Public Finance

§ 1. In any society that has passed beyond the lowest stage of social development, some form of governmental organisation is found to be an essential feature. The various activities or functions of this controlling body furnish the material for what are known as the ‘Political Sciences’ (
Staatswissenschaften). Every governing body or ‘State’ requires for the due discharge of its functions repeated supplies of commodities and personal services, which it has to apply to the accomplishment of whatever ends it may regard as desirable. The processes involved in obtaining and using these supplies naturally vary much in the several stages of social advance: they are comparatively simple and direct in a primitive community, while in a modern industrial society they present a high degree of complication, and are carried out by elaborate regulations. For all States, however—whether rude or highly developed—some provisions of the kind are necessary, and therefore the supply and application of state resources constitute the subject-matter of a study which is best entitled in English, Public Finance.
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The importance of the subject hardly requires much insistence. The collection of funds for state purposes and the use of the resources so obtained are such vital parts of the political organisation, that they are almost certain to receive attention from all who are interested in political and social inquiries. But, if demanded, abundant evidence is at hand. The citizen of any civilised country need only reflect for a few minutes in order to satisfy himself of the number and importance of the actions of the state on its financial side. His letters are carried by a state agency which claims a monopoly, and in some instances realises a large profit for the general revenue. The commodities that supply his table are in many cases taxed to create a fund for the payment of public services. Either his income or property or some of their elements is sure to be subjected to a charge of greater or less amount, and several of the most ordinary avocations are only open to him on obtaining a costly licence for permission to engage in them. Nor do the claims of the State cease here. In addition to the central body, the local authorities have to be considered. If the person of our supposition be the inhabitant of a town, his house may be lighted by public agency, while it is highly probable that for one of the first necessaries of life—water—he is dependent on his municipality. There is little need for further working out of details. The way in which the purely financial agencies of the State—and still more those which have some connexion with finance—affect the members of the society in their everyday existence, is being ever illustrated afresh by the ordinary course of social life.

The importance of a subject is of itself a strong plea for its scientific study, but in the present case more special arguments may be urged. There is in finance, as in all matters depending in some degree on human will, the possibility of choosing between different courses, some of which are likely to prove better than others; and for the formation of a correct judgment as to the relative merits of the lines of action open to the State, careful examination of the conditions affecting the phenomena is indispensable. Such examination is, however, only possible by scientific study, or rather it is that study. More particularly is this true at present in consequence of the great expansion of the functions of the State, which is partly due to—and which in turn increases—the complicated structure of modern societies. The effects of state action in a primitive community are far more easily followed; the forms both of revenue and expenditure are reducible to a few simple kinds, directed by rude or partially developed agencies. The modern State, even when it allows an amount of individual liberty unknown in any former period, is obliged to employ complicated machinery for the regulation and management of its outlay and receipts. The results, moreover, are not so readily perceived; numerous interests and classes are affected by any change in the course of public expenditure or by readjustments of taxation. The many indirect results of financial processes must be considered before we can either understand their operation or fairly judge their merits; but to trace the action of economic forces in their effects on the highly developed systems of modern industrial societies is a task of considerable difficulty, not to be accomplished without the aid of general principles and careful reference to former experience. The case for a scientific study of finance is so strong that it does not require much vindication, and the value of critical investigations has been already proved by the results obtained.

§ 2. The scope of our subject has now been indicated in a general way, but for clearness of thought and in consequence of the differing views of many writers of authority we must determine it more precisely. State expenditure and state revenue at once occur to the mind as the two great heads of inquiry, standing opposed to each other as Production and Consumption, or Supply and Demand do in economic science. Closer examination shows that this simple grouping does not exhaust the field of investigation. Problems of revenue and of expenditure are, indeed, the most important. Adam Smith, who was, at least for England, the founder of the scientific study of public finance, as of political economy in general, devoted separate chapters of his Fifth Book to ‘The Expenses of the Sovereign’ and ‘The Revenues of the Sovereign’; but by the nature of the subject he found himself forced to add a third section, in which the relation between expenditure and receipts is examined. He knew that many ancient and mediæval sovereigns had accumulated treasures; it was apparent that most modern governments had heaped up debts—a process that has been carried much further since his day; and it followed that an inquiry into the balance between state incomings and outgoings was an essential, as well as difficult, part of public finance.

