Public Finance

§ 1. The question of the nature and amount of public outlay forms, as we have seen, one of the cardinal branches of finance; it has an important influence on the other departments of the subject, and may be regarded as the real end of the financial system. In order to estimate correctly the expenditure of any given society, for state or public purposes, it is desirable to see the general features of the agency which so applies this part of national wealth. Most persons are familiar with the conception of a state economy, and are even prepared to adopt the view prevalent among students of social science, that Society is an organism with an independent life, manifesting itself in the exercise of different functions, one set of which has been specialised in the regulating organ or the State. Without pressing this resemblance so far as is sometimes done,
*1 we may accept the evident fact that the state organisation has certain points of analogy with the arrangements of the individual, and that in regard to economic action the comparison is particularly close. The individual and the State have each receipts and expenditure. Each endeavours, or should endeavour, to obtain the greatest result with the smallest effort; for each it depends on the relation between these economic categories whether wealth is being accumulated or debt incurred; and for each a careful method of keeping accounts is needed as a safeguard against errors. There is, however, a still closer parallel to be found in the case of those associations formed for the accomplishment of certain special ends which are usually known as ‘juristical’ persons or corporations. From the ordinary private partnership, through the local trading company, the progression can be traced up to such a body as the East India Company, that at one time was sovereign all but in name. In all these associations the principal financial phenomena are exhibited in a similar manner, and in a way that helps to explain the character of state finance. The existence of such general resemblances should not, however, conceal from us the fact that public agencies are in some essential points distinct from the ‘economy’ of the individual or of the association. It is the presence of these special and peculiar features that renders the examination of state economy needful in treating of public finance.

2. The first distinctive point in the public or state economy is its compulsory character. The individual or private association has to submit to limits other than those of his or its own will, but so far as legal restraints are concerned, the State stands in a position of complete independence. It is entitled to claim all the services and property of its subjects for the accomplishment of whatever aims it prescribes to itself. When stated in so rigid a form, the proposition is likely to awaken dissent, and yet, from the strictly legal and administrative point of view, it is a commonplace since the time of Austin.
*2 The effectual limits to state action depend, not on any legal or administrative rules, but on the difficulty of overcoming the obstacles set by external nature, and the sentiments of its subjects. Its expenditure and the objects to which it is directed are bounded by the productiveness of the national industries, and the facility with which the national wealth can be obtained through taxation for public use. The compulsory nature of state action is, then, a trait which marks it off from the individual or the private society.

A second point of difference appears in the ends to be attained through state agencies. They are mainly, as Roscher remarks,
*3 of an immaterial kind: the protection of the society against aggression, or internal disturbance, and the promotion of progress in civilisation, are hardly capable of being definitely measured and assigned a precise value, nor, even if they were, could the share of each individual be allotted to him in the exact proportion that he was willing to pay for it. The force of the State must prescribe what is to be paid by its subjects as a body, and the share that shall be borne by each. As regards expenditure, the absence of a strict standard makes it very hard to judge the extent to which the public resources should be applied for the satisfaction of the several wants. This vagueness is made still more apparent by confining our attention to a single public need in a given country—say, the amount of protection against foreign and home enemies required by England at present. How shall we determine the expenditure that is suitable for this object? ‘Adequacy in such cases,’ says Sidgwick, ‘cannot be defined by a sharp line. Most Englishmen are persuaded that they at present enjoy very tolerable protection of person and property against enemies within and without the country, but it would be difficult to argue that our security would not be enhanced by more and better-paid judges and policemen, or more and better-equipped soldiers and sailors.’
*4 The problem, it is evident, can only allow of an approximate solution, such as the actual circumstances will permit, and this finds its expression in the sentiment of practical statesmen, who say with Sir R. Peel, ‘In time of peace you must, if you mean to retrench, incur some risk.’

