CHAPTER 2: THE DEVELOPMENT OF PUBLIC

FINANCE
 INTRODUCTION

• The development of the state was a product of developing public finance

institution. Changes in concepts of what should be the functions and
responsibilities of the state have to a large extent shaped concepts of what the
goals of public finance ought to be. For after all, public finance fraises and spends
revenue for the functions of the state. These functions have been changing with
the development of society. Thus, tracing the development of public finance
institutions necessitates an examination of the development of organized society
itself.

• Students of western society identify the following stages of development: the

primitive societies, slave states, feudal systems, capitalist, and socialist systems.
On the other hand, other writers include the less developed countries as a specific
stage of development towards either a capitalist state or a socialist system.
 EARLY PUBLIC FINANCE
• If we are to trace the origins of public finance institutions, we would probably start
with the beginnings of the state under the slave societies. Under the primitive
societies, there was not probably much public finance to speak of. The primitive
tribes were on a subsistence basis, with hardly any surplus. Whatever was
acquired from hunting and fishing was immediately consumed. Battle over
territories, the capture of defeated tribes who were turned into slaves, the
development of settled agriculture and rudimentary advances in the production of
goods led to the great slave empires of Asia, Africa and Europe.

• Ancient public finance provided some of the basic instruments of public financial
management (i.e. budget and expenditures, tax and revenue administration, and
debt and borrowings). Medieval public finance further refined some of these
concepts, distilling their basic aspects by an expanded application to medieval
public goals and conditions. It also introduced some basic tools like accounting and
auditing.
 A. ANCIENT FINANCE: THE SLAVE
SOCIETIES
• The idea of financing public goals and activities is as old as the
organization of public authority. Logically, the beginnings of public
finance started from the creation of the state. The state was created
by the necessarily to protect and purportedly promote the welfare of
man. Basically, the state was comprised of: the government, the
people, territory, and sovereignty. Public finance was supposed to
preserve the state and promote the goals of society.in particular it
financed the activities of government.
 Expenditures
• The role of public finance, therefore, became inextricably linked with
functions of government. The traditional public finance-government
functions unity originated from ancient times. To protect and maintain
the state system, the government had to perform several vital
functions. Among the most basic of these functions was the protection of
the people, the territory and sovereignty from outside aggression.

• Second primary functions, the preservation of internal peace and order

and security and the administration of justice. Considering the fact that
a vast majority of the population might rebel any time, peace and order
for the ruling minority was a primary concern. The administration of
justice, of course, was for the free citizens and not for the slaves.
Security, within and without, can therefore be considered as the main
function of ancient governments; it therefore followed that much of
public finance was poured in this activity.
 Expenditures
• Third function was the maintenance of a state religion. Religion helped
stabilize and rationalize the ruling order in slave empires. It therefore
played a major role in justifying the slave system. In slave empires, as in
Egypt, the rulers were considered gods and goddesses; they were looked
upon as human manifestation of deities and were considered religious as
well as temporal leaders.

• Fourth functions, the maintenance of the king and his household were
deemed the inalienable right of the sovereign. It was the people’s
obligation to provide him with revenues and he, to spend such (as a divine
obligation), for anything he deemed good for the public welfare. This
function has its modern counterpart in the general national government
expenditures.
 Expenditures
• Building and maintenance of public works was also a common activity in
the slave societies. Roads, canals, irrigation systems, pyramids, and
fortification were considered public concerns to be financed from public
resources.

• The term “public works” may not necessarily be descriptive of the massive
structures were built in ancient times since quite a few of them were really
tombs of rulers.

• Finally, the other state concerns included limited goods and services like
the distribution of free grain in times of famine as in Rome, public
recreation, and physical education.
 Revenues
To finance its public functions: the state imposes and collect revenues

