Public and Private Finance: Similarities and Difference

In this article we will discuss about the similarities and difference between public and private finance.

Similarities between Public and Private Finance:

While the individual is concerned with the utilization of labour and capital at his disposal, in order to satisfy some of his wants, the state is concerned with the utilization of the labour and capital and other resources to satisfy social wants.

It will be observed that both private and public finance have broadly, the same objective, namely the satisfaction of human wants. However while private finance em­phasizes individual interests public finance attempt to promote so­cial welfare.

From this it may be thought that public finance is only an extension of private finance, and that the rules and regulations which apply to private finance will also be applicable to public fi­nance.

1. The Principles of Rationality:

The private and public finance are based on rational behavior. The resources at the disposal of private individuals and public authority are limited. Therefore in both cases, maximum care is taken to en­sure better utilization of scarce resources.

A rational individual tries to maximize personal benefits from his expenditure. Likewise a rational government seeks to maximize social benefits from public expenditure.

2. Borrowing:

Borrowing is a common element both in private and public fi­nance. Just as an individual borrows from different sources when current incomes are insufficient to meet the current expenditure, the public authority also resort to borrowing, when its revenue fall short of aggregate expenditure.

3. Problems of Adjustment of Income and Expenditure:

Both public and private finance always face the problem of adjust­ment of income and expenditure. Hence the problem of choice is common in both type of finance.

Both kinds of finance have income and expenditure. Both tries to balance their income and expenditure.

Dissimilarities between Public and Private Finance:

In terms of scope of study, methods of finance and motive of expen­diture, one can notice fundamental differences between public and private finance.

The important differences are:

1. Scope of Study:

Public finance studies the complex problems that center around the revenue – expenditure process of government. Private finance, on the other hand, is confined to the study of those aspects of the economy that arise in the course of operation of private households in the sphere of financial transactions and activities. Hence in terms of scope of study private finance has a limited sphere of operation.

2. Income – Expenditure Adjustments:

There is a difference in approach between individuals and public au­thorities as regards the adjustment of income and expenditure.

In the case of individuals their expenditure is determined by the in­come at their disposal. Whereas a public authority, first decides the volume of expenditure, which it has to incur and then tries to find out the required resources.

Dalton points out “while an individual adjusts income to expenditure, a public authority adjusts expenditure to in­come”. Thus the individual cuts his coat according to his cloth, the state first decides the size of the coat and then sets about gathering the necessary cloths.

In other words an individual normally tries to live within his income and adjust his expenses according to the size of his income. On the other hand public authorities first estimate the various items f expenditure and then device methods of raising the necessary resources.

The difference in adjustment of income and expenditure between private business and public authorities arises, because the individual knows the size of his income, while the government does not know it.

3. Compulsory Character:

“Another characteristic of public expenditure is its compulsory char­acter” (Prof. Findlay Shirras). There are certain items of expenditure which the state can neither avoid nor postpone. Irrespective of the availability of resources, this type of expenditure should be in­curred.

The expenditure on defense, civil administrations etc. are of compulsory in nature. Likewise the state can compel people to pur­chase and consume a particular variety of cloth, wheat or other com­modities at a price fixed by the state.

4. Nature of Resources:

There is a difference between private and public authorities as re­gards the nature of resources. While the individual has only limited resources at his disposal, the public authorities can even draw upon the entire wealth of the community, by raising force, if necessary. Tax payment is a personal responsibility of the tax payer.

Nobody can refuse to pay taxes if it is imposed on him. Besides tax rev­enue, the public authorities can borrow funds from the general public and if needed, from outside the country.

The government can even resort to deficit financing, as and when financial situation worsens. As compared to this, individuals and business houses have only limited source of resources.

5. Coercive Authority of the Government:

An individual cannot raise coercive methods to raise his income. But the government can use force to collect the necessary revenue. Since the public authority possesses coercive power, it can raise rate of taxes, add new taxes to the existing system, and force tax payers to pay taxes promptly. Moreover during financial crisis, the government can intro­duce, compulsory deposit of funds, using coercive authority of the state.

6. Budgeting:

The individual attempts to balance his budget, i.e., his expenditure and income, within a short period of time, say a week or a month. Whereas public authorities may normally take a year as the period, within which their budget will have to balance.

Besides, while the individual attempts to secure a surplus from his income after meet­ing expenditure, the public authorities, usually may not have a sur­plus budget.

In the case of a public authority, it is a matter of fiscal adjustment based on economic circumstances that will decide whether the budget should be balanced, surplus or deficit. Depend­ing upon circumstances, each type of budget has its own merits and advantages.

7. Motive of Expenditure:

In the case of an individual the main consideration in expenditure is whether it will be profitable and beneficial. On the other hand, the motive of profit and surpluses do not influence spending by govern­ment departments.

Government has to finance improvement of a general nature and activities, for which financial return is uncertain or subject to long gestation period. Thus, as far as public authorities are concerned, except in commercial fields, the spending decisions are motivated by maximum social benefit.

Therefore the objective and motive of government in making expenditure are generally differ­ent from those of individuals and private business units.

8. Provision made for the Future:

Private individuals prefer to invest in those fields where returns are quick and immediate. Private investments are governed by short period motives. Very often private capital doesn’t enter into those fields of business where returns are nominal and realized after a long period.

Individuals always seek quick returns from his investment. They set apart only a nominal amount for future and spend more for satisfying their current needs. Individuals usually are not concerned with long term considerations, while disbursing their income.

In con­trast, the state is expected to take a long term view of the interest of the society as a whole. State is a permanent institution.

The state will have to keep in mind the fact that society is a perpetual entity and for the welfare of the people, it has to take up numerous welfare activities, the returns of which may be delayed.

The public authori­ties will have to look after the present and the future generation, while making investment decisions. Hence many expenditure for public purposes are made for the future as much as for the present.

For example investment in education facilities, public health service, infrastructure development, pollution control, environmental protec­tion, afforestation etc. does not generate immediate return, but all are important from the point of view of the community.

9. Expenditure and Welfare Maximization:

In private finance, a rational consumer seeks to maximize his total satisfaction by allocating his income based on the law of equi-mar­ginal utility. Every individual attempts to maximize his satisfaction by distributing his limited income on different goods and services in such a way that marginal utilities of money spent on goods would be more or less the same.

There is a similar law of maximum satisfac­tion known as the principle of maximum social advantage governing the allocation of public expenditure.

According to this principle, the government should spend its income in such a way that the total welfare of the community should be maximized. It is seen that the only difference between private and public finance is that while the individual attempt to maximize his own welfare the public authorities are influenced by the consideration of entire community.

10. Secrecy and Publicity:

Private finance is generally covered in secrecy. Usually an individual doesn’t like to expose his financial affairs to others. On the other hand the government gives maximum publicity to its budget pro­posal. More over accounts of public bodies are subject to statutory audit and inspection. In fact publicity strengthens rather than weak­ens public credit.

11. Nature of Wants:

Private finance relates to the purchase of goods and services, which are subject to private market, mechanisms. In this case ‘exclusion principle’ can be applied. Whereas public finance is concerned with ‘public wants’, where ‘exclusion principle’ can’t be applied in its con­sumption.

Thus on important points, private and public finance differ from each other. It is not correct to assume that the principles and rules which govern private finance are equally applicable to public finance.

A healthy approach to fiscal policy will emerge, if we consider the government as an element in the economy and not as an organiza­tion outside the community.