PUBLIC POLICY OBJECTIVES (BUDGETARY OBJECTIVES)

2.1. INTRODUCTION
There are 3 major functions of budgetary policy:

2.2. THE ALLOCATION FUNCTION

Allocation function: It is a process whereby social goods are provided, or the process by which
total resource use is divided between private and social goods. The government provided such
social goods as security, healthcare, education, recreational services (parks), road etc.
To understand this clearly we classify goods into 2 categories;
Social goods Private goods
1. The need for social goods is felt 1. The need for private goods is felt
collectively individual.
2. The benefits derived from social goods 2. The benefits derived from private goods
are not limited to one particular are limited to one particular consumer
consumer who purchases the good, but who purchases the goods (e.g.
becomes available to others as well. humbugger, shoes)
(Reduction of air pollution benefits all).
[No. ownership right]
3. Social goods cannot be provided 3. Provide goods are efficiently provided
through price mechanism through market mechanism. The
market furnishes a signaling system
whereby producers are guided by
consumer demands.
4. For social good it would be inefficient 4. Nothing is lost and much is gained
to exclude any one consumer when consumers are excluded unless
particularly in the benefits, when such they pay. Application of the exclusion
participation would not reduce principle tends to be an efficient
consumption by anyone else. solution.
Application of exclusion principle is

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 impossible and prohibitively expensive.
5. Social goods do not carry a high rate of 5. Private goods carry high rates of return
return on investment. on investment.

In conclusion: It can be noted that no price could be put on a social good because of the non-
rival ness in consumption. As a result of this, to venture into production of social good it is
highly unprofitable and may not attract private investors. Because of non-rival ness in
consumption, there is market failure. Since the benefits of such goods are not limited to
individuals, beneficiaries may not voluntarily offer payments to the supplier of such goods. It is
as a result of this that the government normally taxes all citizens irrespectively so that it could
provide for such goods.

Public provision of social goods

Just like in the provision of private goods and services there must be consumer preference before
social goods and services are provided. But because so far social goods and service is collective
from the society as a whole, it is very hard to know the nature of the society preference map. It
would be very difficult to seek individual opinion from every citizen on type and quantity of a
social good that should be provided. It would also be difficult to decide how much each
individual should pay for the product. One may argue that consumers pay based on benefit
principle, as in the case of private goods, but then the problem would be, how such benefits
would be determined. Just as consumers are unwilling to voluntarily pay for social goods it
would be difficult to make them reveal accurately how much benefits they are deriving from
such goods.

The question then remains how best public goods could be provided. A different technique other
than market mechanism is needed by which the supply of social goods and the cost allocation
thereof can be determined.

This is where the political process enters the picture and must substitute market mechanism.
Voting by ballot must be resorted to in place of shillings voting. Since voters know that they
will be subject to the voting decision (be it simple majority or some other voting rule e.g.

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through their elected MPs, councilors representatives), they will find it in their interest to vote so
as to let the outcome fall closer to their own preferences. Thus decision making by voting
becomes a substitute for preference revelation through the market. The result will not please
everyone but they will approximately more or less perfectly, depending on the efficiency of the
voting process.

The different set of provision for and production for social goods
1) When the government either directly or through government owned palastatals e.g. post
office, sugar factory, water supply plants etc. or by assigning private producers to
produce goods through tenders, we say that the government has provided the goods.

If we say that social goods are provided publicly, we mean that they are financed publicly, we
mean that they are financed through the budget and made available free of direct charge. How
they are produced does not matter.

2.3. THE DISTRIBUTION FUNCTION

This is a process through which the government redistributes income and wealth among citizens.
In the absence of government intervention in the distribution of income and wealth, the
distribution depends first of all on the distribution of factor endowments. It is important to note
that people’s earning ability differ, ownership of properties also differ. The distribution of
income, based on this distribution of factor endowments, is then determined by the process of
factor pricing, which, in a competitive market, sets factor returns equal to the value of the
marginal product. The distribution of income among individuals thus depends on their factor
supplies and the prices which they fetch in the market. In most countries where free market
policies are followed there tends to a rise a class of society where few become richer and
majority poorer. Because this does not fall in line with what is considered to be just and fair, the
government must employ mechanisms and policies to redistribute wealth and income.

Fiscal instruments of distribution policy

Redistribution is implemented most directly by taking the following action:

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a) Employ a tax transfer scheme. Here a vertically progressive tax system is used to collect
more taxes on income of high income households and using the money to subsidize low
income households.
b) Employ a progressive tax system to finance public services such as medical, education,
water etc.
c) Employ a sales tax: Taxes are collected on goods and services used by high income
classes and funds raised are used to subsidize goods used by low income classes.

2.4.THE STABILIZATION FUNCTION

Here macro-economic policies are employed to maintain and achieve the goals of high
employment, acceptable price stability, favourable balance of payment position, acceptable rate
of economic growth and development.

