Public Finance

CHAPTER

3 1. Causes of Growth in Public Expenditure

2. Canons of Public Expenditure
3. Theories of Public Expenditures
4. Control and Accountability of PE
5. Effects of public expenditure

1
 3.1. PUBLIC EXPENDITURE
Definition;

 PE is the expenditure incurred by public

authorities’

….i.e. central, state and local for the satisfaction of

collective needs of the citizens or for promotion of

economic and social welfare.

3.2. Causes of Growth in Public Expenditure

The most important causes are the

following
 Population growth
 Increasing urbanization
 Provision of economic overheads; to
provide facilities like, roads, communication
services, electric power ….which cannot provide
by private sectors.
 Maintenance of law and order.
 3.2. Causes of Growth in Public Expenditure

 Welfare activities; social security like old age

pension, unemployment benefit, housing for the
poor, re-habitation of displaced persons, subsidy
on food and production inputs, etc.
 Provision of public goods and utility services.
 International obligation; to maintain many
international socio-political and economic links
…support countries in the form of gifts, grants and
loans, and hence incurs considerable expenditures.
 3.3. CANONS OF PUBLIC EXPENDITURE
 Canon of Benefit: It should be so planned and
implemented as to bring about the greatest possible
benefit to society.
 Canon of economy: It should be incurred carefully so
that there is no wastage of funds. Wasteful expenditures
may be due to faulty planning, faulty execution, corrupt
practice and delay due to time lag between plan and
execution.
 Canon of surplus: If possible, the expenditure should be
less than the earnings of government so that the surplus
so generated can be used when there is unavoidable
deficit.
 3.3. CANONS OF PUBLIC EXPENDITURE
 Canon of elasticity It should not be too rigid to
achieve the real purpose and that it should be allowed to
vary according to the needs and circumstances.
 Canon of sanction This canon requires that the
public authorities should not be allowed to spend funds
without having a previous sanction from appropriate
authority for the purpose.
…It also requires that funds sanctioned for a particular
expenditure should not be diverted to a different
purpose.
 Canon of certainty This canon requires that public
authorities should clearly know the purpose and extent
of public expenditure.
 3.4. Theories of Public Expenditures
Classical Theory of Minimum Expenditure
 Classical economists didn’t favor large PE If not
interference would hinder economic progress.
 Most of the economic activities are performed by the
private sector. If PE becomes more & is financed by
public borrowing, there will be withdrawal of funds from
private sector where they are more productively
employed.
….Such diversion of resources will cause a decline in
overall economic efficiency.
 Classical advocated the principle of sound finance
(Balanced budget), i.e. PE should not rise above or fall
below revenue earnings.
 3.4. Theories of Public Expenditures
Principle of Maximum Social Advantage
 The funds paid by tax payers come to the public
treasury should go back to the people through
public expenditure programmes.
 The principle of maximum social advantage lays
down that public expenditure should be so
planned and, hence, revenue raised so as to bring
benefit larger than sacrifice and that the surplus
of aggregate satisfaction in the society is
maximum.
 3.5. Control and Accountability of PE

 Control of public expenditure is sought to be ensured

multi-dimensionally at a number of stages.

 The most important means of control are;

(a) budgetary control

(b) legislative control,

(c) executive control,

(d) audit control,

 3.5. Control and Accountability of PE
1. Budgetary Control
 How much of the public funds is to be spent? for
which particular purpose? and what should be
attainment of physical targets? and what should
be the allocation of funds for the use of a
particular department?
….are all specified in the budget frame.
2. Legislative Control
 After the budget plan is prepared, it has to be
presented in the legislature for its approval &
conduct debate.
 3.5. Control and Accountability of PE
3. Administrative Control
 The rules and regulations ensure that no amount
is spent without proper sanction or diverted to
some other purpose for w/c it is not sanctioned.
 There is elaborate body of rules to fix
responsibility on specific executive personnel for
the funds spent.
4. Audit Control
 There is the system of both internal and external
audit ensures that public funds are spent
according to rules of propriety, economy and
efficient utilization.
 3.6. Effects of public expenditure
Effects on Production and Employment
 Planned PE can promote production and employment in
the given country.
 Further more, it boosts demand for g/s and thus to
boost production.
 The level of production and the level of employment in
any country depends upon factors like:
 Ability of the people to work, save and invest,
 Willingness to work, save and invest, and
 Diversion of economic resources as between d/t uses and
localities.
 It is possible to influence all these factors through PE
either for the better or for the worse.
 3.6. Effects of public expenditure

Effects on distribution of income

 Public expenditure (as part of fiscal policy) can be
used by the government to reduce income
inequality
 PEs on education, public health and medicine,
housing, etc is directed to help the poor & the
lower income classes.
 Thus carefully planned and executed PE, will help
in redistribution of income in favor of the poor
provided.
 3.7. Public Expenditure and Control of Inflation

