KISII UNIVERSITY

BCOM 333: PUBLIC FINANCE

LESSON NOTES

TOPIC ONE: BASIC CONCEPTS & SCOPE OF PUBLIC FINANCE

1.1 Basic Concepts

1.1.1 Concept of Public Finance
 Public finance can be defined as the study of government activities, which may
include spending, deficits and taxation. The goals of public finance are to recognize
when, how and why the government should intervene in the current economy, and
also understand the possible outcomes of making changes in the market. In addition,
public finance can involve issues outside of the economy, including accounting, law
and public finance management.
 Public finance is the management of a country’s revenue, expenditures, and debt load
through various government and quasi-government institutions. This guide provides
an overview of how public finances are managed, what the various components of
public finance are, and how to easily understand what all the numbers mean. A
country’s financial position can be evaluated in much the same way as a business’
financial statements.
 Public finance refers to the activities carried out by the government associated with
raising of finances and the spending of the finances raised (it is the study of how
government collects revenue and how it spends it)
 Public finance is related to the financing of the state activities and a narrow definition
of the public finance would try to say that public finance is a subject which discusses
the financial operation of the fiscal or of the public treasury.
 Public finance has been held as a science which deals with the income and
expenditure of the government’s finance. It has been held as a study of principles
underlying the spending and raising of funds by the public authorities. The various
theories which form the basis of the collection; maintenance and expenditure of the
public income constitute the subject and matter of finance.
 Public finance is the study of the role of the government in the economy. It is the
branch of economics that assesses the government revenue and government

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 expenditure of the public authorities and the adjustment of one or the other to achieve
desirable effects and avoid undesirable ones.
 In public finance we study the finances of the Government. Thus, public finance deals
with the question how the Government raises its resources to meet its ever-rising
expenditure. As Dalton puts it, public finance is concerned with the income and
expenditure of public authorities and with the adjustment of one to the other.
 Accordingly, effects of taxation, Government expenditure, public borrowing and
deficit financing on the economy constitutes the subject matter of public finance.
Public Finance is the study of the effects of budgets on the economy, particularly the
effect on the achievement of the major economic objects growth, stability, equity and
efficiency.

1.1.2 Meaning of Public Finance:

Public finance is the branch of economics. It is made of two words as public and finance. The
term public means government and finance means science of management of money. So
literally public finance means the study of allocation of economic resources for achieving the
goals of public affairs.

Thus, public finance is the study of allocation and management of resources and technology
for achieving the goals of public organization. However, literally it seems to have narrow
meaning but its scope and definition has been widening and changing through the time. In
public finance we study the finances of the Government.

Thus, public finance deals with the question how the Government raises its resources to meet
its ever rising expenditure. Public finance is the study of the role of the government in the
economy. It is the branch of economics which assesses the government revenue and
government expenditure of the public authorities and the adjustment of one or the other to
achieve desirable effects and avoid undesirable ones.

As Dalton puts it, “public finance is “concerned with the income and expenditure of
public authorities and with the adjustment of one to the other.”

Accordingly, effects of taxation, Thus, Prof. Otto Eckstein writes “Public Finance is the
study of the effects of budgets on the economy, particularly the effect on the
achievement of the major economic objects—growth, stability, equity and efficiency.”

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Further, it also deals with fiscal policies which ought to be adopted to achieve certain
objectives such as price stability, economic growth, more equal distribution of income.
Economic thinking about the role that public finance is expected to play has changed from
time to time according to the changes in economic situation.

Before the Great Depression that gripped the Western industrialized countries during the
thirties, the role of public finance was considered to be raising sufficient resources for
carrying out the Government functions of civil administration and defense from foreign
countries. During this period, the classical economists considered it prudent to keep
expenditure to the minimum so that taxing of the people is avoided as far as possible. Further,
it was thought that Government budget must be balanced. Public borrowing was
recommended mainly for production purposes. During a war, of course, public borrowing
was considered legitimate but it was thought that the Government should repay or reduce the
debt as soon as possible.

Government expenditure, public borrowing and deficit financing on the economy constitutes
the subject matter of public finance.

