CAVENDISH UNIVERSITY

BBA/BBF 316 PUBLIC FINANCE CAT 1 WEEK 6

SUBMITTED BY: DITAI JULIUS KAYEREGE

REG NO: 054 - 457

YEAR OF STUDY: THREE

SEMESTER: ONE

a) What is Public financing? (1 marks)

Public Financing refers to the numerous activities government gets involved in to receive
finances and expenditureing of the received finances. Basically it deals with government
revenue, expenses, and debt, as well as its impact on the entire economy. Public financing is all
about the management of finances of the public authorities or public bodies, such as Central
Government, State Government and Local Self Government, for carrying out their operations,
which results in incurring money for providing subsidies, public utility services, and welfare
payments to the residents. Public utility services include education, health, sanitation,
transportation, infrastructure, electricity, communication, food, etc. The basic source of
revenue to provide the services are taxes, duties, fees, foreign aid, sale of goods and services,
borrowing, creation of new money, etc.

Public Financing Studies How the government raises funds, where it spends the funds raised,
and how the government operating at various levels, provides necessary services and facilities
to the public? And how the government arranges funds to provide these services.

In conclusion public financing looks after the facts, principles, policies, theories, techniques,
rules and problems which determine, direct, influence and regulate the use of financial
resources to alternative projects initiated by the government.
 b) Explain the economic and fiscal roles of the government that justify the
government’s involvement in public expenditures. (6 marks)

A government is the system or group of people governing an organized community, generally a state,

normally consists of legislature, executive, and judiciary. Government is a means by which

organizational policies are enforced, as well as a mechanism for determining policy. Each government
has a kind of constitution, a statement of its governing principles and philosophy.

While all types of organizations have governance, the term government is often used more specifically,
to refer to the approximately 200 independent national governments and subsidiary organizations.

Public expenditure is spending made by the government of a country on collective needs and wants
such as pension, provisions education, healthcare ,housing , security, infrastructure. Public expenditure
may be classified into developmental and non-developmental expenditures. Former includes the
expenditure incurred on social and community services, economic services, etc. Non-developmental
expenditure includes expenditures made for administrative service, defense service, debt servicing,
subsidies, etc.

Public expenditure is classified into revenue expenditure and capital expenditure. Revenue expenditure
includes civil expenditure (e.g., general services, social and community services and economic services),
defense expenditure, etc. On the other hand, capital expenditure comprises expenditures incurred on
social and community development, economic development, defense, general services, etc.

Public expenditure may also be classified as plan expenditure and non-plan expenditure.

The following are the roles of government that justifies its involvement in public expenditures.

The role of improving Public Services justifies government involvement in public expenditures.
government spends so as to improve on public services like health, education and transport. These are
important for increasing the quality of life and economic wellbeing

Next is the role of increasing production Capacity of Economy, because some types of government
spending helps to overcome market failure like education which can help increase Labour productivity
and reduce structural unemployment; so government spends on education so as help to increase the
long run trend rate of growth.
Because of the need for expansionary Fiscal Policy, Increased government Spending is justified as
though it may cause a budget deficit, however, the increased Government spending is an injection of
spending to the economy and could help to increase the rate of economic growth.
The role of the need to reduce Inequality also justifies the involvement of government in public
expenditure. A biggest percentage of government spending is spent on social security. This includes
benefits, such as unemployment benefit, income support, child benefit and housing benefit. The
majority of these benefits are means tested and so targeted to those on low incomes. This always
achieves on the reduction of relative poverty and inequality. Non-plan expenditure falls under two
broad heads that is revenue expenditure and capital expenditure. The former comprises interest
payments, defense expenditures, subsidies, pensions, other general services like health, education,
economic services like agriculture, energy, industry, transport and communication, science, technology
and environment, etc.

Another role is that of supply of goods and services that are not supplied by the private sector, such as
defense, roads, and bridges, merit goods such as hospitals and schools, and welfare payments and
benefits including unemployment and disability benefits justifies the involvement of government in
public expenditures.

Not only that but also the need to achieve improvements in the supply side of the macro economy, such
as spending on education and training to improve labor productivity is a justifying role for government
involvement in public expenditure.

The role of providing subsidies to industries that may need financial support for either their operation or
expansion justifies government involvement in public expenditure. The private sector is not able to meet
such financial requirements and hence the public sector plays a crucial part in lending necessary
support. For example, transport infrastructure projects do not attract private finance unless the
government provides expenditures for the industry.