 Unproductive and unplanned PE leads to

inflation.
 However, the government can suitably change
and adjust its expenditure during an inflationary
period so that the inflationary pressure may be
reduced.
 For instance, government can give subsidies to
those industries which are producing inflation-
sensitive goods so as to accelerate their
production or to enable producers to sell them at
lower prices.
Thank You
 Public Finance
CHAPTER

4 1. GOVERNMENT BUDGETING
2. Theories of Government Budgeting
3. Budget Framing
4. Budget as an Instrument of Economic
Policy

16
 4.1. GOVERNMENT BUDGETING
 It is a reflection of not only taxation and PE policy, but
also of a plan for future course of action.
 Though budget is a program for future action and is
generally framed for a year.
 It presents a picture of the details of expenditure,
taxation and borrowings for three consecutive years,
that is:
 The actual receipts & disbursements of the previous
year,
 The budget & revised estimates of the current year and
 The estimated receipts and expenditures of the coming
fiscal year.
 GOVERNMENT BUDGETING
A good budget should be one;
a) That will enable the legislature and the people
to appreciate the proposals of receipts and
disbursements in the context of prevailing state
of economy of the country.
b) It should be one that the proposals can feasibly
be translated into realization.
….They should not be over-ambitious and should
be within the means, financial and otherwise.
 GOVERNMENT BUDGETING
c) It should depict a clear picture of the state of
performance relating to programs of the
government in the previous year

…so that it becomes possible to see

what have been achieved,
what have been the shortcomings and
decide as to what course of action should
be adopted in the budget plan.
 GOVERNMENT BUDGETING
Principles of good budgeting
Comprehensiveness: The budget must cover all
the fiscal operations of gov’t, encompassing all
public expenditure and revenues,
…to enable full and informed debate of the trade-
offs between different policy options.

Predictability: Spending agencies should have

certainty about their allocations in the medium
term to enable them to plan ahead.
 GOVERNMENT BUDGETING
Contestability: All policy and attached funding
should be regularly reviewed and evaluated in
order to ensure prioritization and optimal
performance of spending agencies.
Transparency: All relevant information required
for sound budgetary decision making should be
available in an accessible format, and in a timely
and systematic fashion.
 Budget information needs to be accurate, reliable
and comprehensive.
Periodicity: The budget should cover a fixed
period of time, typically one year.
 GOVERNMENT BUDGETING
The budget passes through different stages of action.
 Firstly, the budget frame is structured. The
government asks different departments to submit
their proposed programs of action for the coming
year.
 Secondly, the budget is presented in legislature and
they carefully considers the proposals for its
approval.
…There may be additions or alternations in budgetary
provisions as considered necessary by the legislature.
 Thirdly, the implementation, Revenues are raised
and PEs relating to the budget plan are made.
 4.2. Theories of Government Budgeting
Two theories of gov’t budgeting : classical (balanced
budget) and modern (Managed) theory of ‘Budget.
1. Classical theory
 This follows philosophy of ‘laissez-faire’ where by
private sector plays a great role.
 Under such a situation, the size of the budget is
always small and the budget should always be
balanced.
 If there is BD and it is financed by public borrowing,
it will withdraw funds from private sector where they
are more productively employed, which will bring
down over all economic efficiency.
 4.2. Theories of Government Budgeting
2. Modern Theory:
• Called Managed Budget does not agree with the
classical assumption of full employment.
And hence to ensure employment of unutilized and idle
resources, a flexible budgetary policy is needed.
It is essentially a counter measure against economic
fluctuations of business cycle to which advanced
countries are subjected.
 When depression and unemployment occurs in the
economy due to deficiency of effective demand,
…the need is to inject additional purchasing power into
the economy so that effective demand, hence employment
of production factors are enhanced.
 4.2. Theories of Government Budgeting
• When there is neither inflation nor unemployment,
the budget should be balanced.
• Generally, whether the budget should be balanced or
a deficit or a surplus should be decided by the
prevailing economic circumstances.
Difference
 The main difference in principle of gov’t budgeting is
concerned with their views on savings and investment.
– To the classical, saving is always equal to investment because
the former is automatically converted into the latter and hence
no unemployment.
– To the modem economists, however, savings and investment
need not be equal.
 4.2. Theories of Government Budgeting
• When S>I, deficiency of effective demand
develops and unemployment occurs due to fall
in production and leads to depression.
• Under such circumstances, the modem theory
argues, the budget policy of government should
be flexible;
– allowing for balanced budget when there is neither
inflation nor unemployment (when S=I) and
– for unbalanced budget when the economy suffers
from either inflation or unemployment, (when S≠I)
 4.3. Budget Framing
• A government budget is framed in the shape of a
financial plan which is a statement of income and
expenditure relating to various economic and
other activities.
i) Revenue and Capital budget
• In the revenue budget, the current expenditure is
met out of domestic taxation, while the
expenditure on capital account is made out of
domestic and foreign borrowings.
 Revenue Budget Capital Budget