1.1.3 Importance of Public finance:

Thus, it is evident public finance is very important for the growth and development of a
country. It is obvious that the government of a country can push up the industrial and
economic development of the country, provide more employment opportunities, encourage
investments and savings in the desired direction and increase social benefits through public
expenditure. It therefore, affects the overall economic and social system of the country. The
major importance of public finance are:

1. Steady state economic growth: Public finance is important to achieve sustainable

high economic growth rate. The government uses the fiscal tools in order to bring
increase in both aggregate demand and aggregate supply. The tools are taxes, public
debt, and public expenditure and so on.
2. Price stability: The government uses the public finance in order to overcome form
inflation and deflation. During inflation it reduces the indirect taxes and genera
expenditures but increases direct taxes and capital expenditure. It collects internal
public debt and mobilizes for investment. In case of deflation, the policy is just
reversed.

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 3. Economic stability: The government uses the fiscal tools to stabilize the economy.
During prosperity, the government imposes more tax and raises the internal public
debt. The amount is used to repay foreign debt and invention. The internal
expenditures are reduced. During recession, the case is just reversed.
4. Equitable distribution: The government uses the revenues and expenditures of itself
in order to reduce inequality. If there is high disparity it imposes more taxes on
income, profit and properties of rich people and on the goods they consume. The
money collected is used for the benefit of poor people through subsidies, allowance,
and other types of direct and indirect benefits to them.
5. Proper allocation of resources: The government finance is important for proper
utilization of natural, manmade and human resources. For it, on the production and
sales of less desirable goods, the government imposes more taxes and provides
subsidies or imposes taxes lightly on more desirable goods.
6. Balanced development: The government uses the revenues and expenditures in order
to erase the gap between urban and rural and agricultural and industrial sectors. For it,
the government allocates the budget for infrastructural development in rural areas and
direct economic benefits to the rural people.
7. Promotion of export: The government promotes the export imposing less tax or
exempting form the taxes or providing subsidies to the export oriented goods. It may
supply the inputs at the subsidized prices. It imposes more taxes on imports and so on.
8. Infrastructural development: The government collects revenues and spends for the
construction of infrastructures. It has to keep peace, justice and security too. It has to
bring socio-economic reformation too. For all these things it uses the revenues and
expenditures as fiscal tools.

1.1.4 Role of Government in the Economy:

a. Provision of Public Goods: Governments often provide public goods such as
national defense, infrastructure (roads, bridges, etc.), and public services that benefit
society as a whole but are not adequately provided by the private sector due to market
failures.
b. Regulation: Governments enact regulations to ensure fair competition, consumer
protection, and the stability of markets. They may also regulate certain industries or
sectors to address issues such as environmental concerns or public health.

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 c. Macroeconomic Stabilization: Governments intervene in the economy to stabilize
fluctuations in economic activity, such as managing inflation, unemployment, and
promoting economic growth. They may use fiscal policies (taxation and government
spending) and monetary policies (interest rates, money supply) to achieve these
objectives.
d. Redistributive Policies: Governments implement policies to redistribute income and
wealth in society, aiming to reduce inequality and provide social safety nets. This may
involve progressive taxation, welfare programs, and other forms of income
redistribution.
e. Market Failure Corrective Measures: Governments intervene when markets fail to
allocate resources efficiently. Examples include addressing externalities (such as
pollution), monopolies, and asymmetric information to ensure economic efficiency
and protect public interests.

1.1.5 Key Principles of Public Finance:

1. Efficiency: Public finance aims to allocate resources efficiently by ensuring that
government expenditures generate the maximum benefit for society given the
available resources. This principle emphasizes cost-effectiveness and minimizing
waste.
2. Equity: Public finance strives for equity or fairness in the distribution of resources
and the tax burden. It involves designing tax policies and government expenditures to
reduce income and wealth disparities and promote social justice.
3. Adequacy: Public finance aims to generate sufficient revenue to fund government
expenditures effectively. Adequacy relates to the government's ability to finance
public goods, services, and programs without creating excessive debt or resorting to
unsustainable fiscal practices.
4. Certainty: Public finance seeks to provide certainty and predictability to individuals
and businesses regarding tax policies, government regulations, and fiscal plans. This
principle helps facilitate economic planning, investment decisions, and overall
economic stability.
5. Neutrality: Public finance should strive to be neutral and avoid distorting economic
behavior or market outcomes. This means designing tax policies and regulations that
do not introduce unnecessary biases or distort incentives for individuals and
businesses.