Economic policies are necessary because high rates of employment and low rate of inflation do
not come up automatically in a free market economy. In fact changes in inflation rate are
inversely related to rate of unemployment as can be shown in the following diagram.

Phillip Curve shows the trade-off

Inflation between unemployment and inflation.
To achieve low unemployment level,
we have to be ready to suffer high
inflation rate.

10%

6%
Phillip’s curve

0 4% 12% Unemployment

Figure 2.1 Relationship between inflation and unemployment

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From the diagram it is clear that countries cannot attain zero level of inflation and unemployment
at anytime. There will always be a combination of the two that would be favourable at one time.
When inflation rate is high, rate of unemployment is low and vice-versa.
 This calls for well planned policy actions to achieve an acceptable level at inflation and
unemployment.
 At times there may be high level of inflation and employment meaning that Phillip’s has
shifted to the right.
Reasons:-
(i) Increased size of labour force due to population growth.
(ii) Low rate of manpower utilization high level of unemployment.
(iii) Low rate of economic growth. Low economic growth implies that when supply is
less than the demand the prices go up hence unemployment.
(iv) Lack of technological know-how – low output.

Therefore economic policy is essential for strong economic growth and development. The level
of employment and prices in an economic depends on level of aggregated demand and level of
output valued at prevailing prices. i.e. Employment = f (Output, expenditure).

 Aggregate demand is also a function of the spending decisions of many consumers,

corporate managers, many financial investors etc.
 The decision of this people in turn depends on:-
a) Past and present levels of income and expected level of future incomes.
b) Level of wealth in a country and its distribution.
c) Credit availability.
d) Future expectations.

Instruments of stabilization policy

a) Recession period
For any given period the level of expenditure or aggregate demand may not be sufficient to
secure full employment of labour and other factors of production. When this happens

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expansionary economic policies must be made to stimulate the economy e.g. increase
government expenditure and reduce taxes. The supply of more money for use in demand
increases production (output) hence rise in employment.
b) Boom period
When aggregate demand is greater than aggregate supply (level of output) employment level is
high in boom period and inflationary pressure is also high.

When this happens, restrictive economic policies must be employed. Reduce in government
expenditure & increase in taxation leads to a decrease in purchasing power resulting in fall in
effective aggregate demand.

2.5.CO-ORDINATION OR CONFLICT OF FUNCTIONS

In order to provide a good co-ordination of the functions there must be a good management of
the economy. When they are not properly co-ordinate there will be conflicts among them.
Proper co-ordination calls for good policy targeting during the planning and implementation
process.

For example, those who are concerned with planning distribution will design a tax transfer plan
to secure the desired distribution. Similarly, those who are in charge of allocation in terms of
public expenditure must ensure that the funds allocated from the taxes are used to finance
projects with consumer evaluations thereof.

Those who are in charge of policy formulation to stabilize and to stimulate the economy must
ensure that they achieve full employment and economic growth. When all functions are in
balance we say that the budget is balanced.

However, this balance may not be sufficient to provide for or sustain the required economic
growth and development. So the government will result to other sources of funds other than
taxation e.g. externally or internally. In real world situation such a perfect co-ordination may not
be realizable. The achievement of one objective (e.g. provision of social goods) is achievable at
the expense of the other e.g. (price stability).

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 Conflict of interest
i) Conflict between allocation and distribution

Taxes are normally imposed so as to redistribute income and wealth and raise funds for
government to provide social good. In order to affect this, a vertical progressive tax to
collect more from the rich and less from the poor is imposed.

But if you looks at less developed countries budget is low and majority of earners are in
lower and middle income classes, hence causing conflicts between allocation and
distribution function.
ii) Conflict between distribution and stabilization function:-
Stabilization functions are used to stabilize the economy. When there is need to stimulate
the economy (time of recession) taxes on lower income groups should be reduced, since
their marginal propensity to consume is higher than that of the rich. This would lead to
increased disposable income, demand, output produced and thus employment.

The opposite course has been made in times of inflation, namely that taxes on low-
income groups should be raised, since they are more potent in reducing demand than
taxes on higher income. Another reason would be, by taxing the rich a lower rate; they
would be motivated to save more because their MPS are high. Conflicts arises in such as
approach because the distribution function of budgetary policy does not achieve the aims
of deducting more from the rich and less from the poor.

iii) Conflict between distribution and growth and economy

Objective of the budget is to attain high growth rate in economy. This would only be
achieved if capital formation, savings and investments are increased. This would mean
withdrawing more from poor and less from rich. This is because people with higher
propensity to save are high income people. Conflict arises between distribution and
growth. The aim of distribution function is to deduct more from the rich and less from
the poor, which is the opposite of the goal of high growth rate.

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