Finance, Public

Public finance is the study of the economic activities of governments. These activities are expressed mostly through budgets, so it is the taxes and expenditures that comprise those budgets that are the primary objects of fiscal theorizing. It should also be noted, however, that nearly anything that can be accomplished through a budget can also be accomplished through regulation. For instance, a government could simply require parents to send their children to approved schools; this would bypass the budget without eliminating government-directed schooling. Recognition that regulations can substitute for budgets calls into question the common use of budgetary magnitudes to measure the size of government within an economy.

TWO APPROACHES TO PUBLIC FINANCE

The history of fiscal scholarship reveals two distinct approaches to public finance, as set forth in chapter 1 of Richard Wagner’s Fiscal Sociology and the Theory of Public Finance (2007). These contrasting approaches can be described as “systems design” and “social theorizing.” In the second half of the twentieth century the most prominent expositors of these distinct approaches were Richard Musgrave and James Buchanan. Musgrave’s Theory of Public Finance (1959) represents the modern-classic statement of public finance as an exercise in systems design. Buchanan’s Public Finance in Democratic Process (1967) presents public finance as an element of social theorizing, and it set forth an orientation that subsequently blossomed into the field of study now known as public choice.

Systems design and social theorizing represent distinct orientations toward their subject matter. These orientations are not incompatible, but they do pose different analytical questions. The systems design orientation treats public finance as a practical discipline in the service of statecraft: The purpose of public finance is to supply guidance for the conduct of statecraft. Following Musgrave (1959), governments would act to correct market failures by providing public goods that would otherwise not be supplied through ordinary market transactions.

In contrast, public finance approached as an element of social theorizing seeks to provide understanding about the actual conduct of government within society. Following Buchanan (1967), governments are arenas of human interaction and are populated by the same types of people with the same types of interests and concerns as populate other arenas in society. If we start from the universal principle that people seek to replace circumstances they value less highly with circumstances they value more highly, public finance as social theorizing seeks to explore how this principle plays out within governments. Governments and markets are both treated as complex processes of human interaction, and the primary analytical challenge for this approach to public finance is to develop better understanding of the actual conduct of statecraft, as distinct from seeking to participate in statecraft.

ILLUSTRATING THE TWO APPROACHES

The systems design approach to public finance dichotomizes the world of goods into private goods and public goods, and assigns public goods to the domain of public finance. The central analytical question revolves around efficiency in the allocation of resources between public and private goods. It is commonly presumed that market arrangements operate well to organize the supply of private goods, but not of public goods. State action is thus conceptualized as providing what market-based organization cannot provide.

In contrast, the social theory orientation starts from recognition that the theoretical distinction between public and private goods does not provide a good frame of reference for understanding the world of practice. A person cannot take the theoretical distinction between public and private goods and apply it directly to the world of experience: Many public goods are provided through markets and governments provide many private goods. For instance, governments provide security services, but security is also organized through markets; educational services and recreational services are provided by governments as well as through markets; governments sometimes regulate product quality, but market arrangements likewise regulate product quality. This will be the same nearly everywhere one wanders throughout the world of goods.

For the social theory approach to public finance, the analytical focal point is the organization of human activity, not some notion of optimal resource allocation. After all, resources cannot allocate themselves. Only people can do this, and they do so within various societal configurations. The social theory approach seeks to locate fiscal activity as occurring on the same plane as market activity: Both types of activity reflect the same underlying economic principles of preference and cost, and fiscal theorizing seeks to explore how those simple principles generate complex patterns of societal organization through interactions among the members of society.

Vincent Ostrom’s The Intellectual Crisis in American Public Administration (1973) is a splendid and seminal treatment of the distinction between the two approaches. Public finance has a presence throughout the world of goods, but in no case do state and market represent distinct domains of human activity. The domains are tightly intertwined, and in both complementary and competitive manners. If we ask whether water, airports, or anything else are better supplied by governments or through market-based commerce, we are asking a question that has little to do with understanding how societal processes actually operate.

Governments are typically involved at numerous places in the provision of water, airports, and numerous other activities. But so are market-based businesses. A reservoir might be owned by a city, whereas the facilities testing and purifying water are provided by market-based vendors. The city might send you a monthly bill for water, but the meter was produced by a market-based company, as was the paper on which the bill was printed.

The analytical challenge for a social theoretic approach to public finance, as illustrated by Wagner (2007), is to explain the emergence and evolution of observed patterns of social organization, recognizing that those patterns entail a mix of fiscal and market activity. The fiscal and the market denote two intertwined realms of organized activity within society, and both stem from the same source: the varied desires of the inhabitants of a society, as these are mediated through the various institutionalized relationships and modes of conduct that characterize that society.

SEE ALSO Government ; Policy, Fiscal ; Taxes