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1.1.7 Scope of public finance
The scope of public finance encompasses the following key areas:

1. Public Revenue: This involves the collection of funds by the government through
various means, primarily taxation. It includes the design of tax systems, determining
tax rates, and implementing tax policies to generate revenue. Other sources of public
revenue may include fees, fines, tariffs, and income from government-owned
enterprises.
2. Public Expenditure: This refers to the government's spending of the collected funds
to finance public goods and services, such as infrastructure development, education,
healthcare, defense, social welfare programs, and administrative expenses. Public
expenditure also includes transfer payments to individuals or groups, such as
pensions, subsidies, and grants.
3. Public Debt: Public finance also deals with government borrowing and debt
management. Governments may borrow funds from domestic or international sources
to finance budget deficits or fund long-term investments. Public debt management
involves strategies to ensure the sustainability of debt, minimize borrowing costs, and
manage the risks associated with debt repayment.
4. Fiscal Policy: Public finance plays a crucial role in formulating and implementing
fiscal policies. Fiscal policy refers to the use of government spending and taxation to
influence the overall economy. It includes decisions on budget deficits or surpluses,
the level of government expenditure, tax rates, and other fiscal measures aimed at
achieving macroeconomic stability, promoting economic growth, and addressing
socio-economic challenges.
5. Public Financial Management: This involves the efficient and effective
management of public funds, encompassing budgeting, accounting, auditing, and
financial reporting processes. It includes ensuring transparency, accountability, and
integrity in financial operations, as well as monitoring and evaluating the performance
of public expenditures.

Overall, public finance encompasses the study of how governments generate revenue,
allocate resources, and manage their finances to promote economic stability, social welfare,
and sustainable development. It provides the framework for understanding the economic role
of the government and how it influences the overall functioning of the economy.

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 THEORY OF SOCIAL AND PRIVATE GOODS:

Social Goods (Public Goods):

 Social goods, also known as public goods, are goods or services that are non-
excludable and non-rivalrous in nature.
 Non-excludability means that once the good or service is provided, it is available to
all individuals, and it is difficult to exclude anyone from benefiting from it.
 Non-rivalry means that the consumption of the good or service by one individual does
not reduce its availability or utility for others.

Private Goods:

 Private goods are goods or services that are both excludable and rivalrous.
 Excludability means that the owner or provider of the good can prevent others from
accessing or using it.
 Rivalry means that the consumption of the good by one individual diminishes its
availability or utility for others.

The Free-Rider Problem:

a. The free-rider problem arises in the context of public goods. Since public goods are
non-excludable, individuals can enjoy the benefits of the good without contributing to
its provision.
b. The free-rider problem occurs when individuals choose not to pay for the production
or maintenance of a public good, relying instead on others to pay for it, while still
enjoying its benefits.
c. This creates a collective action problem, as individuals have an incentive to free-ride,
hoping that others will bear the cost of providing the public good.

Implications for the Provision of Public Goods:

1. The free-rider problem poses challenges for the provision of public goods. If left to
voluntary contributions, public goods may be underprovided or not provided at all.
2. Private markets typically fail to supply public goods efficiently because producers
cannot charge a price for their provision due to non-excludability.
3. Governments often intervene to provide public goods through taxation and public
expenditure, aiming to overcome the free-rider problem and ensure the provision of
essential social goods.

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Examples of Social Goods and Their Significance in Society:
a. National Defense: The defense of a country is a classic example of a social good. It
benefits all citizens and is difficult to exclude individuals from its protection.
b. Public Parks: Parks and recreational areas are often considered social goods as they
are open to the public and can be enjoyed by all without diminishing others'
experiences.
c. Street Lighting: Illumination of public streets is a social good that enhances safety and
security for everyone in the community.
d. Clean Air and Water: Environmental resources, such as clean air and water, are social
goods that have a positive impact on the well-being and health of the entire society.
e. Public Health Initiatives: Programs and initiatives aimed at promoting public health,
such as vaccination campaigns or disease control measures, are social goods that
benefit the community as a whole.

The significance of social goods lies in their ability to contribute to the overall welfare and
common good of society. They address needs and provide benefits that individuals cannot
easily obtain through private markets alone. By recognizing the characteristics of social
goods and understanding the free-rider problem, policymakers can develop strategies to
ensure their provision and promote the well-being of the population.

Significance of Social Goods in Society:

a. Social goods play a crucial role in enhancing societal well-being and promoting the
common good.
b. They address needs and provide benefits that individuals may not be able to obtain
through private markets alone.
c. Social goods contribute to social cohesion, equity, and the overall quality of life in a
community or society.
d. They often have positive externalities, meaning that their benefits extend beyond the
individuals directly consuming them. For example, a well-maintained public park can
enhance property values and promote a sense of community.
e. Social goods are an essential component of a functioning society, as they contribute to
public health, safety, infrastructure, environmental sustainability, and cultural
development.

