Public Finance

Week 8: Budget
Fahmida Sultana
Associate Professor
Department of Development Studies
University of Dhaka
 Lecture Plan
•Definition of Budget
•Different types of Budget
•Different concepts related to Budget
•Budget Forecasting
 Government Budget
• The government budget is an annual financial
statement that is prepared to account for the
revenue and expenditure of a government for
the upcoming fiscal year.
 Budget Deficit
This is a common economic term, normally used to
indicate a situation when the expenditures on
governmental levels surpass its financial savings. As a
matter of fact, Budget Deficit occurs when the government
does not plan its spending, after considering the total
amount of money it has saved.
In other words, a budget deficit occurs when the total
expenses of the government exceeds the total earnings of
it.
 Budget Deficit
• It can indicate the financial health of a
country. The term is commonly used to refer
to government spending rather than
businesses or individuals.
• Budget deficits affect the national debt, the
sum of annual budget deficits, and the
cumulative total a country owes to creditors.
 Budget Deficit
• When a budget deficit is identified, current
expenses exceed the amount of income received
through standard operations. To correct its
nation's budget deficit, often referred to as
a fiscal deficit, a government may cut back on
certain expenditures or increase revenue-
generating activities.
• A budget deficit can lead to higher levels of
borrowing, higher interest payments, and low
reinvestment, which will result in lower revenue
during the following year.
 Causes of Budget Deficit
Both levels of taxation and spending affect a government's budget deficit.
Common scenarios that create deficits by reducing revenue and increasing
spending include:
• Tax structure that under taxes high-wage earners but overtaxes low-wage
earners.
• Increased spending on programs like Social Security, Medicare, or military
spending.
• Increased government subsidies to targeted industries.
• Tax cuts that decrease revenue but provide corporations with funds to
increase employment.
• Low GDP, or gross domestic product, results in lower tax revenue.
(Budget deficits may occur as a way to respond to certain unanticipated
events and policies, such as the increase in defence spending after the
September 11 terror attacks).
 Effects of Budget Deficit
• Budget deficits affect individuals, businesses, and the overall
economy. As the government takes steps to improve the
deficit, spending for programs such as Medicare or Social
Security may be curtailed. Improvements to infrastructure
may also be affected.
• To increase revenue, tax hikes may occur for high-income
earners or large corporations which may affect their ability to
invest in new business ventures or hire new employees.
• A looming concern of a budget deficit is inflation, which is the
continuous increase of price levels. A budget deficit can cause
to release more money into the economy, which feeds
inflation and continued budget deficits can lead to inflationary
monetary policies, year after year.
Strategies to reduce Budget Deficit
• Countries counter budget deficits by promoting economic
growth through fiscal policies, such as reducing government
spending and increasing taxes. Determining the best
strategies regarding which spending to cut or whose taxes to
raise are often widely debated.
• [To pay for government programs while operating under a
deficit, if the government borrows money by selling bonds,
bills and other securities, that carries the risk of devaluing the
nation’s currency, which can lead to hyperinflation.]
• Reduced regulations and lower corporate income taxes
improve business confidence, stimulate further employment,
and promote economic growth leading to higher taxable
profits and an increase in income tax revenue.
 Budget Surplus
•A Budget Surplus arises in a country when the total
revenue earning surpasses that of expenditure in a
particular financial year. Budget Surplus is very important
in the sense that at the time of covering the budget
deficit, it brings about a decrease in the net public debt.
Like Budget Deficit, Budget Surplus also exerts indirect
influence on the tax payers.
•The term often refers to a government's financial state,
as individuals have "savings" rather than a "budget
surplus." A surplus is an indication that a government's
finances are being effectively managed.
 Budget Surplus
•A budget surplus might be used to make a purchase, pay
off debt or save for the future.
•A city government with a budget surplus may use the
money to make improvements, such as revitalizing a
decaying park or downtown area.
•During the final years of Bill Clinton's presidency, the U.S.
government eliminated a large budget deficit, resulting in
a surplus. A surplus is a positive value and is the sum by
which revenues are greater than spending during a set
period, usually a fiscal year. For example, in 2000, receipts
for the year totaled $2.025 trillion, while expenditures
were $1.788 trillion. This resulted in a budget surplus of
about $236 billion.
 Budget Surplus
•A budget surplus is one indicator of a healthy economy.
• However, it is not necessary for a government to
maintain a surplus. The U.S. has rarely run a budget
surplus and has experienced long periods of economic
growth while running a budget deficit.
•A surplus implies the government has extra funds. These
funds can be allocated toward public debt, which reduces
interest rates and helps the economy. A budget surplus
can be used to reduce taxes, start new programs or fund
existing programs such as Social Security or Medicare.
 Causes of Budget Surplus
•A budget surplus can occur when growth in revenue
exceeds growth in expenditures
•It can be occurred following a reduction in costs or
spending or both.
•An increase in taxes can also result in a surplus.
 Impacts of Budget Surplus
•Although having unspent funds can be a sign of prudent
spending, running a surplus is not always beneficial, and
can sometimes come with its own problems.
•Most countries could gain a budget surplus by increasing
their tax revenues, but the economic consequences of
higher taxes could diminish the value of running at a
surplus.
•Keynesian economics suggests that governments should
run a surplus during times of prosperity, and a deficit in
times of depression. This allows the government to save
money when it is well off, and to spend money on fiscal
stimulus when the economy is less well off.
Advantages and Disadvantages of
Budget Surplus
•Running a budget surplus means that government bodies
will have additional money to spend at the end of an
accounting period.
•This extra cash can be used to pay off government debts
or reinvested in other government projects.
•It can even be returned to the public in the form of a tax
cut.
•A large surplus also reduces the need for borrowing
through bond issues.
•This will reduce interest rates in that country, allowing
people and businesses to borrow money at a lower cost.
Advantages and Disadvantages of
Budget Surplus
•However, running a surplus is not always an unmixed
blessing. Although it may seem wise for a government to
save money, those savings mean that the wider economy
will not benefit from the multiplier effect of government
spending.
•In addition, those savings could mean less spending on
public services.
•A budget surplus can also affect a country's inflation
levels and GDP. Government spending is one of the four
components of GDP, meaning that a government that
struggles to reduce spending will ultimately reduce that
country's GDP.
Advantages and Disadvantages of
Budget Surplus
•Moreover, since lower spending reduces the amount of
money circulating in an economy, this can result in
deflation.
•Ultimately, there is no simple answer to whether a
budget surplus is a good or a bad thing.
•Both surpluses and deficits have their own advantages,
and the best action depends on a government's specific
economic situation and priorities.
 Balanced Budget
The term "Balanced Budget" is somewhat influenced by
the Keynesian School of Thought. In the public sector of a
country, a Balanced Budget is said to have achieved, when
there exists equilibrium between income and expenses in a
commercial cycle
 Arguments against Balanced Budget
• The government borrowing may be justified relative to the purpose
for which the money is used. Example of borrowing for road or
school versus borrowing for a project that is never completed (or
never started).
• The government should counterbalance the market failure; it
should not be budget neutral which is meant by balanced budget.
• In a developing country some deficit budgeting would be needed to
provide a financial counterpart to the increasing monetization of
the economy.
• In some situations the deficit budget can help the economy in
recovering from a depression by boosting up production and
employment( with a flexible economy).
• A balanced budget itself does not imply the absence of wasteful
expenditure.
 Arguments for Balanced Budget
• The traditional view is that the deficit in budget should be
avoided and if occurred at all should be wiped out soon for
the conformity with the ideals and soundness of the private
budget. This view was extended for the government budget
also for reducing wasteful and unnecessary expenditure
made by it.
• A deficit budget generally adds to the currency and money
supply and thus strengthens inflationary pressure.
• The government finds it much easier to extend its
expenditure if it has to finance through a deficit when it
finances deficit through creation of money, so the
government may face its expenditure mounting up and this
may force the deficit budget in future also.
 Arguments for Balanced Budget
• The theory of balanced budget multiplier shows that even
with a balanced budget, just an increase in the size of the
budget can raise the level of economic activities and income.
• Deficit financing from borrowing rather than taxing leads to
lower investment and therefore in the long run lower output
and consumption. Reducing the deficit allows interest rates to
fall, stimulating investment and thus promoting economic
growth and better future living standard.
• Higher consumption with lower/no tax->less investment(with
a full employment situation)->increase in the rate of interest
to maintain the full employment without inflation->lower
investment->lower C and Y in the long run.
• Borrowing generates burden for future generation.
Different Concepts Related to Budget

