Public Finance (Econ 4122)

CHAPTER-5
PUBLIC BUDGET
 Objective
• After completing this unit, a student is expected to:
describe the meaning of government budget
explain the features and importance of budget
analyze the principles of budgeting
explain the types of budget
describe the procedure of budgeting
describe performance of budgeting
 Meaning of Public Budget
• Every nation needs to perform various economic as
well as non-economic activities to fulfill the needs of
the society.
• For achieving such objectives, government should
administer its finance properly. To this end, it
describes its intentions and policies that it would want
to perform in the coming period (usually a year) and
prepare financial plan corresponding to its activities.
• This financial plan is referred to as government budget.
 Cont’d…
 Many scholars have defined budget in different ways. But the
main elements that present in a budget are:
 It is a statement of expected revenue and proposed expenditures
of the authorities concerned
 It requires some authority to sanction. For example after it is
prepared, the parliament has to approve public budget in Ethiopia
 It has a periodicity which generally in one current year. For
example : The (2017 Ethiopian budget year extends from Hamle
1, 2016 E.C up to Sene 30, 2017 E.C. It sets procedure in which
the collection of revenue and administration of expenditure is to
be executed.
•Thus with these characteristics we can define budget as:
 The main tool to administer finance, and is an annual statement of
government fiscal policies, revenue and expenditure.
 Importance of Public Budget
 As you know every nation needs to achieve many goals (to
achieve rapid development, to rise per capital income, remove
poverty, to achieve higher employment etc.), but due to the
existence of scarcity of resources it is impossible to achieve all
this goals at a time. A proper plan of action is therefore necessary.
Therefore, public budget enables countries to:
 To use their resources efficiently by setting the physical targets
for different actions considering different factors, It may be
formulating the programs on the basis of past experience
 To avoid arbitrary use of resources
 Avoid corruption. Because at the end of the budget year ,the
government and its various departments know that they are
responsible to the legislature for their action and budgetary
performances
• To achieve regional balance by reallocating funds
 Principles of Budgeting
 A principle of sound budget consists of wise spending and collection of revenue
and involves the following principles.
 Canon of Comprehensiveness: according to this principle a yearly financial plan
of a nation should include complete revenue and expenditure lists. It ought to be
accompanied by an account of the performance of fiscal policies and programmers
of the government during the previous year.
 Canon of Exclusiveness: this canon suggests that public budget should exclude
matters out of finance.
 Canon of Unity -according to this principle revenue should be recorded in a
revenue account and expenditure ought to be recorded in the expenditure account.
 Canon of Specification -this principle suggests that every item of revenue should
be specific, this means the type, and amount and time of collection ought to be
determined. The same should be done for expenditure.
 Canon of Periodicity -this rule implies that government should prepare a yearly
plan of revenue and expenditure.
 Objectives of Budgeting
• As an instrument of economic policy, the objectives of budget are
likely to be different in different countries and in the same country
in different situations. It depends on the economic and social policy
of the government.
• In developing economies the objectives may be economic growth,
reduction of unemployment and reduction in economic
inequalities; but for developed nations which are operating at full
and near full employment level the is maintaining full employment.
 Thus budget as a crucial and imperative instrument of economic
policy would involve the following objectives.
 Building of economic overheads: In less developed countries, there
is scarcity of economic overheads. Thus budgetary provisions help
to build infrastructures, which in turn make important influence on
industrial and agricultural development.
 Objectives of Budgeting
 Balanced development: developing countries suffer from regional
imbalance in economic development. Therefore, government budget can
correct these geographical back ward regions
 Poverty reduction: poverty removal programme is a part and parcel of the
budget in less developed countries. All expenditure measures are designed
so that they directly or indirectly influence reduction of poverty in the
country.
 Full employment and price stability: A significant function of the budget
is to secure the objective of full employment and price stability
 Check on misuse of public goods: No doubt budget is a financial plan
relating to public revenues and expenditures. Thus it is a check whether
the collected revenues are used for the proposed objectives in an efficient
way or not
 Development of human capital: Skilled human labor is most important
for any countries development more than any thing. Thus budget
provisions can go a long way to serve the purpose
 Types of Budgeting
Multiple and unified budgets
 In some countries of the world, for instance U.S.A,
there was traditional way of preparing budgets in parts
and presents each part separately in order to evaluate
specialize function of the government This types of
budgets are said to be Multiple budgets.
 However, in now a day a type of budget that has got
favor is a united budget. In this case a budget is
prepared in a united way; important sub portions are
classified and presented separately under it.
 Types of Budgeting
Revenue and Capital Budget
Revenue Budget Capital Budget
Items of receipts Items of Items of receipts Items of
Expenditure Expenditure
a.Taxes on income a. Administrative a. Loans and a. Public works
and 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 canals
revenue road and railways. etc.
etc.
f. Other revenues. f. Total revenue f. Total capital f. Total capital
Total revenue expenditure receipts expenditure
receipts
 Functional Budget
 It is classified based on the purpose of the expenditure. Therefore, the
functional classification of spending has been divided in to four groups as:
 General services: this group incorporates expenditures on civil and
defense activities such as general administration, tax collection, police
defense, currency, external affairs, provision for against natural disasters
etc.
 Social Services: this group involves expenditures on services like
education, health, family planning, housing, library (public), broadcasting,
employment program, and nutrition program for children, relief
expenditure for disabled persons and etc.
 Economic Services: this category involves all spending which facilitate
economic activity directly or indirectly. They are divided into agriculture,
industry, transport and communication, and other economic activities.
 Un allocable: this group involves those items that cannot be categorized
under the above groups. These are interest payment, pension, food
subsidies, special loan, aid to foreign nations etc.
 Procedure of Budgeting
 One of the most important factors which affect economic growth
is inefficient utilization of limited economic resources,
Therefore, any country has to control it's expenditure in such
away to buttress its growth. There are different stages of
controlling public expenditure. These are:
 Budget preparation- it is the first stage of controlling annual
financial Plan. The Ministry of Finance prepares the National
budget. The main target of budget preparation is to
o Make the plan to send and raise revenue systematically.
o Show economic, social and other government policies.
o Provide consistence means for auditing and careful
implementation of financial plans.
o get approval and power from the legislature to raise the said
revenues and spend them etc.
 Procedure of Budgeting
 Approval of Budget- it is the second stage that implies the
presentation of budget to the parliament and getting approval. The
Minister of Finance presents the budget. The initial speech that it
makes is emphasized on overall economic and related conditions
of the nation and the main budgetary. Finally, the budget is
approved by the parliament and assumes the power of law.
 Execution of Budget- is the third stage of control over of public
expenditure. The implementation of the budget will be started
after it is approved but with great commitment to avoid wastage.
 Auditing of Budget- is the fourth stage of control over of
government spending. In this stage the auditor audits government
account and prepare the audit report. This enables government to
see the area where wastage exists and to correct it.
 Theories of Government Budgeting