Items of receipts items of Expenditure items of receipts items of

Expenditure

3/5/2024
a. Taxes on a. Administrative and a. Loans and a. Public works
income general services recoveries
b. Taxes on b. Social services b. Market loans b. Construction of
property power generation
plant.
c. Custom duties c. economic services c. Small savings c. construction of
roads and
railways
d. Union excise d. community d. External loans d. Flood control
duties services works
e. Non-tax e. Maintenance of e. Other receipts e. Irrigation
revenue road and railways. canals etc.
etc.
f. Other f. Total revenue f. Total capital f. Total capital
revenues. Total expenditure receipts expenditure 28
revenue receipts
 4.3. Budget Framing
ii) Planed and non planed budgets:
• The basic aim of economic planning is to achieve
development in different sectors like agriculture,
industry, power, transport, etc.
• Ethiopia practices five-year plans. A part of the
budgetary receipts and expenditures is devoted to
the administration and implementation of the plans.
• The part of budgetary receipts which goes to finance
the plan expenditure and the outlays on planned
developmental heads constitute the planed budget,
• while the remaining part of the budget is referred to
as the ‘Normal’ or ‘Non-plan budget.’
 4.3. Budget Framing
iii). Balanced and Unbalanced Budget
• In the advanced countries, a balanced budget is
pursued at a time when the economy suffers neither
from inflation nor from unemployment or depression
• When the economy suffers from inflation, a surplus
budget is operated
…while a deficit budget is pursued when the economy
suffers from unemployment.
• The developing and underdeveloped countries suffer
normally from idle resources and, to make their
proper use, additional expenditures are incurred
and, hence, they mostly pursue deficit budgets.
 4.4. Budget as an Instrument of Economic Policy
• Government budget is an important instrument of
economic policy in both developed and developing
countries.
• In the DCs, the economy operates at full
employment level and, hence, there does not exist
unemployed resources. But the economy is
subjected to trade cycle and, therefore, occasionally
faces the problems.
• In the underdeveloped countries, the main problem
is how to attain economic growth and growth
process is faced with a number of problems related
with ; allocational, distributional and stabilisational
 4.4. Budget as an Instrument of Economic Policy
• However, well-designed government budget can
solve these problems in the following ways.
(1) Revenue Raising Device. The government
requires enough revenue to discharge its fiscal
responsibility.
(2) Building of Economic Overheads: proper
economic infrastructure, proper transport and
communication system, large scale generation of
electric power, establishment of basic and key
industries.
 4.4. Budget as an Instrument of Economic Policy
(3) Diversion of Resources to More Useful Production.
• Hence private investment is generally concentrated
on the production of luxury commodities,
….Imposition of heavy tax on harmful and less
essential goods and tax exemption or tax concessions
granted to more essential goods and services can
divert resources.
(4) Proper Allocation of Resources:
The government can correct misallocation either in the
form of production subsidy /supply of g/s.
 4.4. Budget as an Instrument of Economic Policy
(5) Balanced Development:
Underdeveloped countries suffer from regional
imbalance in economic development.
 The government can correct this imbalance by
setting up public sector industries in backward
areas, via;
Subsidy
Tax
Facilities
 4.4. Budget as an Instrument of Economic Policy
(6) Income and Employment: Income of the people
in LDCs can be increased only through increased
productivity and production.
 The budgetary provisions of employment-related
tax concessions/exempition can influence
creation of employment opportunity in the
private sector also.
(7) Saving and Investment: In underdeveloped
countries, the level of saving & investment is very
low.
…Public saving is, therefore, necessary.
 4.4. Budget as an Instrument of Economic Policy
Capacity and willingness to work, save and invest
of the people is increased through various
human capital formation measures and creation
of employment opportunities.
These are all done through budgetary
expenditures.
8) Poverty Removal: Poverty removal programme is
a part & parcel of the budget in UDCs countries.
All expenditure measures are designed in such a
way that they directly or indirectly influence
reduction of poverty in the economy.
 4.4. Budget as an Instrument of Economic Policy
Direct budgetary programs for poverty removal
are those of increasing employment
opportunities & creation of community assets
like;
employment insurance,
social security,
consumption subsidy,
public distribution system & price support
programmes, low-income housing,
area development, input supply,
 4.4. Budget as an Instrument of Economic Policy
(9) Full Employment and Price Stability
• An important function of the budget is to secure
the objective of full employment and price level
stability.
• In the underdeveloped economies where
resources are not fully employed public
expenditure programs and tax incentive
measures are put into operation to secure full
employment.
• All these measures should clearly put in the
government budget.
Thank You