Public Finance: A Comprehensive Guide
Public Finance: Concept, Subject, and Field
1. Public Sector Operations
The systematization of public sector operations can be done according to different criteria. Two of the most used are: whether or not they are reflected in the budget and whether or not they involve a movement of public funds.
The most numerous and relevant public sector operations involve the movement of money and are contained in the budget. These transactions are categorized using a double standard:
- Nature of the transaction: Current account transactions (rent, civil servant payroll, etc.) and capital account transactions (gross capital formation).
- Type of operation: Bilateral operations (movement of goods or services with an opposing funding movement) and unilateral transactions (transfers) which can be positive (subsidies) or negative (taxes).
These criteria are mutually complementary. Their simultaneous use systematizes public sector financial operations into four categories:
- Bilateral income account: Day-to-day contractual operations of Central Public Administration units.
- Bilateral capital account management: Includes public gross capital formation.
- Unilateral income account: Positive (public debt interest, corporate subsidies, transfers to households) and negative (taxes on incomes, taxes on production and consumption, current and foreign transfers).
- Unilateral capital account: Positive (capital account subsidies, loans and guarantees to companies) and negative (taxes on capital funds, negative transfers).
2. Major Indices to Quantify Public Sector Importance
Indices can be derived from public spending or public revenue.
Indices for Measuring Public Expenditure
- Total expenses ÷ non-financial GDP: Indicates the public sector’s influence on the national economy.
- (Total Public Expenditure – Expenditure transfers) ÷ GDP: Reflects resources absorbed by the public sector.
- Current expenditure ÷ GDP: Shows the proportion of GDP allocated to public consumption.
- Capital Expenditures ÷ GDP: Reflects the proportion of GDP allocated to government investment.
Indices for Measuring Public Revenue
The most common are the tax burden and tax pressure.
- Taxes ÷ Total GDP: Expresses the tax burden or tax rates.
- Tax pressure: Can be individual or group-based, using various formulas to calculate the tax burden relative to income, subsistence level, or subsidies received.
3. Public Sector in the Strict Sense
The public sector in the strict sense comprises institutional units whose decisions are made by an authority and imposed coercively. The government’s main economic functions are producing non-marketable goods and services and redistributing income and wealth through compulsory payments.
National accounts subdivide the public sector into:
- Central administration
- Substation administration
- Social Security
This systematization allows for homogenized macroeconomic statistics.
Tasks of Public Finance
1. Income and Wealth Distribution
The market alone cannot achieve equitable income distribution. The public sector intervenes, considering ethical, political, and economic aspects. Redistribution occurs through budgetary and non-budgetary means.
Budgetary Redistributive Interventions:
- Transfers to specific population segments (large families).
- Altering market prices of goods and services (education, health).
- Progressive taxation on income and wealth.
2. Optimal Resource Allocation
Optimal resource allocation requires:
- Market-related conditions: Lack of barriers, full transparency.
- Actor-related conditions: Price-takers, independent utility/production functions, profit/utility maximization.
- Goods and services characteristics: Homogeneous, perfectly divisible, subject to exclusive appropriation by prices, rival consumption, absence of externalities.
Deviation from these conditions necessitates public intervention.
3. Stable Economic Growth
The public sector regulates aggregate demand to maintain stable prices and full employment. This involves:
- Increasing aggregate demand during unemployment.
- Reducing aggregate demand during inflation.
- Maintaining spending at current prices during full employment and price stability.
4. Public Goods vs. Preferential Goods
Pure public goods (polar): Non-excludable and non-rivalrous consumption (national defense, police).
Justification for preferential goods:
- Consumer ignorance or irrationality.
- Externalities.
- Income redistribution policies.
Preferential goods are often considered custodial property, guaranteeing access regardless of income.
5. Redistributive Demand-Side Projects
Budget expenditures can redistribute resources through transfers or by altering market prices of goods and services.
Budget and Public Expenditure
1. Budget: Concept, Characteristics, and History
A budget is a systematic summary of estimated, mandatory expenditures and projected revenues to cover those expenses. Key characteristics include anticipation, quantification, regularity, accounting expression, and obligation.
2. The Budget Cycle
The budget cycle comprises preparation, discussion and approval, implementation, and control. The length varies by country.