Budget Planning
Budget Planning basically guides the allocation of funds
in different sectors of a country. Soon after the
preparation of a country's financial budget for the
current fiscal year, Budget Planning is essential for
making equal distribution of the available funds, to meet
various revenue and expenditure purposes.
Different Concepts Related to Budget

Budget Reform
Budget Reform refers to the changes which are made in
the budget plans, for getting more effective results in
terms of cutting down the overall expenses and
facilitating more income. Without any Budget Reform, a
budget plan tends to become stereotype and stagnant
and no longer remains beneficial in meeting the financial
requirements of the country.
Different Concepts Related to Budget
Receipt Budget
Receipt Budget records the allocation of cash receipts in
various sectors of the country, for their overall growth
and development. In other words, a careful glance at
the Receipt Budget of any country will bring out a
detailed picture of the total cash that the nation has in
hand, for promoting diverse developmental projects
and programs.
Different Concepts Related to Budget

Expenditure Budget
The annual expense plan of a commercial enterprise is
explicitly stated in the Expenditure Budget. The primary
purpose of an Expenditure Budget is to define an
economic policy, with respect to the financial spending
made for infrastructural and equipment purposes, which
include their making and maintenances.
Different Concepts Related to Budget

Budget Crisis: This indicates a situation where both the

executive and the legislature in a Presidential system of
government comes to a standstill, and unable to pass a
financial budget. This is a common feature of most
Presidential form of governments across the world,
where only the legislature has the power to pass a
financial budget. However, the executive is also
empowered to pass a veto, which consists of inadequate
votes, sufficient to overrule the decisions taken.
 Budget Forecasting

•A budget forecast is a type of forecast that takes its

inputs from the budget for the upcoming fiscal period.
•Once a budget is created and expectations are formed
for the upcoming year, a forecast is created to model
what the budgeted values should achieve. The budget
forecast is used in an attempt to predict the outcome of
the budget, if followed exactly.
 Budget Forecasting

A pilot would never fly a plane from Los Angeles to San

Francisco without a flight plan that explains how to get
there. Yet all too often, small business people open their
doors without clear plans to help them get where they
want to go. One of the easiest ways to get there —
wherever that is — is by creating a budget and sales
forecast.
 References

• Bhatia
• Rosen
• Musgrave