PUBLIC FINANCE

Lecture Notes Week 1

Public Finance
Public finance is a scientific discipline /sub-discipline that analyzes the effects of the
expenditures made by the government to meet social needs and the revenues collected to
finance these expenditures on economic activities.

The aim of public finance is to understand the role of the government in the economy. For this
purpose, answers to the following questions are sought:
When should government intervene in the economy?
-Market Failures –Redistribution –Economic Stabilisation -Paternalism
How might government intervene?
-Taxes & Subsidies -Regulations -Public Provision –Public Financing of Private Provision
What is the effect of those interventions on economic outcomes?
- Direct Effects -Indirect Effects
Why do governments choose to intervene in the way that they do?
Economic activities influence political decisions influence the economy
Who or What is the Government?
► From birth to death, our lives are affected in countless ways by the activities of
government.

► Government can be defined as the governing power of the state and acts on behalf of the
state. In democratic systems, government functions with three branches: the legislature,
executive, and judiciary. The government consists of thousands of governmental
units/agencies/administrative departments that govern the state which make rules and
policies and provide public services to meet collective needs.

► Today, all economies operate as a mixed economic system. In these economies, some
economic activities are carried out by the private sector while others are carried out by the
government (public sector). In addition, the government influences the behavior of the
private sector in various ways.
 The Viewpoint Changes the Role of the Government
► As a normative question what should functions of government be is depend on how people
regard the relationship between the individual and the state and how people view the
relative effectiveness of markets and government.
► Organic View of Government: In this understanding, society is regarded as a natural
organism like the human body, and the government is the heart of it. The individual has
importance only as a part of society and the good of the individual is defined according to
the good of the whole. The state sets the goals of society and leads the realization of these
which are superior to the goals of the individual.
► On the other hand, the mechanistic view of government puts the individual at its center.
Government is not an organic part of society but created by individuals for individuals to
better achieve their goals. The individual is above the state, and the state is perceived as
an instrument used to realize the common goals of the individuals who constitute it.
 The Role of Government
Max. Government Min. Government

Socialists advocate command Social Democrats: recognizes Conservatives, like libertarians, Libertarians prioritize private
and control economics. This that markets are generally recognize that markets are property and advocate an
view argues that the government productive but believes that a generally efficient. However, they extremely limited government.
allocates resources to meet significant degree of are more inclined than The government should provide
social needs more efficiently government intervention is libertarians to accept that the national defense, protection of
and fairly than the markets. In necessary for the good of government can do some things property rights and certain
this respect, common or public individuals. Ownership is a more efficiently than the private public works.
ownership of the means of pragmatic issue and the mix of sector. They also argue that the
production is advocated. ownership that best meets the state has an obligation to
goals of society should be support poorer groups in society
adopted. The social democratic and that it is in the state's
tradition emphasizes equality. interest to do so to prevent
Redistribution is seen as an unrest and disorder.
appropriate and desirable
function of the system.
 Historical Perspective
► Assumptions and prevailing views about what the role of government should be in the
economy have changed considerably over the past centuries. For example, while the
dominant economic thought for most of the 19th century was in favor of a limited state,
developments at the beginning of the 20th century led to a view in which the government
plays an increasingly larger role in the economy.

► At the end of the 20th century, following the collapse of the Soviet Union, views that
prioritized the markets and advocated the downsizing of the government were defended.
The economic crises at the beginning of the 21st century and the subsequent Covid 19
pandemic brought about a period in which the role and weight of the government in the
economy increased again.

► The role of the government in the economy is a dynamic concept that changes over time
and place and is shaped according to the conditions of society and the world.
Views on the Role of Government
Mercantilism

► Mercantilism is an economic theory and practice that rose with the decline of feudalism and
the emergence of centralized nation-states and dominated Europe from the 16th to the
18th century. This view emphasizes the importance of government intervention in the
economy to enhance the state's power by accumulating wealth in a zero-sum game.