When the problem is widened so as to include the relations of the several wants of the public organs of the society, its difficulty is increased; the adjustment of the separate items of outlay and the proportion that the total amount shall bear to the sum of national revenue, is a task that tries the abilities of the most skilful administrator.

In connexion with the direction of public expenditure, a third feature of public economy comes into prominence; one which, it is true, may in some degree be found in private associations, but in a very restricted form. That is the existence of special interests opposed to the general welfare. It goes without saying that the individual desires what he deems to be for his own good, and in most private companies the shareholders wish for the prosperity of the institution in which their capital is invested. There are, however, cases where the holder of a few shares may make a gain indirectly, through some action of his company, which will lower its dividends, and being so far an ‘economic man,’ he may vote for and advocate that course. Instances of the kind are not very common, and the power possessed by persons in the situation just described is so slight that it may be neglected. The state organisation is differently placed. ‘Sinister interests’ exercise a good deal of control on its actions. There are large classes whose aim is to increase, not to reduce, the public expenses. More particularly is this true of those connected with the great spending departments of the state.
*5 Military and naval officers are extremely anxious to insist on the importance of increasing our land and sea forces in order to secure a better system of defence. But each fresh addition to outlay unfortunately fails to secure this result, which appears as far off as ever.
*6

Reaction against the evils produced by these tendencies has, in England at least, raised up an opposite school of extremists, who are opposed to even the outlay required for real efficiency. The inherent difficulties of the state economy are thus intensified by conflicts of interest and sentiment which, if not peculiar to it, at all events are most prominently exhibited in its working.

A fourth point of difference between the economy of the individual and that of the State is shown in the determination of the area of work for each. The citizen will naturally adopt the most profitable employment open to him, or should it seem expedient, he will combine several different occupations. The interest of others is a very secondary consideration; his activities will depend, as to their sphere and extent, on the ‘net advantages’ to be gained. His investments of capital will be similarly determined. Within the customary limits of law and morality he will seek to make his advantages as great as possible. The field of state action has to be mapped out on different grounds. The fact that a particular business or part of social action could be managed by the State without economic sacrifice, does not prove that it should be handed over to public agency. It is in general a sound practical rule that ‘the State should not interfere with private enterprise,’ and whatever be the theoretical qualifications needed, it is plain that even its partial truth limits the operations of the public power. The existence and constant working of individual and associated ‘economies’ (
Privatwirthschaften) beside and under the protection of the great compulsory economy (
Zwangwirthschaft) of the State, is a point which should never be forgotten.

Fifthly, a private economy differs from that of the State not only in the limitation of its area of action, but in the object of its working. It seeks to obtain a profit from its operations; in the language of finance it aims at a ‘surplus.’ The individual or company that just makes ends meet at the close of the year
*7 is not in a prosperous condition. Something more is required to give a fund for expenses beyond the necessary minimum in the former, and for dividends in the latter case. The greater the surplus the more successful is the result deemed to be. The ideal of state economy is, on the contrary, to establish a balance between receipts and expenditure. A State that has very large surpluses is as ill-managed as one with large deficits.
*8 The best practical rule is to aim at a slight excess of receipts over outlay in order to prevent the chance of a deficit.
*9 The position of the State as drawing its resources from the contributions of the several private economies under its charge is the reason for this course of conduct.

The last of the points of difference usually noted is rather apparent than real; it results from the mode adopted in regulating state finance, but in fact state and private economy here fundamentally agree. The private person must, it is said, regulate his expenditure by his income; the State regulates its income by its expediture. Such is in form the common mode of determination. The individual says, ‘I can spend so much’: the finance Minister says, ‘I have to raise so much.’ On looking more carefully into the matter, we discover that a certain amount of expenditure is necessary to support individual life, and that each person must procure that amount at least under peril of death. For all classes above the lowest this minimum of expenditure rises to a higher point, and increased outlay is essential for the obtaining of increased income.
*10 On the other side, state expenditure is not definitely fixed; it has to be determined by various considerations, one of which is the pressure that its discharge will place on the national resources. We can easily conceive the United States wisely incurring expenditure that an Indian administration would as wisely avoid.
*11

§ 3. Though the several characteristics that we have been engaged in noticing mark clearly the distinct and peculiar aspect of public economy, we have still to constantly bear in mind that the consumption of wealth for public ends is a part of the consumption of wealth in general. As a study of human wants must form the basis of the economic theory of consumption, so must an examination of the number and order of state wants be an essential part of our present inquiry.