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Private vs. Public Goods
Private Goods:

a. Private goods are excludable and rivalrous in nature.

b. Excludability means that the owner or provider of the good can prevent others from
accessing or using it. Private goods are typically associated with property rights, and
owners can control their use and consumption.
c. Rivalry means that the consumption of the good by one individual diminishes its
availability or utility for others. The use of a private good by one person reduces the
amount or quality of the good available for others.

Examples of private goods include food, clothing, electronics, automobiles, and most
consumer products. Private goods are typically bought and sold in markets, where prices are
determined by supply and demand.

Public Goods:

a. Public goods are non-excludable and non-rivalrous in nature.

b. Non-excludability means that once the good or service is provided, it is available to
all individuals, and it is difficult or impossible to exclude anyone from benefiting
from it.
c. Non-rivalry means that the consumption of the good by one individual does not
reduce its availability or utility for others. The use of a public good by one person
does not diminish the ability of others to use it.

Examples of public goods include national defense, street lighting, public parks, clean air and
water, and public infrastructure like roads and bridges. Public goods are typically provided by
the government or collective actions of society because private markets may fail to provide
them efficiently due to the free-rider problem.

The free-rider problem arises because individuals can benefit from public goods without
contributing to their provision. Since public goods are non-excludable, people may choose
not to pay for them, relying on others to bear the cost. This poses a challenge for their
provision through voluntary transactions in private markets.

To overcome the free-rider problem and ensure the provision of public goods, governments
often intervene by funding their production and maintenance through taxation and public

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expenditure. By collecting taxes, governments can pool resources and allocate them towards
the provision of public goods that benefit society as a whole.

Sources of Government Revenue

Governments generate revenue from various sources to finance their operations and provide
public goods and services:

1. Taxes: Taxation is the primary source of government revenue. Governments levy

taxes on individuals, businesses, and other entities to generate funds. Examples of
taxes include income tax, corporate tax, sales tax, property tax, payroll tax, and value-
added tax (VAT).
2. Customs Duties: Governments collect customs duties or tariffs on goods imported
into the country. These duties are typically based on the value or quantity of the
imported goods and are meant to protect domestic industries or generate revenue.
3. Excise Taxes: Excise taxes are specific taxes levied on specific goods or activities,
such as tobacco, alcohol, gasoline, luxury items, and certain services. These taxes are
often used to discourage consumption or regulate certain industries while generating
revenue for the government.
4. User Fees and Charges: Governments charge fees or user charges for specific services
or facilities they provide, such as tolls on highways, admission fees to public parks or
museums, licensing fees, or fees for government permits.
5. Government-Owned Enterprises: Governments may own and operate businesses or
enterprises that generate profits. Revenue from these enterprises, such as state-run
utilities or nationalized industries, contributes to government coffers.
6. Fines and Penalties: Governments collect revenue through fines and penalties
imposed for violations of laws and regulations. These fines can be for traffic
violations, non-compliance with regulations, or other legal infractions.
7. Grants and Aid: Governments receive grants and aid from other governments,
international organizations, or private entities. These funds may be earmarked for
specific purposes, such as development projects, infrastructure investments, or
humanitarian aid.
8. Investment Income: Governments generate income from their investments in financial
assets, such as stocks, bonds, and real estate. The returns on these investments
contribute to government revenue.

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 9. Borrowing: Governments may borrow money by issuing bonds or taking loans from
domestic or international lenders. The borrowed funds are repaid, usually with
interest, over a specified period, and the interest payments are an expense for the
government.

Reasons why Government Impose Taxes

Governments impose taxes for several reasons, which can vary depending on the specific
goals and priorities of the government:

a. Revenue Generation: The primary purpose of taxation is to generate revenue for the
government. Taxes provide the financial resources necessary to fund government
operations, public goods, and services. Revenue from taxes is used to finance
infrastructure development, healthcare, education, defense, social welfare programs,
and other essential services.
b. Redistributive Purposes: Taxes can be used as a tool for redistributing wealth and
reducing income inequality. Progressive tax systems, where higher-income
individuals are taxed at a higher rate, aim to ensure a fairer distribution of income and
provide a safety net for those in need. The revenue collected from wealthier
individuals and businesses is used to fund social welfare programs and initiatives that
benefit disadvantaged groups.
c. Economic Stabilization: Taxation can be used as an instrument of fiscal policy to
manage the overall economy. During times of economic downturn or recession,
governments may implement expansionary fiscal policies by lowering taxes to
stimulate consumer spending, business investment, and overall economic activity.
Conversely, during periods of inflation or economic overheating, governments may
increase taxes to cool down the economy and manage inflationary pressures.
d. Public Goods and Services: Taxes are necessary to fund the provision of public goods
and services that would be undersupplied or not efficiently provided by the private
sector. Public goods, such as national defense, infrastructure, healthcare, education,
and environmental protection, benefit society as a whole and require collective
financing through taxation.
e. Behavior Modification: Taxes can be used to influence individual behavior and
discourage or encourage certain activities. For example, governments may impose
higher taxes on goods and activities that are considered harmful, such as tobacco,
alcohol, or carbon emissions, to discourage their use. Conversely, tax incentives may

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 be provided to promote socially beneficial activities like renewable energy adoption
or charitable donations.
f. Market Failures: Taxes can be used to address market failures and correct
externalities. Externalities are costs or benefits that affect individuals or entities not
directly involved in a transaction. For example, taxes on pollution can be levied to
internalize the costs of environmental damage caused by certain industries and
discourage harmful practices.
g. Public Debt and Deficit Reduction: Taxes are essential for governments to repay
public debt, cover budget deficits, and maintain fiscal sustainability. Tax revenue
helps finance interest payments on government borrowing and reduces the need for
excessive debt accumulation, which can have negative consequences for the economy.

Principles of Taxation
1. Equity or Fairness: Taxation should be fair and equitable. This principle suggests that
individuals and businesses should contribute to the government's revenue based on
their ability to pay. Fairness can be achieved through progressive taxation, where
higher-income individuals are taxed at higher rates, or through the concept of
horizontal equity, which states that taxpayers in similar economic situations should be
treated equally.
2. Simplicity: Taxation systems should be simple and easy to understand for taxpayers.
Simplicity reduces compliance costs, minimizes administrative burden, and promotes
voluntary tax compliance. Clear and transparent tax laws and procedures contribute to
a more efficient and effective tax system.
3. Efficiency: Taxation should be designed to minimize economic distortions and
promote economic efficiency. This principle suggests that taxes should be structured
in a way that does not discourage productive activities, investment, or innovation.
Efficiency can be achieved by minimizing tax compliance costs, avoiding excessive
administrative burdens, and ensuring that tax rates do not create significant
disincentives for economic participation.
4. Adequacy: Taxation should generate enough revenue to fund government
expenditures and meet the needs of society. The tax system should be designed to
ensure that it can generate sufficient revenue to finance public goods, services, and
government obligations. Adequacy involves striking a balance between the revenue

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 needs of the government and the economic impact of taxes on individuals and
businesses.
5. Neutrality: Taxation should aim to be neutral and avoid distorting economic
decisions. The principle of neutrality suggests that taxes should not favor or
discriminate against particular economic activities, industries, or individuals. Neutral
taxes do not influence economic behavior and allow market forces to allocate
resources efficiently.
6. Administrative Feasibility: Taxation systems should be administratively feasible and
capable of efficient implementation and enforcement. The tax system should be
designed in a way that can be effectively administered and enforced by the tax
authority. Administrative feasibility reduces compliance costs, enhances tax collection
efficiency, and reduces opportunities for tax evasion and avoidance.
7. Transparency and Accountability: Taxation should be transparent, and taxpayers
should have a clear understanding of how their tax contributions are being used.
Transparent tax systems enhance public trust and confidence in the government and
provide accountability for the use of tax revenue.
8. Flexibility: Taxation systems should be flexible and able to adapt to changing
economic and social conditions. Flexibility allows tax policies to be adjusted in
response to economic changes, emerging challenges, or evolving societal needs.

Public Expenditure
Public expenditure refers to the spending of public funds by the government on various
goods, services, programs, and infrastructure to meet the needs of society and achieve policy
objectives. It encompasses the allocation of financial resources towards public goods, social
welfare programs, infrastructure development, defense, education, healthcare, public
administration, and other government activities.