To help redistribute income and promote social welfare is another role that justifies government
involvement in public expenditure.
income is the consumption and saving opportunity gained by an entity within a specified timeframe,
which is generally expressed in monetary terms. For households and individuals, income is a sum that
includes any wage, salary, profit, interest payment, rent, or other form of earnings received in a given
period of time also known as gross income. Net income is defined as the gross income minus taxes and
other deductions (e.g., mandatory pension contributions), and is usually the basis to calculate how
much income tax is owed.
On the other hand, Social Welfare can be defined both as a system and as an overall effort. This means
that it can be designed as a systematic set of programs that assist the population in different stages of
their lives but, that system comes from an effort and intention to provide that social welfare situation on
the first place. Overall, social welfare means an ongoing attempt to take care of particular needs
identified in the society.

There are many different social welfare programs and they are implemented very differently depending
on the country that we are looking at. There are unemployment care programs, elderly-people
programs, retirement programs; assistance for disabled individuals, widow’s care, among a wide range
of support efforts most frequently developed as part of a government agenda to attend those particular
situations.

The role of causing multiplier Effect to cause magnitude of changes in GDP of the economy also justifies
government involvement in public expenditure. as a result of Autonomous spending encourage a rise in
aggregate demand, and high levels of aggregate demand lead an economy to achieve higher levels of
output for example, when the government injects 100 million for a school project, this provides labor for
the architecture, plumbers, electricians and more. The sources of raw material for capital also receive
income. If 20% of the incomes received are spent on tax, 10% on savings and the other 10% on imports
of goods and services, this leaves 60% of spending to domestic goods and services, presenting the
marginal propensity to consume as 0.6.  According to [1/(1-mpc)], in this example, the multiplier is 2.5.
Therefore, the amount of $100 million is now 2.5 times greater, amounting to $250 million of final
addition to national income. Assuming a constant price level, this reveals that an “increase desire of
aggregate spending increases equilibrium GPD by a multiple of the initial increase in autonomous
spending” and illustrates the magnifying change government spending has towards national income.

Therefore, as a result of government expenditure, many opportunities are created to reach the
productive potential of an economy and foster growth of national income. Government expenditure is
important in stimulating aggregate demand to stimulate productive output, increasing induced
consumption spending and providing opportunity for higher disposable incomes. Nevertheless, the
balance between injections and leakages in the economy may shift equilibrium to a lower position
dependent on the net output and ultimately, what the government decides to do with the revenue. The
government expenditure can determine changes in the level of national income through their influence
in aggregate demand.

c) Discuss the challenges faced by Governments in carrying out its roles. (4 marks)

Governments face numerous challenges while carrying out their roles in public expenditures among
which includes the following.
Governments gets challenged by the heavy influences of off budget spending’s. While the overall scope
of most government spending does not appear excessive in relation to their GDP when measured in
terms of explicit government spending, the government controls or heavily influences a substantial
amount of off-budget spending in various forms which, in other countries, are more typically left to
private or non-state entities, or are carried out through the explicit government budget. The extensive
resort to extra budgetary and off-budget spending results in a severe lack of transparency in
governments public spending and undermines accountability and efficient administration of that
spending.
There is also lack of transparency accentuated by the continued use of systems for compiling and
reporting government expenditures derived from the central planning era, which are based on
administrative criteria that often make it difficult to determine how much is being spent on key
economic functional areas, such as education or science, and by which government entities.
governments public spending has recorded rapid growth over the past years and although the rate has
moderated somewhat, expenditures are significantly higher now relative to GDP’s than they were in the
past years. These trends raise questions about the future prospects for aggregate spending and whether
it is adequately controlled. The analysis suggests that growth in general government expenditure could
slow significantly in coming years but that expenditures associated with contingent liabilities, primarily
from the financial system, constitutes an important risk to the expenditure outlook.

The allocation of public expenditure out of line with the governments development needs and priorities
in some important respects. International benchmarks and some other indicators suggest that
governments may need to spend more on key social services such as education, health, and science and
technology if it is to achieve its development objectives.
There is also the challenge of substantial gap between the expenditure responsibilities of sub national
governments and the resources they have to finance these responsibilities. These gaps have been an
important factor behind the growing resort to off-budget funds and to the growth in contingent
liabilities. The gaps vary widely across provinces/ regions and are particularly severe for township and
county governments. Disparities among provinces in these gaps are substantially the result of the
uneven decentralization of expenditure versus revenue assignments and the inadequacy of the central-
local government transfer system. The disparities are further magnified for lower levels of government
within provinces by the general lack of objective criteria to ensure that revenues are allocated in
accordance with expenditure needs and by inefficiencies and distorted incentives in the allocation of
spending by sub-national governments.