The classification most familiar to English readers is that of J. S. Mill, who distinguishes between the ‘necessary’ and the ‘optional’ functions of Government.
*12 The value of this division is, however, much impaired by his subsequent admission that no employment of state agency can ever be purely optional, as also by the further concessions made in his examination of the limits of
laissez faire. The arrangement suggested by Roscher is more in analogy with the case of private outlay, viz., that into (1) necessary, (2) useful, and (3) superfluous or ornamental expenditure,
*13 corresponding to the necessaries, decencies, and luxuries of individual consumption. It does not require much acumen to add, that the first head is unavoidable, that there is generally a presumption in favour of the second, while there is always one against the last. The formation of such general categories as the foregoing does not help to solve the real difficulties of the matter.
*14 The terms used to describe the groups just mentioned carry with them an already-formed judgment. By placing a particular form of expense under the heading of ‘necessary’ or of ‘ornamental’ outlay, we have pronounced an opinion on its merits or demerits. It still remains to settle—and this is by far the most troublesome part of our task—the several items to be placed under each head. In order to meet this difficulty we shall find it necessary to consider the proper functions of the State, and how far it is bound to discharge each and all of those functions under circumstances of financial pressure. One of two possible lines of inquiry may be adopted. Starting from our conception of the State, we may seek to determine the proper sphere of its action, and the amount of its justifiable outlay within that sphere, using either general reasoning or appeals to specific experience as our guide. Or we may prefer to trace the development of public tasks, and endeavour by following their direction in the past to form an estimate of their present position and probable future. It may even be expedient to combine the two courses of inquiry, using each as the corroborator or corrective of the other. Here, as often elsewhere, the historical or inductive method comes in to support and check the conclusions of deduction.

§ 4. The primitive theory of politics, if theory it can be called, accepted the omnipotence of the State as a leading principle. The legislator was to fashion the society in the mould which seemed to him best; the very idea of individual claims had no place in such a doctrine. In its passage through feudalism European Society obtained the idea of private liberty, though, owing to the imperfect state organisation of the period, the effect that might naturally be expected was not produced. The centralised monarchies which succeeded the mediæval system claimed the privilege of regulating individual action in a mode that in some respects recalled classical antiquity. The religious and political struggles of the sixteenth and seventeenth centuries were the result of their undue activity in those domains of human life. Commerce and industry did not assert their right to freedom till a later period. State regulation of industry found its highest expression in the so-called mercantile system of the seventeenth century, and particularly in the administration of Colbert.
*15 The reaction against this policy produced the first theory of state action that had an economic basis—the doctrine of
laissez faire, or, as it was entitled by Adam Smith, ‘the simple and obvious system of natural liberty.’ Its rise at the particular time was the result of powerful forces. It is true of humanity that ‘it learns truth a word at a time,’ so that, as the problem of the sixteenth century had been religious liberty, that of the seventeenth political liberty,
*16 it was reserved for the eighteenth century to assert the claims of industrial and commercial liberty. The similarity in general features of these movements is remarkable. Each was the natural reaction against exaggerated pretensions; each perhaps attached too much importance to its special object, but all have profoundly affected European society for good. In examining this earliest scientific theory of the State, it is most desirable to see exactly what its doctrines really were. The common opinion that the advocates of
laissez faire were opposed to any state action is dissipated by a study of their writings. They lived in an age of restrictions in which the most pressing work was to get the many hindrances to effectual industrial activity removed. A body of thinkers including Quesnay, Turgot, and Du Pont de Nemours among its members can hardly be said to have been indifferent to the necessary functions of the State. The real bearing of the
laissez faire or ‘natural liberty’ system can be best appreciated by a consideration of the exposition given of it by Adam Smith. In a well-known passage of the
Wealth of Nations he has set forth the functions of the ideal State in a manner that leaves no room for mistake as to his views.