• The slave state’s revenue were ordinarily limited to lootings and

tributes from conquered peoples, war chests, fines, and direct taxes
imposed on non-citizens of the State or on conquered peoples. The
vassalage taxes imposed on conquered provinces and donations or
gifts from the wealthy citizens of the state.
• Imposes taxes in times of emergency.
• Gifts of some citizens
• Public domain particularly from agriculture and mines
• Poll tax levied on Egyptians male populations and non-Roma citizens
engaged in business
• Tax on inheritance
• Higher tax rate for childless couples and unmarried individuals
 Budgeting
• Budgeting was exercised because of the need to
allocate public revenues for specific purposes. Since
the public budget was emerged with the king’s purse,
there was no distinction between the public and the
king’s private expenditures.
 Borrowings
• Public borrowings and debt management were
unheard of. Although there was already a form of
money lending, the ancient state did not borrow
money even in emergencies. It only solicited gifts or
levied limited taxes. The ancient state was relatively
self-sufficient and public expenditures were usually
borne by the citizens and non-citizens without
recourse to loans.
 Auditing
• State audit was also an ancient and respected branch
of state administration. The principle of accountability
for those in charge of government expenditures, if a
resource from public funds, is perhaps as old as
organized government. The principle of independent
state audit was accepted in ancient Greek state.

• To summarize, public finance in ancient time was

understandably limited in scope and activity. This was
because concepts concerning the responsibilities of
the slave state were likewise limited to a few basic
functions.
B. MEDIEVAL PUBLIC FINANCE (395 A.D-1500)

• The development of medieval public finances closely followed

changes in the political structure of the state during the middle
ages. The changes encompassed the weakening of the monarchy
(central government) at the outset of the medieval period, the
subsequent fragmentation of public authority resulting in the
systems of feudalism, and the rise of limited monarchy at the end of
the era. The shifts in the form of government very gradual. Hence,
the ramification was not only diverse but overlapping. Moreover,
medieval conditions were greatly varied in scope and nature among
the different European states.
 Feudalism
• Feudalism was essentially the system of economic relationship
based land tenure, among the king, the lord, and the vassals. In
England and France, it developed to its fullest, embracing as well
the politics, social, and cultural patterns of life. Some western states
while not fully feudal also experienced varying degrees of feudal
life.

• The feudal lords became vassals to the king (suzerain), accepting

the fiefs in promise for aids and soldiers. Many lords acquired more
lands (manors) than they could manage or farm.

• One of feature of the feudal system, the suzerain-lord relationship

implied the responsibility of the feudal lords to support the king
with revenues for the latter’s public expenditure.
 Feudalism
• More often, the king was increasingly forced to subsist mainly
upon the income from the property he directly owned (the royal
demesne). The king imposed fees on his subjects who hunted or
fished in his demesne and imposed fines on trespassers. In
addition, the king derived revenues from the bona vacantia,
precious metal found, stolen goods, stray cattle and wrecked ships.

• By way of summary on public finance in medieval times or

feudalism, revenue raising and expenditure occurred at two levels-
at the level of the king or the central government and at the level
of the feudal lords. During this period, most of the traditional
functions and prerogatives of the king were assumed by the feudal
lords
 Feudalism
• Since feudalism was an economic relationship centered on land,
most of the taxes were imposed on land-based activities and
relationships. The feudal lord collected a wide range of taxes, fees,
licenses, and tolls. While impositions increased, the limited
concerns of the state remained essentially the same as in the slave
societies: war, internal peace and order, religion, maintenance of
ruler and his household and public works. The feudal period can
rightly be credited with the development of one major public
finance institutions: taxation, which emerged as the major source
of public revenue.
II. THE BREAKDOWN OF FEUDALISM: BEGINNINGS OF CAPITALISM

A. The Rise of Central Government (1300-1500)

• During the rise of central governments, they needed more money

to operate. To get this money, they expanded and changed how
taxes worked. This happened because governments had to deal
with higher costs and wanted more control over their finances.
They brought back old taxes and created new ones. These taxes
affected many people and were often changed because of how
society and the economy were evolving.
 A. The Rise of Central Government (1300-1500)

• After central governments introduced various taxes, disputes arose

over their fairness and practicality.
• This tax eventually became a key part of modern state finances.
Additionally, changes in how governments were structured also
affected how public finances were managed.

• Bill of Rights in 1688 ensured that taxes were only imposed with the
agreement of representative bodies and the people.