► In order to accumulate precious metals (gold, silver), which are the main measure of wealth,
and to increase the wealth of the country, it was aimed to protect the domestic industry,
encourage exports, and discourage imports except raw materials with policies aimed at
foreign trade surplus. In this respect, it is a protectionist /interventionist doctrine.

► Another fact that characterizes the period is colonization/colonialism in order to supply raw
materials and create markets.
 Views on the Role of Government
Physiocracy
► Is a system of thought that was particularly influential in France in the 18th century. It is the
period when financial issues were theoretically put forward and scientifically defended for the
first time. In physiocrat thinking, there is a natural order (natural order, the hand of God) and
government intervention in this order should be minimal.
► Unlike the mercantilists, the physiocrats emphasized the free market and argued that
regulation and control were obstacles to growth. In this respect, they were the pioneers of
Liberalism 'Let them do, let them pass'.
► According to the physiocrats, agriculture is the only productive sector while manufacturing
changes the form of wealth and trade changes its location and owner. Taxes should be levied
on landowners who confiscate the surplus product without producing it.
 Views on the Role of Government
Classical Liberal Thought
► It emerged in the late 18th and early 19th centuries with the ideas of thinkers such as Adam Smith,
Thomas Malthus, Jean Baptiste Say, David Ricardo, and John Stuart Mill and was the dominant system of
economic thought until the Great Depression of 1929.
► Although influenced by the physiocrats, the natural-divine order was replaced with the invisible hand of the
market. According to this approach, the market mechanism provides spontaneous equilibrium in the
economy. Adam Smith argues that when individuals try to achieve self-interest in the markets, the resulting
market outcomes will benefit society as a whole. In this respect, the government should not intervene in
the economy.
► In Wealth of Nations, Adam Smith argued that the government should protect “the society from the
violence and invasion of other independent societies,” and protect “as far as possible every member of the
society from the injustice or oppression of every other member of it”. In addition, the government should
provide public services that are beneficial to society but which certain individuals or groups of individuals
will not provide because they do not find them profitable.
► Smith opposed private ownership of transport infrastructure such as roads, canals and harbors, as
monopolists could exploit the system. He also supported public expenditures such as education.
 Views on the Role of Government
Classical Liberal Thought
► Although it is against government intervention in principle, it is accepted that the existence
of the government is necessary.
► It is assumed that the government will waste resources. Government expenditure must
therefore be small in volume. The budget should be balanced. In line with these
propositions, public revenues should be naturally limited.
► Taxes that do not alter the relative price structure and maintain neutrality toward economic
activities should finance public expenditures. Public expenditures and taxes should not
cause changes in production, consumption, investment, and saving decisions. Fiscal
instruments should be used only for fiscal purposes.
► Borrowing is an extraordinary public revenue that can be resorted to only in times of war,
budget deficits should not be financed by short-term debts and the governments should
borrow from the capital market where long-term funds are raised instead of the money
market.
 Views on the Role of Government
Keynesian Approach (Interventionist Government)

► The Great Depression, which caused the US unemployment rate to reach 25 percent and
national output to fall by about a third from its peak in 1929, fundamentally changed views
on the role of the government in the economy.

► John Maynard Keynes built the intellectual foundation for an interventionist government
approach in order to raise aggregate demand in such a way that the economy would return
to the full employment level in his seminal work "The General Theory of Employment,
Interest and Money" and his views were widely accepted.