‘According to the system of natural liberty, the Sovereign has only three duties to attend to; three duties of great importance indeed, but plain and intelligible to common understandings: first, the duty of protecting the society from the violence and invasion of other independent societies; secondly, the duty of protecting as far as possible every member of the society from the injustice or oppression of every other member of it, or the duty of establishing an exact administration of justice; and thirdly, the duty of erecting and maintaining certain public works and certain public institutions, which it can never be for the interest of any individual, or small number of individuals, to erect and maintain; because the profit could never repay the expense to any individual, or small number of individuals, though it may frequently do much more than repay it to a great society.’
*17

It is only necessary to read this passage in order to see that the policy favoured by Adam Smith was not a purely negative one. The State has not merely other functions than the economic ones; where private interest is likely to prove insufficient, it has economic ones also, and those, too, of great extent and importance, as will appear when considering his more detailed discussion.

The temporary predominance in the domain of political speculation of the
laissez faire view is a commonplace of the historians of political economy.
*18 We need not repeat the account already given of the different effects produced by the Smithian doctrine on French and English thought. It will suffice to see the operation of newer tendencies, and for this purpose we may pass at once to J. S. Mill. His theory of state action is, in fact, a product, or rather application, of his utilitarianism, and thus we are led to expect what we do in fact find, viz., a close resemblance between his practical proposals and those of Bentham.
*19 He declares emphatically that—

‘The admitted functions of government embrace a much wider field than can easily be included within the ring-fence of any restrictive definition, and that it is hardly possible to find any ground of justification common to them all except the comprehensive one of general expediency.’
*20

This extremely vague and general statement is, however, supplemented by a declaration in favour of
laissez faire as a general rule. ‘Letting alone, in short, should be the general practice: every departure from it, unless required by some great good, is a certain evil.’
*21

In regard to state action, as in so many other respects, Mill occupied a transitional position. He had accepted the traditional creed of the economists which was strengthened by his own sympathies in favour of freedom, as well as by his study of the brilliant work of Dunoyer,
*22 which he frequently quotes with approbation. But other influences affected him: the writings of the French socialists and the social philosophy of Comte both tended to impress him with the advantages of state action in certain comparatively untried directions, and consequently his attitude as to the true policy of the State is in some respects not defined with sufficient precision.

Since his time, the disposition to criticise the shortcomings of the doctrines of the Physiocrats and Adam Smith has become general. The possible theoretical difficulties and the conflicts of individual with general interest have been most forcibly stated in Sidgwick’s minute and thorough discussions.
*23 This natural tendency has been reinforced by the influence of German economists who repudiate the practical position of Adam Smith as a product of the ‘shallow
a priori rationalism’ of the eighteenth century, which regarded the State as an agent for determining private rights and duties (
Rechtsstaat) in opposition to the older system of paternal government (
Polizeistaat). This newer and wider conception of the State’s sphere is conveyed in the term ‘civilising State’ (
Culturstaat), or in the fuller description of Bluntschli, who regards ‘the proper and direct end of the State as the development of the national capacities, the perfecting of the national life, and finally its completion.’
*24

Admitting the force of some of the criticisms that have been urged against an exaggerated policy of
laissez faire, it seems nevertheless possible to adhere to the substantial truth of the doctrine quoted above from the
Wealth of Nations. The real ground for limitation of state functions is not the existence of an abstract rule forbidding various classes of acts. The rule itself is dependent on the results of experience. To the plea that in many cases state intervention would obviate evils to be found under a system of liberty, Adam Smith would reply that the legislator’s ‘deliberations ought to be governed by general principles, that he must act by rules which in the supposed cases would do more harm than good, and that it is the balance of advantage which needs to be regarded.

