances and the spending of the finances raised (it is the study of how government collects revenue and how it spends it)
The components of public finance are;

1. Public revenue
2. Public expenditure
3. Public debt
   1. Public revenue-refers to the revenues (income) and resources received by the government from different sources.
   2. Public expenditure-refers to the resources spent by the government.
   3. Public debt-refers to the money and resources borrowed by the government.

Purpose of public finance

1. Provision of essential goods and services. The government has a responsibility of providing its citizens with essential goods and services such as security, health, schools, drought control, law etc. such facilities and services may not be adequately covered by the private sector because of the high costs involved and risks.
2. Encouraging consumption of certain commodities-The government may encourage consumption of certain commodities e.g. maize by subsidizing on their productions or lowering their taxes.
3. Controlling consumption of certain commodities-The government may also encourage consumption of some commodities e.g. cigarettes and alcohol by imposing heavy taxes on them.
4. Promotion of Balanced regional development-This may be done by initiating economic projects in areas that are under developed/lagging behind.
5. Wealth Redistribution-This is done by heavily taxing the rich and using the money raised to provide goods and services that benefit the poor
6. To promote economic stability-Economic instability may be caused by factors such as unemployment. Such problems can be solved through public expenditure in projects that generate employment such as ‘kazi kwa vijana’
7. Creation of a conducive Business Environment-Through public expenditure, the government may develop infrastructure such as roads, electricity, and security etc. thereby creating a conducive environment for businesses to thrive in.
8. To raise government revenue-Through public finance, the government raises revenue which it uses in provision of essential goods and services to the public.
9. Improving balance of payment-This may be done by improving heavy taxes such as customs duty to discourage importation.

Sources of public finance

There are two major sources of public finance i.e.

1. Public revenue
2. Public debt (government borrowing)

Public revenue
This is the income that the government gets from its citizens. The main sources of public revenue are:

1. Tax - This is a compulsory payment levied by the government on individuals and firms without any direct benefit to the payer.
2. Fines and penalties - These are the charges imposed on individuals, firms and corporations who break the laws of the country.(offenders)
3. Fees - These are the payments charged by the government for the direct services it renders to its people e.g. road license fee, marriage certificate fee and import licence fee.
4. Rent and rates - Charged on use of government properties e.g. game parks, forests etc.
5. Eschiats - Income obtained from properties of persons who die without legal heirs or proper wills. Such people’s properties are taken over by the state.
6. Dividends and profits - These are the income received from the government direct investments e.g. income/surplus from public corporations.
7. Interest from loans - This is the interest on loans advanced by the government to firms and individuals through its agencies such as ICDC, AFC etc.
8. Proceeds from scale of government property.
9. Public debt (Government borrowing) -This is the money that the government borrows when public revenue is insufficient to meet all its financial obligations. Government borrowing is also referred to as national debt. It includes all outstanding borrowing by the central government, local authorities and government corporations.

These are two majorly two sources of public debts:

1. Internal borrowing
2. External borrowing

Internal borrowing
This refers to borrowing by government from firms and individuals within the country. This may be done through:
Open market operation; the government sells its securities such as treasury bonds and treasury bills. This however has a disadvantage of causing ‘crowding out effect’ where the government leaves the private investors with little to borrow from.
External borrowing

• This refers to government borrowing from external sources. It may either be on a bilateral or multilateral basis.
• Bilateral borrowing is where the government borrows directly from another country.
• Multilateral borrowing is where the government borrows from international financial institutions such as international monetary fund (IMF), World Bank, African Development bank etc. such bodies get finances from various sources which they lend to their member countries who are in need of such funds.
• Generally, external borrowing has strings attached. The borrowing country is expected to meet some set conditions, sometimes adversely affecting some sectors of the economy.
• The total internal borrowing (internal debt) added to the total external borrowing (external debt) constitutes the national debt.

Classes of public (National debt)

​These are two classes of national debt:

1. Reproductive debt
2. Dead-weight debt.

Reproductive debt
This is borrowed money used to finance project(s) that can generate revenue. Such projects, once started may become self-sustaining and may contribute towards servicing/repaying the debt. E.g. money used to finance irrigation schemes, electricity production etc.
Dead-weight debt
This is borrowed money that is used to finance activities that do not generate any revenue. Examples are money used to finance recurrent expenditure e.g. payment of salaries or for famine relief etc.
Dead-weight debt is a burden to members of the public since they are the ones who are expected to contribute towards its repayment.
Factors to consider before the government decides whether to borrow internally or externally
This refers to how the government spends the finances it has raised on behalf of its citizens.
Categories of government expenditure

1. Recurrent expenditure
2. Development expenditure
3. Transfer payments.

Recurrent expenditure
This refers to government spending that takes place regularly e.g. payments of salaries to civil servants, fuelling of government vehicles e.g.
Every financial year, the government must allocate funds to meet such expenditure.
Recurrent expenditure is also known as consumption expenditure.
Development expenditure
This is also referred to as capital expenditure .It is government spending on projects that facilitate economic development. Such projects includes construction of railway lines, roads, airports, rural electrification etc.
Once completed expenditure on such projects ceases and may only require maintenance.
Transfer payments
This is expenditure on things/people who do not directly contribute to a country’s national income. Such expenditure include money spent on famine relief, pension, bursaries etc.

