Public Finance

Public Finance is the branch of economics that studies the taxing and spending activities of government. The term is something of a misnomer, because the fundamental issues are not financial (that is, relating to money). Rather, the key problems relate to the use of real resources. For this reason, some practitioners prefer the label public sector economics or simply public economics. Public finance encompasses both positive and normative analysis. Positive analysis deals with issues of cause and effect, for example, “If the government cuts the tax rate on gasoline, what will be the effect on gasoline consumption?” Normative analysis deals with ethical issues, for example, “Is it fairer to tax income or consumption?”

Modern public finance focuses on the microeconomic functions of government, how the government does and should affect the allocation of resources and the distribution of income. For the most part, the macroeconomic functions of government—the use of taxing, spending, and monetary policies to affect the overall level of unemployment and the price level—are covered in other fields.

This chapter is a reprint of an essay that first appeared in The Encyclopedia of Public Choice edited by Charles K. Rowley and Friedrich Schneider and published in 2004 by Kluwer Academic Publishers, Volume I, 252–262.