1) Classical Theory of Balanced Budgeting : The assumption of ;

 Full employment
The economic problem is not the attainment of growth i.e. the economy function with
maximum efficiency .
 Liaises fair
The role of government is limited to minimal i.e. the economic activity is performed by
the private sector.
 Under such a situation, the size of the budget is always small and the budget should
always be balanced. If there is budget deficit and it is financed by public borrowing, it
will withdraw funds from private sector where they are more productively employed.
 Such diversion of resources will bring down over all economic efficiency. since
deficit financing through borrowing is easy, the practice of unbalanced budget will
encourage expansion of government activities as against the classical notion of small
budgets.
 Theories of Government Budgeting

 This will reduce the capacity of government to spend for more important purposes
because interest charges on borrowed funds have to be paid in addition to repayment of
the principal amount.
 Thus, public borrowings are expensive; they require double payment in the form of
debt charges as well as repayment
There are two views regarding the balanced budget theory.
• According to one view, the balancing of budget is brought about by equating current
revenues with current expenditure.
• There is no role of borrowing in the budget. Since total revenues are equal total
expenditures, the budget is balanced.
• In the other view of balanced budget, governmental receipts include public debt also.
The budget has, however, two parts – current budget and capital budget, both of
which are balanced.
• Thus, current expenditures are financed by current revenues while capital expenditures
are financed by public borrowing. Thus, the overall budget is balanced.
 Theories of Government Budgeting

2) The modern theory of managed budget

 The modem theory argues, the budget policy of government should be flexible,
allowing for balanced budget when there is neither inflation nor unemployment
i.e., when savings and investment are equal and for unbalanced budget when the
economy suffers from either inflation or unemployment, i.e., when savings and
investment are unequal.