Principles of Public/Government Expenditure

These are the considerations that are necessary before any expenditure can be incurred by the government.
They include:

1. Sanctions: Every public expenditure must be approved by the relevant authority like parliament.
2. Maximum social benefit: Any public expenditure must be incurred in such a way that majority of the citizens are able to reap maximum benefit from it e.g. improved living standards and quality of life.
3. Flexibility /elasticity-The policy on public expenditure should be flexible enough to meet prevailing economic situations i.e. it should be possible to increase or decrease the expenditure on projects depending on the prevailing circumstances e.g. during drought, it should be possible to spend on famine relief.
4. Economy-public expenditure should be planned carefully and prudently to avoid any possible waste.
5. Proper financial management (Accountability)-public funds should be well managed. This should be facilitated by maintenance of proper records which should be audited as required.
6. Productivity-The biggest proportion of public expenditure should be spent on development projects and less on non-development projects.
7. Equity-Government expenditure should be distributed equitably to all sectors of the economy in order to reduce income and wealth inequalities.
8. Surplus-Surplus revenue collected should be saved for emergencies or for when collection of revenue is below projections.

Taxation

Tax: is a compulsory payment by either individuals or organizations to the government without any direct benefit to the payer.
Taxation-refers to the process through which the government raises revenue by collecting taxes.
Purposes/reasons for taxation

1. Raising revenue for government expenditure. This is the main reason for taxation.
2. Discouraging /controlling consumption of certain commodities e.g. alcohol and cigarettes which are considered to be harmful.
3. Discouraging importation of certain commodities in order to protect local industries. This is done by imposing heavy taxes on such commodities.
4. Controlling inflation. Taxation reduces money supply by reducing peoples ‘disposable’ income thereby controlling inflation.
5. Reducing inequality in income distribution; this is done by taxing the rich heavily and using the finances raised in provision of goods and services that benefit the poor.
6. Influencing locations of businesses. This is done by taxing businesses located in urban areas heavily and those in rural areas lightly hence businesses moving to rural areas.
7. Correcting unfavorable balance of payments. High taxes are imposed on imported commodities thereby discouraging their importation leading to an improvement in the balance of payments.
8. To protect the key selectors of the economy such as the agricultural sector, by stimulating their growth.

Factors that determine the amount of money raised through taxation

1. Distribution of incomes
2. Social and political factors
3. Honesty and efficiency of tax authorities
4. Citizens level of real income
5. Economic structure of the country i.e. relative size of the country’s commercial and subsistence sectors.

​Principles of taxation

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question & answer session

Discuss five principles of taxation

1. Equitable/principle of equity-Every subject of the state should pay tax in proportion to their income. A tax system should therefore have horizontal and vertical equity.
   Horizontal equity means that those at the same level of income and circumstances should pay the same amount of tax. Vertical equity means that those earning higher incomes should pay proportionately higher amounts of tax than those earning less.
2. Certain/principle of certainty-The tax that an individual should pay should be clear in terms of the amount, time and manner in which it should be paid. The government should also be fairly certain of the amount of tax expected so that planning can be easier.
3. Convenient/principle of convenience-Tax levied ought to be convenient to both the contributor and collector, it should be levied at a time when the payer has money and mode of payment should be convenient to both the payer and the payee.
4. Economical/principle of economy-The cost of collecting and administering the tax should be lower than the tax so collected.
5. Flexible/principle of flexibility-It should be readily adaptable to changing economic times i.e. when the economic conditions of the people improve it should give raised revenue e.g. VAT
6. Ability to pay/non-oppressive-A tax system should be designed in a way that the amount charged is not too high to the extent that the contributors are unable to pay or is discouraged from working hard.
7. Diversified/principle of diversity-There should be different types of taxes so that the tax burden is on different groups in the society. This also ensures that the government has money at all times.
8. Simplicity-A good tax system should be simple enough to be understood by each tax payer. This will motivate them to pay tax.
9. Elastic/principle of elasticity-The tax system should be able to generate more revenue for the government by targeting items of mass consumption.

Outline five sources of non-tax public revenue

• Fines and penalties imposed on law breakers.
• Income from government properties e.g. land.
• Fee from direct services.
• Government borrowing (internally and externally)
• Interest earned on government investments.

Explain five principles of public expenditure

1. Sanctions; every public expenditure must be approved by the relevant authority like parliament.
2. Maximum social benefit; any public expenditure must be incurred in such a way that majority of the citizens are able to reap maximum benefit from it e.g. improved living standards and quality of life.
3. Flexibility /elasticity-The policy on public expenditure should be flexible enough to meet prevailing economic situations i.e. it should be possible to increase or decrease the expenditure on projects depending on the prevailing circumstances e.g. during drought, it should be possible to spend on famine relief.
4. Economy-public expenditure should be planned carefully and prudently to avoid any possible waste.
5. Proper financial management (Accountability)-public funds should be well managed. This should be facilitated by maintenance of proper records which should be audited as required.
6. Productivity-The biggest proportion of public expenditure should be spent on development projects and less on non-development projects.
7. Equity-Government expenditure should be distributed equitably to all sectors of the economy in order to reduce income and wealth inequalities.
8. Surplus-Surplus revenue collected should be saved for emergencies or for when collection of revenue is below projections.

Highlight five reasons for imposition of tax by the government

1. To raise revenue for the government
2. To discourage consumption of some products
3. To reduce inequality income distribution
4. To discourage importation of some products
5. To stabilize prices 

Discuss five characteristics of a good tax system

• Simplicity
• Equitable.
• Difficult to evade.
• Economical.
• Convenient.

​Outline five reasons why the Kenya government must impose tax

• To generate revenue
• To control import
• To distribute income from the rich to the poor.
• To maintain price stability
• To influence consumption pattern

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