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Public finance deals with the role a government plays in the economy of the country. It is a section of economics that evaluates public revenue and expenditure, particularly taxes. This paper discusses different concepts regarding public finance and their application in the budget-making process.
Principles of Public Finance
Public finance assesses the effect of the government on equitable distribution of resources, income, and macroeconomic stability. The primary objectives of public finance are to control essential sectors of the economy, for example, agriculture, foreign trade, and industries, and to provide basic services to citizens of a nation. These services include security, protection of life, and maintenance of law and order. Other roles of public finance include providing social services such as medical care and education, and ensuring sustainable economic development.
The Equi-Marginal Principle
The equi-marginal principle is an economic concept that is widely used in the budgeting process. According to this principle, when consumers divide their income among various products and services, they are likely to choose combinations of products that maximize their satisfaction. Therefore, it is also known as the principle of maximum satisfaction. This principle provides for the maximum utilization of inputs to increase profitability. The equi-marginal principle can be applied in budget discussions by guiding the allocation of resources to sectors that yield maximum returns. Consequently, the government can accept investments with high return rates to ensure optimum utilization of capital resources.
Pareto criterion is an economic state whereby in the distribution of resources, one entity improves its position while the other entities’ positions worsen. It is impossible to improve one party’s situation without making affecting the other party’s situation. This criterion does not entail equal distribution of resources. A Pareto improvement is a change that enables at least one unit to improve its position without interfering with the position of another entity (Caamaño-Alegre, 2016). In the economic state of potential Pareto criterion, the winning entity makes enough benefits to be able to compensate the other unit. However, the application of this rule may lead to certain issues.
Public choice is a segment of economics that is derived from the study of public spending and taxation. Public choice applies the same principles used by economists to evaluate consumers’ behavior in the marketplace and uses these ideologies to assess people’s behavior in the decision-making process. The public choice theory is sometimes applied when describing how government decision-making often results in consequences that are opposed to the interests of the public. Consequently, proponents of the public choice theory claim that politics is full of irrationality (Hindmoor & Taylor, 2015).
The Budget Process
The budgeting process is the hallmark of an excellent public expenditure management process. Budget preparation is essential to control public expenditure, ensure proper allocation of resources, and guarantee effective delivery of public services. Legal and regulatory frameworks direct the budget-making process. The first step in the budget process involves assessing the soundness of a budget, which includes checking to ensure that the budget covers all government operations comprehensively and upholds transparency.
It is also necessary to ascertain that the budget is based on a realistic macroeconomic framework. The Pareto principle applies during the budgetary allocation of funds to different items. For example, when funds are limited, allocating extra resources to one need may have a detrimental effect on the other requirements. Therefore, there is a need to strike a balance during resource allocation. The second step in the budget-making process is ensuring that the budget abides by the rules that guide the budgeting process in a given country. The final step is identifying different responsibilities within the budget system. This step includes obtaining information about budgeting powers, budgeting timetable, legislative limits, and funding of activities.
Management of public finance and budgeting play an important role in creating socioeconomic balance. These factors also determine the macroeconomic performance by balancing the income and expenditure. For these reasons, it is necessary to consider how different public finance concepts affect the budget process.
Caamaño-Alegre, J. (2016). The search for a better public/private mix in contemporary market economies. Science, 4(32), 24-28.
Hindmoor, A., & Taylor, B. (2015). Rational choice (2nd ed.). London, Great Britain: Palgrave Macmillan Ltd.