Nor is this the only addition. The phenomena to be dealt with do not admit of being conveniently grouped under Adam Smith’s three heads. This difficulty is at once felt on calling to mind that the expenditure and revenue under consideration are
state expenditure and
state revenue. We must examine, not merely the processes, but also the mechanism by which those processes are carried on. For the collection and application of wealth by the State legislative and administrative action is needed. The right of voting supplies and supervising expenditure—’the power of the purse’—is one of the leading privileges of a representative body; it is also the most effectual safeguard of constitutional rights. Methods of administrative control seriously affect the working of the national finances, and are deserving of attentive study. No financial treatise can be complete unless it considers the problems of ‘the budget’ and ‘financial administration’ (
Finanzverwaltung), and such has in late years been the almost invariable practice.
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In one respect the scope of public finance has been curtailed by some of its ablest expounders. French writers, more especially M. P. Leroy-Beaulieu, have refused to regard the problems of public expenditure as a part of their subject. The reason for this limitation is said to be the difficulty of scientifically determining the proper amount of state outlay, as that must depend on the functions assigned to the State. ‘This kind of inquiry,’ says M. Leroy-Beaulieu, ‘does not in my opinion belong to the science of finance….. A State has wants: it does not belong to us at present to know what they are, and what they ought to be, but how it is possible to satisfy them in the amplest manner with the least loss and sacrifice to individuals. If you engage a builder to build you a house, it is not his business to inquire if the building is too large for your income or your social position; what does concern him is to build the house in question with the utmost possible solidity, convenience and beauty, at the lowest cost to the owner. In like manner, a writer on finance can sincerely lament that States spend too much; but his real task lies in showing how a State can obtain supplies, while treating the interests of individuals with due tenderness and respecting justice.’
*3 English writers have gone further in this direction, and, by disregarding all forms of State revenue except that derived from taxation, have replaced the broader treatment of Adam Smith and the Germans by treatises on ‘Taxation’ and ‘Public Debts.’
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It nevertheless seems clear that the question of expenditure is just as much a financial problem as that of revenue. Neither in theory nor in practice is it advisable to separate them completely. The greatest finance ministers have made their reputations as much by judicious control of outlay as by wise reforms in respect to revenue,
*5 while for theoretical discussion the principles and facts of expenditure are of considerable interest. M. Leroy-Beaulieu’s suggested parallel of the builder is not in point, since the practical statesman is the only person to whom the illustration would apply, and he evidently does not act in conformity with it; the scientific student is only limited in his inquiries by the nature of the material that he is investigating. One admission may indeed be made. Questions of expenditure do not allow of quite as precise treatment as those referring to taxation, some parts of the latter subject permitting the use of lengthened deductions. This test of fitness for exact investigation would, however, exclude other large parts of the subject—
e.g. ‘the public domain’—which are nevertheless discussed by all recent writers, M. Leroy-Beaulieu included. For a complete inquiry into the theory of finance some consideration of the conditions governing State outlay is indispensable—
e.g. the increase of military expenditure in European States, its causes and limits, cannot be left wholly unnoticed by any thorough student of public finance. Such an inquiry is more especially needed owing to the fact that expenditure and revenue are connected. Public outlay is not something unchangeable and determined, to be met ‘with the least loss and sacrifice to individuals.’ Expenditure that would be legitimate in a lightly taxed State would be blameworthy in one that is heavily taxed. The aim of the statesman is not simply to distribute loss and reduce it to a minimum; it is rather to procure the maximum of advantage to the community, and to so balance expenditure and revenue as to attain that result.