Here are some key aspects and categories of public expenditure:

a. Public Goods: Public expenditure is often directed towards the provision of public
goods that benefit society as a whole. Public goods are non-excludable and non-
rivalrous, meaning that their consumption by one individual does not diminish their
availability for others. Examples of public goods include national defense, law
enforcement, public infrastructure like roads and bridges, public parks, and street
lighting.

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 b. Social Welfare Programs: Governments allocate funds for social welfare programs
aimed at improving the well-being and living conditions of citizens. These programs
include social security, unemployment benefits, income support, healthcare subsidies,
housing assistance, education grants, and food assistance programs. The goal is to
provide a safety net and reduce poverty and inequality.
c. Infrastructure Development: Public expenditure plays a crucial role in developing and
maintaining infrastructure such as transportation systems, water supply networks,
energy facilities, communication networks, and public facilities like schools and
hospitals. Infrastructure investments contribute to economic development, facilitate
trade and commerce, enhance connectivity, and improve the quality of life for
citizens.
d. Education and Healthcare: Governments allocate significant funds to provide
accessible and quality education and healthcare services to their citizens. Public
expenditure in education includes funding for schools, universities, teacher salaries,
scholarships, and educational programs. Healthcare expenditure includes funding for
hospitals, clinics, medical personnel, research, public health initiatives, and health
insurance schemes.
e. Defense and Security: Governments allocate resources to ensure national defense and
security. This includes funding for military forces, defense equipment and technology,
intelligence agencies, border security, and law enforcement agencies. Defense
expenditure is aimed at safeguarding territorial integrity, protecting citizens, and
maintaining peace and security.
f. Public Administration: Public expenditure is also directed towards funding the
functioning of government institutions and public administration. This includes
salaries of civil servants, administrative costs, public offices, and governance-related
activities such as elections, legislation, and policy development.
g. Debt Servicing: Governments may allocate funds for servicing public debt, including
interest payments and repayments of borrowed funds. Debt servicing ensures the
government's obligations to lenders are met and helps manage fiscal sustainability.

The allocation of public expenditure is influenced by government priorities, societal needs,

economic conditions, political considerations, and budgetary constraints. Governments make
decisions on expenditure through budgeting processes, taking into account revenue sources,
policy objectives, and public interest.

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Types of Public Expenditure
Public expenditure can be categorized into various types based on the nature and purpose of
the spending:

1. Current Expenditure: This refers to regular and recurring expenses incurred by the
government for the provision of ongoing services and operations. It includes
expenditures on salaries and wages of government employees, pensions,
administrative costs, maintenance and repairs, and other day-to-day expenses.
2. Capital Expenditure: Capital expenditure involves spending on the acquisition or
improvement of long-term assets and infrastructure. It includes investments in the
construction of roads, bridges, schools, hospitals, public buildings, water supply
systems, power plants, and other physical infrastructure. Capital expenditure aims to
enhance the productive capacity of the economy and provide long-term benefits.
3. Subsidies and Transfers: Governments provide subsidies and transfers to individuals,
businesses, or specific sectors to support and incentivize certain activities. This
includes subsidies for agriculture, energy, education, healthcare, housing, and various
industries. Transfers may include income support programs, welfare payments, grants,
and other forms of financial assistance to individuals or groups in need.

Fiscal Policy
Fiscal policy refers to the use of government revenue collection (taxation) and expenditure
(spending) to influence the economy. It is one of the key tools available to governments to
manage the overall macroeconomic conditions, stabilize the economy, and achieve policy
objectives.

Main components of fiscal policy

Fiscal policy can be expansionary or contractionary, depending on the economic situation and
policy goals. Here are the two main components of fiscal policy:

1. Government Expenditure: Governments can use expenditure to stimulate or restrain

economic activity. Expansionary fiscal policy involves increasing government
spending on public goods, infrastructure projects, social welfare programs, and other
initiatives. This increased spending injects money into the economy, stimulating
aggregate demand and economic growth. On the other hand, contractionary fiscal
policy involves reducing government spending to cool down an overheating economy
or to address budget deficits.

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 2. Taxation: Taxation is another important tool in fiscal policy. Governments can adjust
tax rates, exemptions, and credits to influence economic behavior. Expansionary
fiscal policy may involve reducing tax rates to encourage consumer spending,
business investment, and overall economic activity. This can be done through
measures like tax cuts or tax incentives. Conversely, contractionary fiscal policy may
involve increasing tax rates to reduce aggregate demand and control inflationary
pressures.