• During the French Revolution in 1789, many feudal taxes were

abolished, including the tithe and the taille, which exempted the
clergy, wealthy middle class, and nobles from paying taxes. Adam
Smith criticized the taille, saying it dishonored those who had to pay it.
 A. The Rise of Central Government (1300-1500)

• The French Revolution abolished feudal taxes and limited the king's
spending powers.
• It relieved the burden of the king's extravagant spending and debts.
• The National Assembly declared that no tax could be imposed without
its consent.
• Despite this, French public finance remained poorly managed, chaotic,
and financially insufficient.
• Napoleon's administration later established a competent and efficient
national financial system.
• The rise of central governments led to increased public borrowing due
to the growing costs of government and insufficient national
finances.
 A. The Rise of Central Government (1300-1500)

• The development of industry and trade created a money and credit

economy, with secular banks providing commercial credit
• Wealthy merchants were willing to invest in government bonds,
providing a source of borrowing for the government.
• Constitutional and stable governments reduced uncertainty about loan
repayments.
• The central government's expanded taxation powers improved the
security of loans.
• Long-term national debts replaced short-term royal borrowings.
• By the late 18th century, public borrowing became a regular and
important part of public finance.
 A. The Rise of Central Government (1300-1500)

• As central governments expanded, they faced higher costs and turned

to borrowing because national finances were insufficient. The growth
of industry and trade created a money-based economy, with banks
providing credit. Wealthy merchants invested in government bonds,
and stable governments reduced repayment uncertainty. Enhanced
taxation powers made loans more secure, leading to long-term
national debts replacing short-term ones. Public borrowing became a
regular practice by the late 18th century.
 A. The Rise of Central Government (1300-1500)

• Some thinkers like Sir James Stewart and Alexander Hamilton saw
public debt positively, believing it increased a nation's credit and
contributed to its capital stock.

• During the later medieval period, there was a growing concern among
governments for economic efficiency and prudence in taxation and
public finance.

• Medieval writers emphasized the importance of controlled

government spending and proper accounting practices.

• Carlo Carafa advocated for the judicious use of taxes by state officials,
while Jean Bodin emphasized the importance of maintaining detailed
records of government expenditures.
 A. The Rise of Central Government (1300-1500)

• In summary, The rise of central governments in Europe after feudalism

led to significant changes in public finance institutions.
• Income tax became a major source of national revenue, alongside
various indirect taxes.
• The principle that taxes require consent was integrated into the tax
system.
• Accounting and audit institutions developed to meet increased
demands for accountability.
• Public borrowing became a major activity in public finance.
 B. Beginnings of Capitalism

• Feudalism declined as individualism grew, leading to the establishment

of factories and increased trade.
• Technological advancements and colonial expansion fueled economic
growth and demand for goods.
• The feudal system's rigid structures gave way to the nation-state
governed by a strong central government.
• Economic thinkers developed mercantilism and cameralism as ways to
make nations economically strong and prosperous.
 1. Mercantilism

• Mercantilism was a set of policies pursued by European states during

the 16th, 17th, and 18th centuries.
• It aimed to enrich nations through trade and manufacturing.
• Mercantilist policies were primarily protectionist and focused on
accumulating wealth through exports and controlling imports.
• These policies emerged with the rise of national states and central
governments, as well as increased economic activity and colonial
ventures.
• Mercantilism dominated economic policies from the end of the Middle
Ages until the emergence of laissez-faire capitalism.
• Mercantilist trade focused on accumulating and controlling gold and
silver bullion.
 Taxation

• Accumulating metal enabled the central government to mint money

for domestic use.
• Money made it easier to collect taxes, customs duties, and other
revenues, increasing collection and simplifying administration.
• With a stable source of revenue, the central government could
maintain large armies and navies, consolidate its power, and establish
bureaucracies and civil services.
• Public expenditures focused on trade promotion, including building
and maintaining state merchant fleets.
• In colonies, revenue administration emphasized collecting taxes and
other revenues in metal currency.
 Taxation

• Mercantilist countries imposed high customs fees on foreign ships

passing or docking at their ports to monopolize trade.
• Tariffs were set so high that they prevented foreign ships from
engaging in profitable trading.
• In colonial trade, goods were exported to colonies by ships from the
colonizing country, such as English ships passing through English ports
and delivering products to English trading companies.
• Imports from colonies followed the same route, ensuring control and
profit for the colonizing nation.
 Budget and Expenditures

• Public spending increased significantly due to mercantilist government

concerns, expansion of national government and bureaucracies, and
maintenance and protection of colonial ventures.
• Accumulation of metal currency led to the development of a money
economy, making exchange easier and boosting large-scale business
activities.
 Influence of Public Finance