Performance and Program Budgeting system

(PPBS)
Performance Budgeting Classification
 Burk head defines performance budget as one which presents the purposes and
objectives for which funds are requested, the costs for programs proposed for
achieving these objectives and quantitative data measuring the
accomplishments and work performance under each programme
 Performance Budgeting Classification
 Its main purpose is to measure the benefits and to relate them to costs incurred.
 The targets to be achieved during the budget period are set as objectives. Thus, a
determination of attaining a specific amount of benefit from a particular outlay
inevitably takes into consideration some sort of cost-benefit analysis on the basis of
either past performance or comparative study of the relevant market situation.
 In the mixed economy of developing countries where a part of the budget is
concerned with planned development programs and a time bound achievement of
objectives is all the more necessary, the role of performance budgeting is
paramount.
 This classification also helps to detect the pockets of inefficiency in administration
as well as resource allocation so that corrective steps may be designed to improve
the efficiency level of administering and executing the development programs.
 Programme Budgeting Classification

 The budget would frame a programme structure to attain a

particular objective and specify spending to attain it.
 Program budgeting aimed at direct funding more towards the
achievement of actual policy objectives or outputs.
 We may think of all those expenditures allocated to the set of
programs under a particular objective as belonging to a total
spending agency which is responsible for attainment of the
objective .
 Under program budgeting, government activities are divided
into the hierarchical structure of program, subprogram,
activity and component (if necessary).
 Appropriations can then be made to particular program
according to the priorities of the government of the day.
 Zero Base Budgeting
 It is one of the most common type of budgeting .
 The assumption that all department budgets are zero and must be rebuilt from
scratch.
 Managers must be able to justify every single expense aiming to avoid any and
all expenditures that are not considered absolutely essential to the company’s
successful (profitable) operation.
 In ZBB, all the numbers reset to zero and given a fresh thought over all the
items of budget.
 The new numbers of every item shall be justified with proper reasoning and
shall not be ad hoc figures.
 It helps the management to avoid traditional expenditures which are no longer
required. As the base is zero, management can actually give a new thought to
each and every item of expense and reassess the requirement or possible cost
saving.
 Incremental based
budgeting(IBB)
The budget is prepared by taking the current period’s budget as a
benchmark, with incremental amounts then being added for the new budget
period.
• In Incremental Budgeting the figures of each expenditures and income
starts with previous years actual numbers and adjusted for inflation,
overall market growth and other factors management deems fit.
Example :
• Assume in Debre Markos University total salary paid to employees in a
year 2010 E.C is birr 500,000.
• The human resource directorate of the university thinks that they need five
more new employees who will be paid birr 30,000 each and also an
increment of 10 % to existing employees shall be given.
• Then ,When the budget is prepared for the year 2011E.C, therefore, in
incremental budgeting the budget for salary would be birr 700,000
($500,000 + 10% raise to existing employees + ($30,000*5 new
employees).
 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 of depression or
unemployment and inflation or pressure of excess purchasing
power.
 In the LDCs, the economy operates at less than full
employment level and, hence, the main problem is how to
attain economic growth. In these poor countries, growth
process is faced with a number of problems. They are
allocation, distributional and stabilization.
 Budget as an Instrument of Economic
Policy
 The following are the important ways in which the government
budget can influence the economy of a country.
(1) Revenue Raising Device.
 The government requires enough revenue to discharge its fiscal
responsibility.
 Modern countries have increasingly become welfare states with
larger and larger state activities coming under the fold of public
sector.
 Hence, resources have to be found in sufficient quantity. Budget
secures this purpose through a financial plan.
 The receipts side of the budget clearly mentions the sources and
the extent of funds for the purpose of financing state activities.
 Budget as an Instrument of Economic
Policy

(2) Building of Economic Overheads.