This consideration duly weighed suggests the possibility of so modifying the older position as to include a class of cases that has appeared to be the greatest stumbling-block in its way, viz. the functions of the State in the lower stages of social development. Now it is beyond question plain that the province, and therefore the expenditure, of the regulating organs of society will vary at different stages of social progress. We may take it as indisputable that the duties of the Sovereign of a central African State and of the government of a European society are and must be very different, but the conclusion does not follow that there are no general principles to which the modes of state action may conveniently conform. The construction of a ‘cut and dried’ formula for the duties of the State is perhaps an impossible task, but a careful study of the nature and forms of state activity, as determined by the character of its organisation, will help to elucidate the difficult problem of its suitable duties.

§ 5. For understanding the true position of the State it is essential to see the way in which its functions have been gradually evolved. In the rudest forms of society each individual depends on his own resources. The Fuegians
e.g., have no conception of government, and consequently, as Darwin notes,
*25 no chance of attaining to civilisation. In the hunting tribe, where the first advance beyond the lowest stage of savagery has been made, the elder is leader in war and judge in peace, the ‘warriors’ are soldiers and administrators. The tribe hunts in common over its territory, which it tries to protect from intruders, and it divides the game that is captured among its members. Thus we see that war, justice, or rather the administration of custom, and economic effort are the three forms of the rudimentary society’s activity. The two former, and especially war, are, however, the kind of action in which regulation is chiefly needed, and where the power of the chief is particularly manifested.

The domestication of animals, which is the characteristic of the pastoral stage, facilitates the further differentiation of the chief and ruling body. The accumulation of the peculiar wealth of the period is more an individual concern, but war and justice are public duties. Here, and even in the preceding stage, we can notice the primitive forms of public expenditure, viz., the services of the members of the clan, and commodities, in the form of weapons and supplies for those going on expeditions.

When the tribe settles down on the land and devotes itself to agriculture, a further division of duties appears. The primitive agricultural community frequently tills its land by means of slaves; the freeman confining himself to warlike pursuits and to the duty of attendance at the public assembly, where he has to decide disputes and regulate matters of general interest.

Far later in historical order, but still presenting many points of resemblance, so far as public functions are concerned, comes the ‘feudal’ organisation. Some of the actuating sentiments are different, and the traditions of the Empire and the Church exercise a potent effect; but the same economic basis brings about a reversion to the phenomena of earlier periods. The feudal society is essentially militant. State power is vested in the ‘King’ or ‘Lord,’ who represents and personifies the community. In this capacity he contracts with the vassals for the supply of his (
i.e. the State’s) needs. The feudal army with its loose organisation is one result of this arrangement. Justice is administered through the Lord’s Courts. The economic side of state activities appears in the management of the domain and the regulation of commerce. In this particular historical form we notice the rudiments of much that is important in the developed financial systems of the present time.

The City State as it is found in ancient Greece and Italy, or in Germany and Italy during the mediæval period, presents a distinctly higher type of political life. There is no longer the tribe struggling dimly to attain to the conception of political unity. The disorganisation and absence of the idea of political, as opposed to personal, duty which mark the ‘feudal’ epoch have disappeared. The free citizen of Athens or Florence had as firm a grasp of the truth that he owed duties to his city as the Englishman of to-day. An exaggerated conception of the State’s powers, and a disregard of private rights, were the natural consequence, but so far as the financial aspect of political life is concerned, we may note the close analogy in many respects to the modern State. More especially is this true of the objects of public outlay. The maintenance of military (and in some cases of naval) force, the administration of justice and police, the furtherance of certain economic ends, are the principal claims on the public resources. Subordinate to these main parts of public service may be enumerated certain requirements, also represented in modern budgets—to wit, provision for religious service, for education, and for matters affecting social well-being.