3. Classic Budget vs. Budget Crisis
The classic budget views public units as analogous to households and businesses. Four key questions are addressed: who decides, when, how, and why.
4. Political and Economic Principles of the Classic Budget
Political Principles
- Principle of competition: Legislative power decides on payments and receipts.
- Principle of universality: All revenue and expenditure included.
- Principle of budgetary unity: All state activities in a single statement.
- Principle of specification: Specific and conditional authorization for spending.
- Principle of publicity: Public access to all stages.
- Principle of clarity: Simple and understandable language.
- Annuity principle: Budget refers to a specific period.
Accounting Principles
- Gross budget principle: Gross amounts, no retailers.
- Principle of unity of style: Centralized treasury.
- Principle of specification: Logical classification of receipts and payments.
- Top financial year: Accounts closed at the end of the fiscal year.
Economic Principles
- Limitation of public expenditures: Encourage savings and investment.
- Tax neutrality: Non-discriminatory charges.
- Annual budgetary balance principle: Expenditures funded by ordinary revenue.
- Self-assessment of debt: Debt used for investment generating repayment resources.
5. Budget Preparation and Discussion/Approval
Budget preparation: The executive branch prepares forecasts. Discussion and approval: The legislature discusses, modifies, and approves or rejects the budget.
Public Revenues: General
1. Tax Principles
Basic Tax Principles
- Sufficiency principle: Total revenue sufficient and well-harmonized.
- Flexibility principle: Alignment between revenue collection and economic activity.
- Equity principle: Horizontal (equal treatment for equals) and vertical (unequals treated unequally).
- Neutrality principle: Minimal interference with market equilibrium.
Efficient Management Principles
- Matching principle: Homogeneous tax forms, avoiding overlaps and gaps.
- Principles of practice: Simple and understandable for taxpayers and authorities.
- Principle of continuity: Stable tax provisions.
- Principle of economy: Minimized application, collection, and control costs.
2. Tax Progressivity
A progressive tax has a tax rate that increases at a higher rate than the tax base. Progressivity can be measured using revenue-based elasticity.
3. Public Revenue: Contractual and Coercive
Contractual revenues: Income from assets, proceeds from asset disposal, prices for government services, public debt.
Coercive revenues: Penal power revenue, eminent domain income, tax revenue.
4. Qualitative Aspects of Tax: Taxable Event
The taxable event includes assumptions of taxation, exemptions, time considerations, and spatial considerations.
5. Quantitative Aspects of Tax: Tax Base
The tax base is the monetary value used for tax calculation. Direct and indiciary assessment methods exist.
6. Qualitative Aspects of Tax: Tax Rate
Tax rates can be fixed, proportional, regressive, or progressive.
7. Classes of Taxes
Taxes can be classified as direct or indirect, personal or real, recurring or accidental, ad valorem or unit.
Tax on Income of Natural Persons
1. Taxable Event and Income Classes
The taxable event is any increase in the taxpayer’s ability to contribute during the tax period. Income can be classified by place, attribution, materiality, and regularity.
2. Capital Gains and Irregular Income
Capital gains are positive or negative changes in asset value. Irregular income can be taxed through partial computation, cancellation, mobile averaging, mobile-fixed rate averaging, or simple average recalculation.
3. Problems with Personal Income Tax Items
Challenges include graduating the tax based on dependents and household circumstances, allocating income in multi-earner households, and managing the volume of returns and payments.
4. HS Concept of Income
The HS concept of income (Y = C + ΔW) considers consumption and changes in assets as measures of ability to pay.
5. Income Subject to HS Concept
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6. Territorial Income Tax Requirement
Taxation can be based on territoriality (income generated within a territory) or personality/residence (income of residents, regardless of location).
7. Tax Base in Income Tax
Regular income includes income from personal work, capital items, and economic activities. Capital income includes income from real estate and movable capital.
8. Tax Base in Income Tax: Capital Gains
Capital gains are positive or negative changes in asset value. They are classified by effectiveness (realized vs. unrealized) and nature (interest rate, monetary, pure).
9. Capital Gains: Tax Treatment
Possible tax treatments include full inclusion, special tax, or inclusion with differential treatment.