The fiscal decentralization system also creates adverse incentives and limits accountability for
expenditure decisions at the sub-national level. Unfunded mandates from the central government have
added to fiscal strains at the sub-national level. At the same time, sub-national governments’ lack of
discretion over tax rates together with governments top down system of evaluation and promotion of
government officials creates strong incentives for sub-national governments to spend as much as they
earn in revenue, without adequate regard to the social trade-off between the benefits of their
expenditures versus the costs of the taxes that pay for them.

In addition, sometimes governments fail to raise the anticipated revenues due to happenings in
the economies for example the occurrence of COVID 19 has made many governments to fail
raising expected revenues this has been because of antagonized activities

d) Examine the different principles that should guide public expenditures. (4 marks)

Public Expenditure refers to the expenditure that are incurred by government at different
levels. Public Expenditure is incurred on various activities for the welfare of the people and also
for the economic development, especially in developing countries. In other words, The
Expenditure incurred by Public authorities like Central, State and local governments to satisfy
the collective social wants of the people. The below examined are the principles that should be
guide public expenditures.

The Principle of Maximum Social Benefit should guide in public expenditures. It is necessary that all
public expenditure should satisfy one fundamental test of Maximum Social Advantage. To mean the
government should discover and maintain an optimum level of public expenditure by balancing social
benefits and social costs. Every money spent by a government must have as its aim the promotion of the
maximum welfare of the society as a whole. Care must to be taken that public funds are utilized for the
benefit of not a particular group or a section of society. The aim is the general welfare. Government
exists for the benefit of the governed and the justification of the government expenditure is, therefore,
to be sought in the benefit of the community as a whole.

Next to the above is the principle of Economy, Although the aim of public expenditure is to maximize the
social benefit, that does not exonerate government from exercising utmost economy in its expenditure.
Economy does not mean niggardliness. It only means that extra spending and waste of all types should
be avoided. Public expenditure has great potentially for public good but it may also prove injurious and
wasteful. Thus, if revenue collected from the tax payer is wastefully spent, it would be obviously
uneconomical. To satisfy economy principle therefore government should avoid all duplication of
expenditure and over lapping of authorities. Further public expenditure should not adversely affect
saving. In case government activity damaged the individual’s will or power to save, it would go against
the canon of economy.

Another important principle of public expenditure is that of sanctioned, that is before it is actually
incurred it should be sanctioned by a competent authority. Un authorized spending is bound to lead to
extravagance and overspending. It also means that the amount must be spent on the purpose for which
it was sanctioned. Not only is previous sanction of public expenditure essential but post-mortem
examination being equally imperative. That is, all the public accounts at the end of the year should be
properly audited to see that the amounts have not been misspent or misappropriated.

There is also the Principle of Surplus, it is one of the soundest or orthodox principle of public
expenditure that as far as possible public expenditure should be kept well within the revenue of the
State so that a surplus is left at the end of the year. In other words, the government should avoid deficit
budget, But the modern economists, especially Keynes, do not regard surplus budgeting as a virtue,
rather deficit budgeting is more useful in raising the levels of income and employment in the under-
developed countries. All the same, budget deficits running over a series of years are considered bad for
the financial stability of the country and they cause inflation which is injurious to the health of the
economy.

In addition to the above is the principle of elasticity, another great principle of public expenditure is that
it should be fairly elastic. It should be possible for public authority to vary the expenditure according to
need or circumstances. A rigid level of expenditure may prove a source of trouble and embarrassment in
bad times. Alteration in the upward direction in not difficult. It is easy, rather tempting, to increase the
scale of expenditure. But elasticity is needed tempting, to increase the scale of expenditure. But
elasticity is needed most in the downward direction. When the economy axe is applied it is a very
painful process. Retrenchment of a widespread character creates serious social discontent.

It is very necessary, therefore, that when the scale of public expenditure had to be increased, it should
be increased gradually. A short spell of prosperity should not lead to long-term commitments. A fair
degree of elasticity is essential if financial breakdown is to be avoided at a time of shrinking revenue.
Not only the above but also the principle of No Adverse Influence on Production or Distribution.

It is also necessary to ensure that public expenditure should exercise a healthy influence both on
production and distribution of wealth in the community. It should stimulate productive activity so that
income and employment of the living. But this object of raising of living standards of the masses will be
served only if wealth is evenly distributed. If newly created wealth goes to enrich the already rich, the
purpose is not served. Public expenditure should aim at reducing the inequalities of wealth distribution.

In conclusion therefore the above examined are the principles that guide the public expenditure.

(Total: 15 marks)