Later developments of state life, either in the Roman Empire or in modern European countries, present the same general groups of public wants. Many special points will require attention when we come to examine more closely the detailed heads of expenditure, but so far as the general outline goes there is in many respects a consensus of practice in all stages of society respecting the sphere of the State.
*26

§ 6. The preceding survey of the actual development of state functions, brief and imperfect as it is, tends to confirm, and yet in some degree to qualify, the conclusions of theory. The forms of state outlay have arisen gradually in the course of history as the outcome of social conditions and sentiments, and they in turn influence the society. A community in which some special duty has been for a long period entrusted to the public power will not easily be able to dispense with this mode of supplying its need. The force of habit is here considerable. The conditions of social life are, however, subject to incessant change. The state outlay suited for the Middle Ages, when war and religion were the great operating forces, is almost necessarily unfit for the modern age, concerned as well with industry and commerce. The ready acceptance of this truth must not lead us to ignore the equally important fact, that state wants in their main features are permanent to a surprising degree. It is not in the character of the public needs, but in the modes of supplying them, that the most remarkable changes occur. There is, moreover, a universal recognition of the superior claims of defence and justice as being the primary duties of the State.

Writers of all schools agree in this belief, and so far history and analysis are in accord. The disputable part of state outlay is that which more especially concerns economic and social administration, and even here a good deal of the matter of controversy lies outside the subject of pure finance, and belongs more fitly to economic policy. Some trifling amount may be expended on, say, the promotion of art. The advocate of
laissez faire may object to the course as a matter of economic policy, but so far as finance is concerned the smallness of the amount makes it a matter of comparative indifference. The question of public expenditure in its fiscal aspects is best considered in relation to each particular period of society. We may even accept the doctrine of Mill, that ‘in the particular circumstances of a given age or nation, there is scarcely anything really important to the general interest, which it may not be desirable, or even necessary, that the government should take upon itself,’
*27 while we at the same time remember that Adam Smith’s determination of the Sovereign’s duties can include these possible cases. Financial theory in its application to the modern state is at all events bound to recognise and indicate clearly the difficulties which extension of state action is likely to produce. The growing budgets of all modern societies have the tendency towards enlarging the sphere of the State as their ultimate cause, and it is important to see that persistence in this policy is certain to lead to embarrassments in financial administration; but the very necessity for discussing this subject compels us to examine the forms of expenditure as they have been, and are, while seeking to indicate what they ought to be.

§ 7. Another aspect of the problem of state wants requires some consideration. All economic life depends on a due supply of two distinct classes of objects, viz., commodities and services, or, in less technical language, material objects and human labour. The public power cannot dispense with either of these forms of supply, and at each period of its existence we find it demanding them both. The hunting tribe requires its warriors and their weapons and food; either the men without equipment, or the outfit without the men, would be useless. This distinction runs through every phase of social evolution, though it is much more complex in the higher stages. A very rude community can summon its members to act for the public good, and require them to fit themselves for their task. In such cases outlay and income are combined; the member of the tribe is at once paying his taxes and performing a public service. The opposite extreme is witnessed in a civilised State of the present age. The supply of public wants is obtained by the purchase of commodities and the hire of services, the power to carry out these transactions being procured through the possession of the public revenue. Intermediate stages show us the way in which personal service was commuted for money payment, and the delivery of commodities in kind was obviated by the development of a money economy. Survivals of the older order continue; in some cases they are too important to be regarded as mere relics of the past: they are rather ‘revivals’ under new and favouring conditions. When dealing with revenue we shall have to compare the direct with the circuitous method of supplying public needs, and in the present Book we shall have to note some of the economic consequences of the adoption of one or other of these modes.

Having disposed of the more general aspects of public expenditure, we shall next consider the several details, commencing with the oldest and most enduring—the need for defence against outside enemies.