The principal difficulty in the scientific examination of public expenditure is found when attempting to limit the mode of treatment. Some writers enter into discussions as to the legitimacy of certain state functions, and their relative urgency. Others simply state the forms and facts of public outlay, leaving further inquiry to the political theorist. In the present work, in accordance with the precedent set by Adam Smith, the several items of expenditure will be treated on a positive basis, and at the same time the considerations naturally arising from their existence, and the financial questions that they suggest will be noticed, though no complete examination of state functions will be attempted. Whatever theoretical questions may be raised, such seems to be the course that convenience suggests, and is one to which the subject naturally lends itself. Our object is to elucidate the principles of public finance; and the admission or exclusion of any special topic, as well as the extent of treatment in each case, must be determined solely by reference to that end.
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§ 3. Theoretical writers on finance, especially in Germany, have very fully considered the relations of their subject to cognate branches of knowledge,
i.e. to the various social and political sciences, and have in particular laid stress on the ties that bind it to economics.
*7 In its origin financial science was a product of economic study. It appears either as a special section, or as the main subject of the older treatises of Political Economy, ‘when considered as a branch of the science of a statesman or legislator,’ to quote Adam Smith’s phrase. In another aspect it may be regarded as belonging to administration, and as such formed a large part of the ‘Chamber Science’ (
Cameralwissenschaft) which was in Germany the precursor of scientific economics. The undue limitation of the scope of finance by English writers has led to its inclusion under the title of ‘taxation’ in the various systematic expositions of political economy,
*8 and the more enlarged view taken by German writers has not prevented a similar result in that country, for since the time of K. H. Rau, political economy has been regarded as comprising, in addition to the general theory, the economics of special industries, economic legislation and administration, as well as public finance.
*9 This apparent absorption of finance in economics is really the result of a peculiar conception. If the latter science be limited, in the manner usual in England and France, to an investigation of the laws governing the phenomena of wealth, it is beyond dispute that public finance cannot form a part of it, as political and fiscal conditions have to be recognised to an extent impossible in a pure science of wealth. Moreover, practical considerations have to be weighed in every department of finance. That political economy in the most extended use of the term may fitly include finance is indeed true, but then it would appear that this wider political economy is nothing more than a common name for the various social and political sciences; it is in fact a rudimentary Sociology and Art of Politics combined.
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Though the problems of finance are really suited for treatment in a separate form, it does not follow that their relation to economics should be disregarded. On the contrary there is a close connexion, or rather series of connexions, between the two studies. State outlay is a part of the consumption of the society of which the State is the regulating organ, and for a knowledge of the conditions that govern it we must have a theory of the consumption of wealth in general. Unhappily, questions relating to consumption have been too much neglected by economists, and thus there is no complete theory available for application to financial problems. Still, the leading truths on the matter are suggested in modern economic theories, and may be developed by their aid. The management of state property, again, requires a reference to various economic doctrines, and more especially the industrial enterprises carried on under a public monopoly illustrate and are explained by the general theory of monopolies. It is, however, when we reach taxation that the aid of economics becomes most valuable. The merits of the general system of taxation, as also those of each special tax, have to be tested by the aid of economic principles. The important problem of justice in taxation is indeed an ethical one, but until its economic effects are known it is impossible to say whether any given form of taxation is just or the reverse. All the intricate points respecting the incidence of taxation can be handled successfully only by applying a sound theory of the distribution of wealth, and the effect of taxation on accumulation makes it necessary to constantly bear in mind the conditions of effective production. In another department of finance, the nature and effect of public loans can be best explained by the economic theory of credit, and such is the course usually adopted. An acquaintance with economic science is, it may be said, an indispensable part of the equipment of the student of finance.

§ 4. Close as is the relation between economics and finance, it is by no means exclusively to the former science that we have to look for aid when developing the latter. In a subject so inseparable from the State, it is in many cases necessary to recognise the action of political and administrative conditions. Financial problems are often the occasions on which constitutional issues are raised, and, as noticed above, they may make a line of conduct desirable, that from the purely economic point of view would be very objectionable. The same statement holds good of administration.
*11 The whole system of finance must be kept in conformity with the general mode of managing the affairs of the State. This is, in fact, involved in the position that public finance belongs to the domain of political science.

The science of finance has another important auxiliary in history, which illustrates, verifies, and in some instances affords data for its principles. The material of financial study is not confined to that afforded by modern societies, and even for a true knowledge of actual conditions it is often necessary to be acquainted with their growth. No pure
a priori system of finance can be successfully established. Each country has special features arising from its previous history and the sentiments of its people—in great part the product of historical forces. The most violent revolution cannot really break this connexion with the past.
*12 As a consequence, a system admirably suited for one country, may be quite unfitted for another. A comparison of the systems of the United Kingdom and of India shows at a glance extraordinary differences, and yet in each case the attainment of solid results. These obvious truths, however, suggest the need of a caution. The necessary varieties of financial practice do not show that general principles are unattainable, though they tend to render their application more difficult. The conclusions of financial theory ought to underlie all the special systems and regulations, but they require to be applied with most careful regard to the circumstances of time and place, and, above all, to the sentiments and habits of the people. Any form of expenditure or taxation that is peculiarly obnoxious has, by that fact alone, a strong presumption raised against it, to be rebutted only by very weighty reasons on the other side.

As history throws light on the evolution of finance, and enables us to confirm or to limit our general propositions by the evidence derived from previous times, so does statistics give us a firmer position in dealing with the present. Without correct information as to state revenue and expenditure, financial policy is little better than guesswork. In order to comprehend the effects of taxation it is indispensable to have full statistics as to the distribution of wealth among classes and among localities. Such materials as those collected by census agencies and statistical departments are necessary elements in any financial calculations, and their absence, of itself, suffices to explain the late origin of financial science. In no respect is modern administration so superior to that of ancient and mediæval times, as in the improved data on which it bases its estimates and makes its practical suggestions.