• Mercantilism emphasized the importance of government intervention

in the economy.
• It showed that governments could stimulate economic growth through
fiscal policies.
• Adam Smith reacted to this with his laissez-faire principle, which
advocated for minimal government interference in the economy.
• Mercantilism expanded the role of fiscal instruments, like taxes and
budgets, to guide economic activities towards prosperity.
• It broadened the uses of public funds beyond traditional economic
purposes to include social and political goals.
 Influence of Public Finance

• Mercantilism's impact extended beyond national boundaries,

influencing economies of other states through subsidies, import taxes,
and colonial ventures.
• The concept of "balance of trade" emerged from mercantilism,
focusing on exporting more than importing to increase bullion
reserves.
• Although initially crude, this concept evolved into the modern
"balance of payments," a key indicator of economic performance.
• Mercantilism, as seen in England and other Western states, taught that
simply acquiring gold and silver wasn't enough for national wealth.
• England's experience showed that true economic prosperity came
from within the nation itself.
• The real bases of national growth and development were found in the
development of agriculture alongside industrialization.
 2. Cameralism

• Cameralism like mercantilism, aimed to empower and enrich the state.

However, unlike mercantilists who prioritized accumulating bullion
through restrictive trade, cameralists focused on developing a nation's
internal resources through efficient administration and economic
control. Figures like Von Just and Sonnenfels advocated using public
finance institutions, such as taxation, to guide the economy towards
prosperity. They believed in utilizing fiscal measures to regulate
economic life effectively.
•
• The cameralist approach underscored the importance of structuring
the tax system to function as a potent economic tool.
 3. Physiocracy

• The Physiocrats, including Francis Quesnay and Jacques Turgot,

focused on taxation and its stability. They believed that the key to
establishing a stable tax system was to base it on a sector that
consistently generated a surplus, which they identified as agriculture.
According to their analysis, only agriculture produced a net profit or
surplus that could sustain taxation.
• To ensure revenue certainty, they proposed abolishing all existing taxes
and implementing a single direct tax on land-rent income derived from
agricultural cultivation.
• They viewed the agricultural surplus as the foundation for a lasting
taxation system, as it sustained the flow of income and goods in the
economy.
 III. CAPITALISM: PUBLIC FINANCE AND FREE ENTERPRISE

• The transition from feudalism to capitalism was propelled forward by

the industrial revolution, which introduced machines and innovations
that revolutionized productivity worldwide. This shift not only
transformed Europe but had a global impact. Economic dynamics
shifted from land-based transactions to industrial ones, altering
relationships from feudal lords and tenants to capitalists and workers.
Consequently, perceptions of the state's role and functions evolved to
accommodate the changing economic landscape.
 III. CAPITALISM: PUBLIC FINANCE AND FREE ENTERPRISE

• Mercantilist government intervention gave way to laissez-faire

policies, minimizing government interference in the economy.
• Feudalism revolved around the feudal lord, while capitalism centered
on the capitalist or entrepreneur.
• Under free enterprise philosophy, government intervention in the
economy should be minimal, focusing on defense, public works,
bureaucracy maintenance, and limited services in education and
health.
• The private sector, under perfect competition, was expected to
provide all other services efficiently and at the lowest prices.
• The era of capitalism was also marked by classical economists whose
ideas influenced both industrialized countries and less developed
countries (LDCs).
 Adam Smith (1723-1790)

• Adam Smith initiated classical economics with his book "An Inquiry
into the Causes of the Wealth of Nations" in 1776.
• His work laid the foundation for a new generation of writers interested
in political economy.
• Smith's ideas justified free enterprise or capitalism as the ideal
economic system, emphasizing self-interest as a motivator.
• He advocated for minimal government interference in business
activities, promoting the laissez-faire policy.
• Smith's views on public finance, detailed in Book V of his work,
became authoritative on taxation, budgeting, and borrowing.
• He emphasized taxation should be based on scientific and equitable
principles, outlined in his canons of equity, certainty, convenience, and
economy.
• Smith warned against excessive borrowing, likening public finance to
prudent household management.
 B. David Ricardo (1772-1823)