10. Differences Between Income, Yield, etc.
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Personal Income Tax: Legal Persons
1. Controversy Over Corporate Profit Tax
Arguments against corporate profit tax include the inability of corporations to contribute, double taxation, impact on company financing, and effects on capital allocation.
2. Taxable Income, Deductible Expenses
The tax base is typically the profit and loss account, with adjustments. Deductible expenses include forecasts, supplies, inventories, and depreciation.
3. Linking Operations and Entities
Related-party transactions and transfer pricing pose challenges. The arm’s length principle requires transactions to be valued as if between independent parties.
4. Corporation Tax: Concept and Characteristics
Corporation tax is a direct, personal, and general tax on the income of legal persons.
5. Different Tax Treatment of Capital Gains
Capital gains in corporate tax are usually taxed only when realized. In personal income tax, various treatments are possible.
6. Total Systems Integration of Dividends
Total integration systems aim to eliminate double taxation by integrating corporate and personal income taxes. Methods include unit systems, partnership systems, and fiscal transparency systems.
7. Partial Integration Systems
Partial integration systems include deduction systems, dual-rate systems, and dual-payment systems.
8. Partial Integration in Dividend Income Tax
Partial integration systems in dividend income tax include dividend exemption schemes and attribution systems.
9. Thin Capitalization
Thin capitalization occurs when a company is funded excessively by debt rather than equity. This can lead to tax avoidance.
10. Transfer Pricing
Transfer pricing refers to the valuation of transactions between related entities. The arm’s length principle should be applied.
Property Taxation
1. Taxation of Inheritance
Inheritance taxes can be levied on the entire estate (relict tax) or on individual shares (inherited portion tax). Gift taxes are also relevant.
2. Real Estate Tax: Base and Valuation
Valuing real estate for tax purposes can be challenging. Methods include market values, capitalized rent, and cadastral valuation.
3. Rationale and Assessment of Net Worth Tax
A net worth tax complements income tax, improving overall progressivity. Considerations include equity, efficiency, and management.
4. Methods of Transfer Taxes
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5. Advantages and Disadvantages of Estate Tax
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6. Advantages and Disadvantages of Inheritance Portion Tax
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7. Real Property Tax: Tax Base
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8. Valuation in Real Property Tax
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9. Differences Between Capital Levy and Net Worth Tax
A capital levy is a one-time tax, while a net worth tax is recurring. The capital levy is strongly progressive, while the net worth tax has lower rates.
Consumption Taxation
1. Excise Taxes on Luxury Consumption
Excise taxes on luxury goods can be used for redistribution and as an alternative to rationing.
2. VAT (Value Added Tax)
VAT can be calculated by addition or subtraction. Advantages include simplicity, broad application, and avoidance of the pyramid effect.
3. Monophasic Taxes
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4. Advantages and Disadvantages of Plurifásicos vs. Consumption Taxes
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5. VAT-Exempt Transactions
VAT exemptions are limited and typically apply to transactions closer to the final consumer.
6. Excise Taxes: Functions
Excise taxes serve both tax collection and regulatory functions.
7. Advantages and Disadvantages of Consumption Tax Phases
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Other Public Revenues
1. Contractual Tax Revenue
This includes fees and special levies. Fees compensate for specific services, while special levies fund public improvements.
2. Life Cycle of Public Debt: Issuance and Conversion
Issuing debt involves determining loan terms and issue price. Debt conversion involves reducing interest rates with creditor consent.
3. Life Cycle of Public Debt: Depreciation
Debt repayment can be through strict amortization (one-time or gradual) or through inflation or repudiation.
4. Concept and Characteristics of Fees
Fees are coercive revenues compensating for specific services.
5. Concept and Characteristics of Special Contributions
Special contributions fund public improvements that increase property value.
6. Differences and Similarities Between Fees and Special Levies
Special contributions are one-time payments for specific benefits, while fees are periodic payments for ongoing services.
7. Differences and Similarities Between Fees and Taxes
Fees compensate for specific services, while taxes fund general public services.
8. Differences and Similarities Between Taxes and Special Contributions
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9. Differences and Similarities Between Fees and Public Prices
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10. Definition and Types of Public Debt
Public debt is a unilateral contract where a public body borrows money, committing to pay interest and repay principal. Debt can be classified by currency, term, and issuance method.