► The concept of neutral government and balanced budget were abandoned and the view
that argues the economy should be intervened with fiscal policy instruments such as public
expenditures, taxes and borrowing in order to achieve the objectives was adopted.
Views on the Role of Government
"Economic Rationale" Approaches
The government should intervene in the economy when economic rationality – economic situation
requires it. The government should engage in activities other than traditional functions like national
defense, public order, justice, and diplomacy.
Samuelson's View
Indivisible goods and services (pure public goods and services) should be provided by the
government and divisible goods and services (semi-public and private goods and services)
should be provided by the private sector. However, if the private sector is unable to provide
divisible goods and services, the government should also provide these goods and services.
Tabatoni and Brochier's View [Cost Comparison]
The decision in which areas the public and the private sector will produce should be made by
comparing their costs. Whichever of the public or private sector is more efficient should
undertake production.
Chamberlin's [Imperfect Competition] View:
The government should operate in monopoly and oligopoly markets that are far from perfect
competition, regulate the activities in these markets, and thus ensure optimal resource
allocation
 Views on the Role of Government
Musgrave's View

► Richard Musgrave argues that since the market cannot achieve efficiency in resource
allocation, distribution of income, and economic stabilization by itself, the government
should intervene in the economy for these three functions.

The allocation function requires the government to respond to market failures, such as the provision
of public goods, the solution of externalities, the promotion of competitive markets or the regulation
of market power, and the protection of individuals from information failures.
The distribution function requires the government to eliminate poverty and reduce income
inequality
The stabilization function requires government intervention to ensure price stability and full
employment.
Views on the Role of Government
Public Choice and Constitutional Economics

► This approach, which treats the political process as an exchange, argues that the utility-
maximizing actions of politicians and bureaucrats, - the supply side of the public economy-
and voters and interest groups, -the demand side- should be limited by constitutions. In
contrast to the argument of market failures, which is the main justification for state
intervention in the economy, " government failures", which are the inefficiencies caused by
government intervention in the economy, are emphasized.
 State Modals
Minimal State

► It is the state model envisaged by liberal thought and the classical school of economics. It
is a type of state whose intervention in the economy is sufficient to maintain organized
economic activity. The responsibilities of the minimal state include national defense, public
order, and justice. These services are related to the protection of property rights and
contract enforcement.

Public Services State (R.Musgrave and J.Stiglitz)

► In this form of state, resource allocation (what? how much? how? for whom? how to
distribute?) is basically carried out by the market mechanism. However, in cases where the
market does not function and there are disruptions in resource allocation, the government
intervenes in the economic structure in a wide range from regulations to redistributive
fiscal policies; from public solutions to externalities to price stabilization measures.
State Models
Developmental State Model

► The developmental state is a form of state that combines strategic government intervention with
private ownership and market dependence and is based on strategic industrial policy measures.
Especially in developing countries, the government intervenes in the economy through planning in
order to overcome the lack of capital accumulation.

► With import substitution policies on the one hand and extensive public entrepreneurship on the other,
the state has become the locomotive of economic development. It has been particularly successful in
the 1950s and 60s in countries such as South Korea, Taiwan and Hong Kong.

Welfare State Model

► A welfare state is a type of state that tries to increase the welfare level of the people through various
social expenditures financed from public resources. (Keynes-Beveridge) The main tasks of the
government are to ensure full employment and redistribution of income. In this context, the
redistributive government advocates the right to private property, but limits and controls private
property and the right to contract in the public interest.
State Models
Marxist Model of State

► According to Marxist theory, the state functions in a class based society to protect the
interests of the ruling class, not all individuals. The main task of the state is to ensure the
profit maximization of the capitalist bourgeois class. In this context, it is partly responsible
for the exploitation of the labour class. As a solution, they argue that the ownership of the
means of production should belong to the state.

Contemporary State [Proactive – Neo Developmental State]

► With the globalization phenomenon, the state’s form has also changed with many other
things. While on the one hand, there is a focus on making national firms competitive in
global markets, on the other hand, there are increasing public expenditures in order to
partially protect the victims of increased globalization.