• Ricardo, a British economist, played a significant role in refining

modern fiscal administration concepts and practices.
• He is known for his theory of the distribution of tax burden, which he
applied to analyze the shifting and incidence of taxes.
• Ricardo's concepts helped establish equality and uniformity in
modern taxation and shaped the progression of tax structures.
Additionally, his analysis of public credit expanded the understanding
of how public borrowings could be utilized.
 C. Adolf Wagner (1835-1917)

• Adolf Wagner, an influential economist, believed that the state should

use fiscal measures to reduce inequalities of wealth.
• His ideas contributed to the use of fiscal policies for distributive
purposes in modern times.
 D. John Stuart MIll (1806-1873)

• John Stuart Mill, a proponent of laissez-faire economics, contributed

to public finance by correlating the functions of the state to public
expenditures.
• He argued that government action typically increased expenses, which
were funded through compulsory contributions from individuals and
properties.
• Mill believed that the burden of these expenses was one reason why
governments preferred minimal interference in private affairs.
IV. THE CRISIS OF CAPITALISM:- KEYNESIAN PUBLIC FINANCE

• Prior to the 1930s, classical economists like Adam Smith, David

Ricardo, John Stuart Mill, and Alfred Marshall advocated for minimal
government intervention in the economy.
• They believed that labor could be fully employed and resources
efficiently utilized under a free enterprise system.
• However, the economic depression of the 1930s challenged these
views.
• Economists realized that industrialized economies did not respond to
classical prescriptions as expected.
• They discovered that capitalist economies were subject to cyclical
fluctuations and suffered from issues like inflation, stagnation, and
recession.
IV. THE CRISIS OF CAPITALISM:- KEYNESIAN PUBLIC FINANCE

• In 1936, the landscape of modern capitalist economics shifted

dramatically with the publication of "The General Theory of
Employment, Interest, and Money" by English economist John
Maynard Keynes. This book challenged the long-held economic views
of Adam Smith and his successors.
• Keynes argued that the government could and should influence various
aspects of the economy, including prices, consumption, employment,
and income distribution, through taxation, borrowing, and the buying
and selling of goods and labor.
• He introduced the concept of fiscal policy as a tool for correcting
imbalances in the economy, emphasizing its role in stabilization and
compensation.
• Keynes rejected the idea that government activity should be limited
to basic functions and insisted that public finance should directly
intervene in the economy's workings.
IV. THE CRISIS OF CAPITALISM:- KEYNESIAN PUBLIC FINANCE

• Keynes's work directly challenged Adam Smith's revered notion of

the balanced budget, reshaping modern public finance. His influence
extends beyond industrialized countries to developing ones, with
concepts like aggressive economics and macroeconomics becoming
integral to the public finance vocabulary. Terms such as fiscal policy,
monetary policy, deficit financing, and compensatory financing are
now standard tools used by policymakers in mixed economies
worldwide, whether for stability or development objectives.
• Keynes revolutionized public finance by introducing government
management of the economy within the capitalist system, departing
from earlier theories of free enterprise economists. Critics argue that
Keynes acted as a reactionary, as his theories are believed to have
"saved" capitalism from collapse.
 V. THE MARXIST CHALLENGE: SOCIALIST PUBLIC FINANCE

• Capitalism spread rapidly during the industrial revolution, leading to a

significant increase in goods and services production and market
expansion.
• This growth was accompanied by exploitation of the unorganized
working class, including women and children, in harsh working
conditions such as sweatshops.
• Fierce competition resulted in the emergence of giant monopolies and
wars over markets and raw materials.
• In response to these issues, communism emerged as a direct challenge
to capitalist philosophy, with Karl Marx writing "Das Kapital" as a
response to Adam Smith's "Wealth of Nations."
• Marx's ideas laid the foundations for socialist public finance,
emphasizing the need for collective ownership of resources and the
redistribution of wealth.
 A. Marxism

• Marxist thought covers various disciplines like history, economics, and

politics because Karl Marx aimed to provide a comprehensive
interpretation of society.
• Marx's approach is known as the "materialist conception of history,"
which emphasizes the importance of economic factors in shaping
historical events and societal development.
• According to Marx, the economic system of a society determines its
social structure, institutions, and ideologies.
• He believed that conflicts between social classes, particularly between
the bourgeoisie (owners of capital) and the proletariat (working class),
drive historical change.
• Marx argued that capitalism would eventually lead to its downfall due
to inherent contradictions, leading to the establishment of socialism
and ultimately communism.
 A. Marxism