 The main reason of underdevelopment, of the poor countries is
absence of proper economic infrastructure.
 Without proper transport and communication system, large scale
generation of electric power, establishment of basic and key
industries and proper training facilities for workers and
entrepreneurs, industrial development is not possible.
 Similarly, agricultural production and productivity cannot improve
in the absence of proper irrigation facilities, flood control measures,
technological improvement with research and development
activities, etc.
 These facilities must be provided by the government. The cost of
supplying these services is heavy and cannot be raised directly from
the beneficiaries.
 Budget as an Instrument of Economic
Policy

3) Diversion of Resources to More Useful Production.

 Free market mechanism leads to production of those goods which give
maximum profit to private enterprises. Hence private investment is
generally concentrated on the production of luxury commodities.
 It is, therefore, necessary to divert resources to the production of more
useful goods and services, particularly of the kind of mass consumption
ones. This can be done by government interference through the budget.
 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 to the production of right kind of goods
and services.
 Grant of facilities through budgetary expenditure can also do the same
job.
 Budget as an Instrument of Economic
Policy

4) Proper Allocation of Resources.

 Most efficient allocation of resources is given by the equality
between marginal cost and price which is possible only under
perfect market conditions.
 Underdeveloped countries seriously suffer from misallocation of
resources.
 The general market conditions in private sectors are set by
existence of monopoly, monopolistic competition and oligopoly.
 To correct this misallocation, the government has to interfere
either in the form of production subsidy or supply of goods and
services by public authorities so that the gap between average
revenue (i.e. price) and the marginal cost is reduced as far as
possible
 Budget as an Instrument of Economic
Policy

(5) Balanced Development.

 Underdeveloped countries suffer from regional imbalance in
economic development.
 Left to the private sector which is motivated by profit
maximization, the industries will be located in the urban and
already-developed areas.
 The government can correct this geographical imbalance by
setting up public sector industries in backward areas.
 Budget as an Instrument of Economic
Policy

(6) Income and Employment.

 Since underdeveloped countries are low ­income economics,
people live in poverty and, hence, saving and investment is very
low.
 Income of the people can be increased only through increased
productivity and production.
 Budgetary provisions can go a long way to achieve this.
 When agricultural technology is improved through budgetary
programs, the income of the people engaged in agriculture rises.
 People get gainful employment in the sector.
 Improvement in small scale industries in the rural areas and
setting up of public sector industries in the backward regions
will increase employment opportunities in these industries.
 Budget as an Instrument of Economic
Policy

(7) Saving and Investment.

 In underdeveloped countries, the level of saving and
investment is very low. Moreover, without increased
saving and investment, economic growth cannot be
achieved.
 Due to low level of income, marginal propensity to
consume is very high and, hence, the mass people cannot
save. Public saving is, therefore, necessary. Taxation of
various types serves this purpose.
 The saving and investment of private individuals are also
influenced by the savings-investment related tax
concessions and other budgetary subsidy programs.
 Budget as an Instrument of Economic
Policy

(8) Poverty Removal

 Poverty removal programme is a part and parcel of
the budget in underdeveloped countries. All
expenditure measures are designed in such a way that
they directly or indirectly influence reduction of
poverty in the economy.
 when budgetary resources are spent on account of
education, whether general or technical and
vocational or on health measures, land reforms, flood
control and irrigation, etc., an important objective is
to remove poverty of people.
 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.
 We have seen how this should be done in the case of depression
and inflation.
 When the economy, on the other hand, suffers from neither
inflation nor deflation, the budget is to maintain full employment
and prevailing prices through judicious programs of public
expenditure and taxation.
 In this case, a balanced budget is helpful in developed countries.
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.
 Budget as an Instrument of Economic
Policy

(10) A Check to Misuse of Public Funds.

 Since budget is a financial plan relating to public revenues and
public expenditures for the budgeted period, it imposes definite
restraints on the tax collectors n spender.
 The legislature and the people know from the study of budget
how the revenues will be raised and how will they be spent.
 Revenue mobilization and public expenditure activities will be
put to scrutiny of the legislature and also of the members of
public.
 In case of inefficiency or misuse in the task of budgetary
performance, the executive agencies will be accountable. This
will definitely put a check on the improper use and
mishandling of public funds.