► Briefly in the proactive - neo-developmentalist state model, "decision-makers seek an

optimum balance between integrating their economies into the global economy, attracting
foreign capital investment and easing domestic distributional problems".
 Public Sector in Türkiye

Funds Revolving Funds Public Economic Enterprises

General Government
Money allocated from the budget Enterprises established within the Public economic enterprise (PEE) is
Central Government Local Governments Social Security Institutions or extra-budgetary sources in general and special budget the common name of State
Special Provincial Public administrations established by order to realise a specific purpose administrations with the capital Economic Enterprises (SEE), whose
General Budget Administrations
Administrations law or presidential decree to provide and kept in a designated account allocated for the continuation of capital is wholly owned by the state
Administrations that do not have a Municipalities social security services. to be spent when necessary. the activities related to the and which are established to
separate legal personality, are Associations and Social Security Institutions: Budgetary Funds production of goods and services operate in the economic field
included in the legal personality of administrations that are Social Security Institution • Support and Price Stabilization arising from the primary and according to commercial principles,
the state, do not have their own related to or established General Directorate of Turkish Fund permanent public duties of those and Public Economic Institutions
property and income, and are within or participated as Employment Agency Extra-Budgetary Funds administrations and that cannot (PEI), whose capital is wholly owned
the scope of the principle of treasury members by them • Defense Industry Support Fund be carried out according to the by the state and which are
unity. • Savings Deposit Insurance Fund principles of general established to execute production
TGNA, Presidency, All Ministries, • Social Assistance and Solidarity administration. and marketing of the monopoly
Constitutional Court, Court of Support Fund goods and services, due to its public
Cassation… • Unemployment Insurance Fund obligations.
• Privatization Fund A Joint stock company formed by a
Special Budget Administrations • Promotion Fund production unit or a group of
• Turkey Wealth Fund production units, more than 50% of
Institutions established to carry out a specific the capital of which is owned by the
public service under or related to a ministry, SEEs or PEIs is called as subsidiary,
with separate legal personality, with its own Joint Stock Companies, in which
revenues and spending authority. SEEs or PEIs or their subsidiaries
Council of Higher Education, State have minimum 15% maximum 50%
Universities, Turkish History Society, Turkish of their capital are called as
Language Association, participation.
The Scientific And Technological Research
Council Of Türkiye

Regulatory And Supervisory Agencies

Regulatory and supervisory bodies organized
as boards, institutions or supreme boards by
law or presidential decree.
Radio and Television Supreme Council, Capital
Markets Board, Banking Regulation and
Supervision Agency
 Size of the Public Sector
General Government Revenue and Expenditures
2015 2016 2017 2018 2019 2020 2021 2022 2023 (1) 2024 (2)

Total Revenue (Million TL) 799.173 904.305 1.028.170 1.238.511 1.429.249 1.636.668 2.239.451 4.180.694 7.697.388 12.859.787

Total Revenue (% GDP) 33,99 34,43 32,81 32,93 33,10 32,42 30,86 27,85 30,21 31,24

Total Expenditure (Million TL) 801.532 940.469 1.085.493 1.327.133 1.560.855 1.835.395 2.430.807 4.300.770 9.349.050 15.328.589

Total Expenditure (% GDP) 34,09 35,81 34,64 35,29 36,15 36,35 33,50 28,65 36,69 37,24

Source: Presidency of Strategy and Budget

(1): Provisional
(2): Program
 Central Government Expenditures in Turkey FY2024 (Million TL)

2.558.608
%21,4 3.655.403

%30,6

1.422.845
%11,9

%5,2
155.522 %1,3
%6,5 %5,9 623.935
784.216 %2,4
%14,1
%0,15
294.639 708.819
18.221
1.689.526
General Public Services Defense Public Order and Safety
Economic Affairs Environmental Protection Housing and Community Amenities
Health Recreation, Culture and Religion Education
Social Protection

Source: Budget Justification of FY2024

 Central Government Budget Revenue Estimations FY2024 (Million TL)
253.506 145.883 115
214.384 7.526 1.206.409
68.961
%14,47

1.409.765 %16,91

1.314.512

%15,76

%39,99
3.341.959
Income Tax Corporate Tax Value Added Tax
Special Consumption Tax Motor Vehicle Tax Banking and Insurance Transaction Tax
Fees Stamp Duties Inheritance Tax

Source: Central Government Budget Law FY2024