§ 5. From an examination of the various sciences that may assist the study of finance, we pass by a natural transition to the proper method of inquiry. In regard to all the social sciences, and notably to economics, this question has been vigorously discussed, even to the neglect of the positive matter of research. The principles of scientific inquiry and the appropriate method of investigation belong in reality rather to logic than to the special sciences; though the processes employed in discovery can only be adequately appreciated by those who are conversant with the particular branch in which they are used. At all events, it is clear that the disputes as to method have in many cases arisen from misapprehension as to the exact position of each of the contending parties. Protracted controversy has, however, finally led, if not to complete agreement, at least to a recognition of the common ground occupied by the disputants, and also, it may be said, to a belief that the whole question is, as has often been remarked, one of ’emphasis.’ A difference in view is, in many cases, the result of personal tastes; one writer places much weight on a particular method, another on a different and apparently opposed one, though both, if interrogated, would probably allow that each form of inquiry was valid within limits, the exact fixing of which would be the only point in dispute.
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The principal ground of debate was for a long period as to the claims of the ‘inductive’ and the ‘deductive’ methods to be regarded as the sole legitimate process of investigation. To that question it may be confidently replied that both are in particular cases valid and indeed indispensable. Without ‘induction’ in the wider sense of the term
*14 no materials for study would be available: mere observation without arrangement and generalisation is evidently worthless for scientific use. The particular form of induction which proceeds by comparison is frequently serviceable. The simple juxtaposition of two financial systems will sometimes throw a great deal of light on the conditions governing each. In this process history, as we saw in the preceding section, plays a great part, and it is thus quite correct to maintain that the science of finance is in one of its aspects ‘inductive,’ ‘comparative,’ and ‘historical.’

But this, though the truth, is not the whole truth. The generalisations of economics and the permanent facts of human nature enable us to draw important conclusions as to the effects of certain forces in their bearing on finance. The whole theory of the shifting and incidence of taxation is and must be ‘deductive,’
i.e. it must be developed from simple conditions by logical trains of reasoning. Deduction, too, is needed in order to ascertain the effects of public indebtedness as well as to trace the ultimate results of public expenditure. It must be remembered that in all these cases verification by appeal to facts is required, but the process of verification is admittedly one of the component parts of the deductive method. On the whole, the study of finance will force on us the conclusion that ‘induction’ and ‘deduction’ are not so much opposed, as complementary, methods, each remedying and making good the weakness of the other.

The preceding argument holds, to some extent, of even the most extreme forms of the two methods. Thus, some—as Macaulay—have maintained that experiment is the really fruitful form of social inquiry. Now, though it is evident that, strictly speaking, experiment is impossible in respect to any part of social life, since we cannot bring about that isolation of a particular phenomenon without which no experiment can be conclusive, it yet seems true that a modified form of experiment may give a probable result that will, in some cases, prove of great practical use. Thus in finance, each change of taxation may be regarded as an experiment in the popular sense; if, to take an instance, it appeared that a reduction in the rates of taxation on commodities so stimulated consumption that the loss in revenue through the reduction was made up by the increase in the quantities used, it might fairly be said that the policy of reducing duties was experimentally justified, notwithstanding that the logical conditions for experiment were absent. We must, however, notice that a result of this kind cannot safely be extended to fresh cases unless it is supported by more general considerations.
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The advocates of the mathematical method stand at the other extreme. There is, at first sight, something absurd in suggesting so exact a mode of inquiry in a subject where very many complications exist, and where each fact is dependent on a number of circumstances, but in those parts of finance in which deduction is the best instrument of research it may prove convenient to arrange the steps of reasoning in a mathematical form; the problem will perhaps be thereby more easily solved, or its exposition more readily followed.
*16 Where the conditions can be sufficiently simplified, and where it is important to develop the quantitative results, this procedure is probably advisable.
*17 It is, however, at best confined to a very limited area, and needs to have its conclusions tested by the best statistical results available. The more concrete problems of finance are entirely unamenable to this rigid and precise method of treatment.

§ 6. Having thus briefly considered the questions preliminary to the study of public finance, it only remains to give an outline of the course of our further inquiries. After a very concise account of the historical development of financial science (Introduction, Chapter II.) we shall take up the subject of public expenditure and its principal problems (Book I.). Next in order of treatment will come the public revenues, and first what may be described as the economic and industrial receipts of the State and their subdivisions (Book II.). The examination of these more primitive forms of revenue will lead up to the discussion of taxation. Owing to the great extent and complexity of this topic it will be expedient to devote a separate book to the general problems of taxation (Book III.), reserving the study of the several taxes for distinct treatment in Book IV. The questions relating to revenue having been thus disposed of, Book V. will deal with the balance of expenditure and receipts, or, in other words, with public treasures and public debts; while the mechanism, administration, and control of the financial system will form the subject of a final book (Book VI.).

In order to emphasise the close connexion that exists between general and local finance, the matter usually collected under the latter head has been distributed among the different divisions of the work. Thus local expenditure is examined in Book I., local economic revenue in Book II., the principles of local taxation in Book III., and in like manner the tax forms, the indebtedness, and the financial mechanism of subordinate political bodies are discussed in the books dealing with those parts of public finance.