Government finance

Ravi K. Prajapati
Syllabus LH 15

• Government budget: Concept, classification, and component and

Government budget
• Deficit financing: Concept, objectives and methods of deficit financing
• Fiscal policy: Concept, types, objectives and instruments of fiscal
policy
Government Budget
• The financial proposal is government's budget which contains the estimate
of government revenue/income and expenditure for one fiscal year.
• Government budget is a financial document relating to expected revenue
and proposed expenditure for a specified period of time normally for one
financial/fiscal year.
• It has the approval to collect revenue and to incur expenses on the
activities proposed in it.
• It sets up rules and procedures for collecting revenue and making expenses
for chosen targets of the economy.
• It has timetable of activities and sources of revenue to implement these
activities.
Classification of Government Budget
• Functional Classification
• Economic Classification
• Organizational Classification
• Object Classification
Functional Classification
• Expenditure
• General services: includes both civil and defence expenditures on items such
as general administration, police, justice, tax-collecting, etc.
• Community services: covers road and bridges, sanitation and others.
• Social service: This includes education, health, social security, water supply
and other social services.
• Economic services: Agriculture, fuel and power, industries and minerals,
transportation and communications, and others.
• Revenue
• tax revenue
• Direct tax revenue
• Indirect tax revenue
• non-tax revenue.
Economic Classification
• breakdown of government expenditure and its method of financing in
certain income categories such as expenditure on salaries, wages,
receipts from the market borrowing, etc.
• Such classification provides information on consumption, investment,
saving, creation of financial assets and liabilities.
Organizational Classification
• classification of government budget according to organizational units
of the government such as Ministries and Departments.
Object Classification
• focuses on expenses on personal services, transfer payments, the
purchase of commodities, the purchase of property, etc.
Components of Government Budget
• Revenue
• Expenditure
Revenue
• sources and amount of revenue that the government is expected to earn
within the budgetary period of one year.
• Tax revenue and Non-tax revenue.
• Tax revenue consists of government income from direct taxes like taxes on
income and wealth, and indirect taxes like goods and services taxes (GST),
value added tax (VAT), etc.
• Direct taxes are the taxes that are to be paid directly by the individual and institution
they fall on.
• Indirect taxes are the taxes the burden of which can be passed along to other, such
as general sales tax which can be forwarded to customers as high prices.
• Non-Tax Revenue is the revenue received by the government from non-tax
sources. For example, revenue collected in the form of fees, fines, license
and permits, profit of public enterprises, income from sales of public
services like telecommunication, electricity
Deficit Budget
• If the government expenditure is greater than government revenue, it
is said to deficit budget
Surplus budget
• If the government revenue is greater than its expenditure, it is said to
be surplus budget.
Balanced budget
• If the government budget is equal to government expenditure, it is
said to be balanced budget.
Process of Budget Formulation
1. Estimate of Overall Expenditure and Income
2. Determination of Priorities
3. Preparation and Selection of New Projects
4. Discussion
5. Proposals of New Taxes
6. Final Document
7. Authorization and Implementation
1. Estimate of Overall Expenditure and
Income
• The budget section of the Ministry of Finance (MOF) provides the
budget form to all concerned Ministries, their departments and local
offices.
• They fill the form and return to Ministry of Finance showing the
estimated expenditure and possible income for next fiscal year.
• The budget section prepares the estimate of overall expenditure and
possible income considering the ceiling of resource committee.
2. Determination of Priorities
• The budget section of MOF determines the priorities of the sectors
for expenditure.
• Due to the limitation of revenue all the sectors would not get equal
priorities.
• So, budget in different sectors like: agriculture, industry, service etc.
are allocated according to their priorities.
• Priorities are set according to the need of development, past
priorities, present condition of the sectors and so on.
• By principle the highest priority sector gets more budget and lower
priority sector gets less amount of budget in coming fiscal year.
3. Preparation and Selection of New Projects
• The budget unit of MOF selects and prepares the new project
proposals from primary (agriculture), secondary (industry) and
tertiary (service) sectors.
• Projects are selected according to the priorities, importance, and
urgency.
• In Nepal the projects which are selected are submitted to Planning
Commission for their feasibility study.
• Then, the Planning Commission makes necessary review and analysis
on the proposed projects and offers permission on economically,
socially and environmentally viable projects.
4. Proposals of New Taxes
• To raise the volume of revenue, government increases the rate of tax