• Marx's theory of historical materialism emphasizes how economic

factors shape society. He argued that in the process of social
production, people enter into relations of production dictated by the
prevailing mode of production, which forms the economic structure of
society. This economic structure influences social, political, and
intellectual life.
• Marx identified three main modes of production: classical (slave),
feudal, and capitalist, with capitalism receiving particular attention. He
believed that capitalism, like feudalism before it, would eventually be
replaced by communism, a non-antagonistic mode of production.
• In the transition from feudalism to capitalism, laborers were deprived
of common lands and communal property, leading to their
dependence on wage labor for survival. This transformation turned
social means of subsistence and production into capital, while workers
became dependent on others for their livelihoods.
 A. Marxism

• Marxist contributions to our understanding of society and political

economy have been significant. Marx emphasized the economic factor
in society and analyzed social classes, which has greatly influenced
modern public finance. His insights into the role of economic structures
in shaping societal dynamics and his examination of class struggles
have provided valuable perspectives for understanding fiscal policies,
taxation
 B. Basic Features of Society Public Finance

1. In socialist public finance, central planning is essential, unlike in

capitalist theory, which relies on the market for production and
distribution. In socialism, where the state controls all sectors, central
planning is feasible and has shown success.
2. In socialist public finance, taxation plays a minor role compared to
mixed economies.
3. In socialist countries, it's claimed that budgets don't run deficits but
instead have surpluses of revenue over expenditure. This is different
from mixed economies, where deficits in budgets are common.
 VI. THE IMPACT OF WESTERN PUBLIC
FINANCE INSTITUTIONS ON LDC's
• The detailed account of the development of Western public finance
institutions is important because these institutions were transferred to
developing countries (DCs) when they were still colonies. Today, we can
see traces of these institutions in the public finance structures of these
countries. Understanding their origin, context, and the theories that
influenced them is crucial for understanding how mixed economies,
like the Philippines, have been shaped.
 A. Classical Public Finance
• Adam Smith's ideas, especially his principles of taxation, are still
studied in many developing countries. His concept of progressive
taxation, which promotes fairness, is even enshrined in the Philippine
Constitution. However, in many less developed countries (LDCs), these
principles are often not followed as they should be. Additionally,
Smith's views on maintaining a balanced budget were followed in the
Philippines until 1972, when deficit financing was officially adopted as
a major policy approach.
 B. Keynesian Public Finance
• John Maynard Keynes had a profound impact on post-World War I
economic practices, especially in less developed countries (LDCs)
striving for independence. His ideas emphasized the government's
significant role in managing the economy, aligning with the aspirations
of many nations for development. Keynesian economics, which
prioritizes fiscal policy, became widely accepted and influenced LDC
policymakers. Despite evolving theoretical concepts, Keynesian
principles still shape current fiscal policies, including those in the
Philippines, although some argue they are no longer relevant,
particularly in industrialized countries.
C. Will the LDC's follow the varicus stages
of development of the industrialized
countries?
• Over the past two decades, there has been a shift in understanding
among students and participants in Public Fiscal Administration and
Finance seminars regarding the developmental trajectory of less
developed countries (LDCs). Initially, there was a belief that LDCs would
follow the same path as industrialized countries, moving from slave
systems to feudalism and then to capitalism and industrialization.
However, recent perspectives acknowledge that this trajectory cannot
be simply replicated. While LDCs like the Philippines underwent phases
resembling these historical stages, interruptions and different
motivations, such as colonial exploitation, have influenced their
development differently.
C. Will the LDC's follow the varicus stages
of development of the industrialized
countries?
• The Philippines endured centuries of colonization by Spain, followed by
American tutelage and Japanese occupation, which led to the
depletion of its resources and wealth. Colonial finance facilitated the
transfer of these assets to the colonizing countries, leaving the
Philippines with empty coffers upon gaining independence. This
situation forced the country into borrowing and maintaining old
economic relationships, hindering its development. Similar challenges
are faced by other less developed countries (LDCs), prompting scrutiny
of existing public finance systems to ensure they align with national
development goals.