Public finance: an explainer
Public finance is the term used to discuss income, spending, and debt within the public sector.
In the United Kingdom, the public sector is formed of governments at all levels – including national and local governments – as well as their publicly funded institutions and services, such as the National Health Service (NHS), the police and armed forces, and welfare benefits such as state pensions. This means that the economic resources that the public sector generates, allocates, and manages are public money and assets.
It is one of the key functions of government to appropriately manage its public finances and effectively allocate its resources. Governments and other public institutions are accountable to the people they represent and serve for the decisions they make, whether it’s how they generate revenue, how they determine their public expenditures, or how they manage public debt.
The scope of public finance
In the United Kingdom, only the government can propose legislation to raise public revenue through taxation, or to use public funds to pursue policy objectives. These proposals are made to Parliament, which then needs to approve the legislation. Once approved, government ministers can carry out their policies within their relevant departments. HM Treasury, meanwhile, is responsible for overseeing the individual department budgets that are allocated from the central budgets it administers.
What is the difference between public finance and taxation?
Public finance is often conflated with taxation, but while they’re indelibly linked, the two are not the same. Taxation is a method of generating public finance funding. For example, in the UK, taxation can include levies such as personal income tax, national insurance contributions, corporation tax, and the value added tax (VAT) on goods and services.
Public finance, on the other hand, considers how best to use and invest the funds raised through tax revenue – as well as through other government revenues, such as investments, borrowings, commercial enterprises, and partnerships – in the interest of individuals, businesses, and wider, macroeconomic stability.
Choosing what to spend public money on
Decisions on how public money is spent are made by ministers appointed by the Prime Minister. Ministers – each have a direct responsibility for a governmental department andare responsible for the public policy direction and business within their departments. They are, effectively, the most influential policymakers in government, but are also required to heed the advice of their accounting officers with regards to conducting public business, and must gain parliamentary approval for government spending.
It’s worth noting that ministers’ policies are typically aligned with the direction, priorities, and – more generally – their party’s policy platform or manifesto. Crucially, the party that forms the government is democratically elected by citizen voters on the basis of its manifesto.
Other potential influencers of policies and public spending include:
- the media
- special interest groups
- wider public opinion
Determining how best to fund and deliver public services
Ministerial departments have considerable control over how they distribute and allocate their budgets. However, while they are largely free to organise, manage, and spend their resources, they are also subject to:
- parliamentary standards
- the direction of their ministers
- adequate controls and reporting arrangements
Within each ministerial department is a departmental board, chaired by the senior minister, that leads on how to fund and deliver public services. These plans are then put into motion by departmental staff and civil servants.
Additionally, HM Treasury is tasked with ensuring that departments raise revenue and spend resources only within agreed limits, and for setting the ground rules for the administration of public money.
Income distribution occurs when public funds are transferred from one group or area to another. For example, money raised through taxation can used to fund:
- state pensions
- public education
- infrastructure projects
- initiatives for tackling climate change
- benefits programmes such as Universal Credit
Distributing income in this manner works to alleviate income inequality and ensure a good quality of life for all people. Economists typically explore income distribution through the lens of a country’s total gross domestic product (GDP), and how this is distributed among its people.
Stabilising the economy
Well-managed public sector finance is credited with helping to ensure economic stability and even economic growth.
For example, it can contribute to:
- stable prices – rather than inflation – in key markets
- lower interest rates
- increased private investment and savings
- reduced public debt, budget deficits, and associated interest
- robust social programmes and social services that enhance health and well-being, and in turn allow for spending reductions in areas such as social care and healthcare in the long term
What are the principles of public finance?
The UK government’s HM Treasury outlines its principles for managing public resources in its Managing Public Money publication. These principles are:
The document goes on to say that these principles are carried out in the spirit of – and to the letter of – the law, as well as in the public interest, to high ethical standards, and achieving value for money. It also notes complementary guidance in the Financial Reporting Council’s (FRC) UK Corporate Governance Code, which applies to central government departments. Among others, the code’s principles include:
- promoting long-term, sustainable success that contributes to wider society
- ensuring that necessary resources are in place to meet objectives, and measuring performance against them
- establishing frameworks for prudent and effective controls so that risk can be assessed and managed
- effective engagement with, and encouraged participation from, stakeholders
- workforce policies and practices that are consistent with agreed values
Finally, the Chartered Institute of Public Finance and Accountancy (CIPFA) represents 14,000 members who work in public finance. CIPFA’s Standard of Professional Practice on Ethics is based on five principles:
- professional competence and due care
- professional behaviours
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