by the way of budget.
• So, the finance minister proposes new tax policy in the parliament
through budget speech.
6. Final Document
• The final budget document is prepared before one month of new
fiscal year commences.
7. Authorization and Implementation
• The legislature authorizes the budget document and it becomes an
act.
• In Nepal after the authorization, the budget is disbursed into four
months basis to the Ministries, Departments and Local offices under
the headings of recurrent and capital expenditures.
Deficit Financing
• Deficit financing is a system of fiscal policy of covering the excess of
government expenditure over its revenue receipts mainly by
borrowing from domestic and external sources rather than increasing
taxes.
• Deficit budget refers to the phenomenon in which the public
expenditure in current account exceeds the current revenue in the
budget while deficit financing is the process of financing deficit
budget through printing of new notes or withdrawal of cash balances,
borrowing from the commercial banks and borrowing from the
central bank.
Objectives of Deficit Financing
• Control economic depression
• Mobilize inactive saving
• Capital formation
• Bring economic growth
• Employment generation
Methods of Deficit Financing
• Borrowing from domestic sources
• Market Borrowing
• Non - Market Borrowing
• Withdrawal of cash balances
• Issue of new currency (printing of new notes) by the government
• Borrowing from abroad
• Bilateral Borrowing
• Multilateral Borrowing
Disadvantages of deficit financing
• Inflationary
• Crowding-out
• Debt accumulation
Fiscal Policy
• Fiscal policy refers to government's changes in the pattern and level
of its expenditure, taxation and borrowings in order to achieve
specific objectives of achieving higher economic growth,
employment, income equality and overall economic stability.
• It is a planned adjustment of taxation and government expenditures.
• also known as budgetary policy.
• captures all the budgetary aspects of the government such as
revenue (taxation), expenditure, debt, deficit financing, borrowing,
grants, etc.
Types of Fiscal Policy
• Expansionary:
• government either increases spending or reduces revenue through lower
taxes.
• The purpose is to stimulate growth to a healthy economic level.
• This type of fiscal policy is most often used during a recession
• Contractionary:
• government either cuts spending or increases revenue through higher taxes.
• The purpose is to slow growth to a healthy economic level.
• This type of fiscal policy is used during time of economic boom where
inflation becomes a severe problem.
Methods of Fiscal Policy
• Automatic Stabilizer or Built-in-Stabilizers
• Discretionary Fiscal Policy
• Compensatory Fiscal Policy
Automatic Stabilizer or Built-in-Stabilizers
• The automatic stabilizer or built-in-flexibility fiscal tools are those
parameters that start to operate in the system automatically.
• This fiscal system has the quality of automatic adjustment in the
government expenditure and tax revenue in response to a rise or fall in
GDP.
• During expansion tax revenue increases because household income
increases with increase in GDP. As tax revenue increases government
expenditure decreases automatically with increase in GDP. Similarly, during
recession tax revenue decreases and government expenditure increases
automatically with the decrease in GDP and increase in unemployment.
• During recession govt spend more it increases GDP
• During prosperity govt people have high income and they have to pay ore
taxes
Limitations of Automatic Stabilization Policy
• Automatic stabilization works only when cyclical factors come into
being within the economy due to change in income and spending.
• This policy does not work when an economy is over affected by
external factors.
• works efficiently only in the advanced economies, not in less
developed countries.
Discretionary Fiscal Policy
• Discretionary fiscal policy involves new laws designed to fix economy
• Discretionary policies refer to actions taken by policymakers in
response to changes in the economy but they do not follow a strict
set of rules; rather, policymakers use personal judgment to deal with
each situation in typical manner.
• Changing the public expenditure by keeping tax-structure constant,
• Changing the tax-structure while keeping public expenditure constant,
• Changing both the tax-structure and public expenditure simultaneously.
Compensatory Fiscal Policy
• Compensatory fiscal policy aims at compensating the economy to
meet unending situation of inflation and deflation by handling taxes
and public expenditures.
• Compensatory fiscal policy can take the form of discretionary or non-
discretionary policy but its basic feature is to compensate the
economy in a situation with unemployment or inflation.
Objectives of Fiscal Policy
• Attainment of higher economic growth
• Achieving full/higher employment
• Reducing inequality of income and wealth
• Maintenance of economic stability
• Optimum Allocation of Resources
Instruments of Fiscal Policy
• Tax
• Direct
• Indirect
• Government Expenditure
• Recurrent Expenditure: The expenditures which the government has to make
repeatedly almost on the same headings year after year, is known as
recurrent expenditure.
• Capital Expenditure: Capital expenditure is allocated for developmental
works.
• Government Borrowings