Objectives of fiscal policy

The objectives of fiscal policy can vary depending on the economic conditions and policy
priorities of the government. Some common objectives of fiscal policy include:

a. Economic Stabilization: Fiscal policy aims to promote macroeconomic stability by

countering fluctuations in economic activity. During recessions or periods of low
economic growth, expansionary fiscal policy can be used to boost demand, increase
employment, and stimulate economic output. In times of inflation or overheating,
contractionary fiscal policy can be implemented to reduce demand and control
inflationary pressures.
b. Full Employment: Fiscal policy can be employed to achieve and maintain full
employment levels in the economy. By increasing government spending or reducing
taxes, fiscal policy can stimulate economic activity, leading to increased job creation
and reduced unemployment rates.
c. Economic Growth: Governments can use fiscal policy as a tool to foster long-term
economic growth. By investing in infrastructure projects, education, research and
development, and other areas, fiscal policy can enhance productivity, increase
competitiveness, and promote sustainable economic growth.
d. Income Redistribution: Fiscal policy can be utilized to address income inequality and
promote social equity. Progressive tax systems, where higher-income individuals are
taxed at higher rates, can help redistribute wealth and provide a safety net through
social welfare programs. Government expenditure on education, healthcare, and social
services can also contribute to reducing income disparities.
e. Budgetary Sustainability: Fiscal policy plays a role in maintaining budgetary
discipline and ensuring the sustainability of government finances. Governments can
use fiscal measures to manage budget deficits, reduce public debt burdens, and
maintain fiscal stability in the long run.

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The implementation of fiscal policy requires careful consideration of economic conditions,
potential impacts on different sectors of society, and coordination with monetary policy.
Governments typically formulate and implement fiscal policy through the annual budgeting
process, where revenue projections, expenditure plans, and policy priorities are determined.

Government/Public Budget
 A public budget is a plan of expected incomes and expenditures for the upcoming
fiscal year, which is typically a twelvemonth period.
 The budget is generally composed of an operating budget, which shows expenditures
for the current period, and a capital budget, which shows the financial plans for long-
term capital improvements, facilities, and equipment.
 The two budgets may be consolidated in order to indicate the amount of total
estimated revenues available for the current period and the amount of new debt to be
incurred for projects in the capital budget.
 The government budget is an important tool for implementation of policy decisions to
achieve social, economic and political objectives.
 Essentially it involves the determination of resources and their use for attainment of
government objectives.
 Budget serves as a tool for economic and financial management as well as
accountability. It also serves as a mechanism for allocating resources among different
needs and priorities as well as bringing economic stability and growth.
 There is a body of laws, regulations and administrative procedures which govern the
budget system. They regulate format, timing and procedures as well as the allocation
of formal powers and rights in the budget cycle or process.

Objectives of public sector budgeting

Budgeting in the public sector context shares many similarities with the private sector but
contains a greater focus on the relationship with policy development, performance monitoring
and statutory objectives. The key objectives of public sector budgeting are:

i. Assisting in planning expenditure to meet policy requirements;

ii. policy implementation and control;
iii. measuring and monitoring performance;
iv. to determine the total expenditure of the organization and ensure that it is consistent
with total revenues (e.g. fixing the rate of local taxation);

17
 v. provide the basis for authorizing expenditure and collection of fees and charges;
vi. provide the basis for budgetary control;
vii. Satisfaction of statutory requirements.

Differences between Budgeting in the Public and Private Sector

a. Aims of national and county governments are so diverse that there are continual
conflicts over the use of limited funds
b. Because of unforeseen conditions in society, government must adjust to sharp changes
in spending and revenue
c. By law government budgeting must be an open process with key decisions made in
the public arena
d. Public money choices are subject to constraints imposed by law and political
conditions outside of government.

The Budget Process

The following are important steps in the preparation of the budget

1. Formulation of budget policy and resource projections

 The budget process begins with formulation of budget policy objectives,
priorities and resource projections based on macroeconomic performance
review.
 Review of macro-economic performance: this review of macroeconomic
performance starts with an assessment on performance of the previous budget
assumptions and targets to determine the level of achievement
 Other variables, which are reviewed, include economic growth rate, inflation
and government finance
 Setting of macroeconomic policy targets: based on the macroeconomic and
other developments as indicated in the economic performance review, the
overall framework for the future is then formulated

The framework generally covers the following:

 Projected economic growth (GDP)

 Level of inflation
 Financing
2. Budget authorization by parliament:

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  The process of obtaining parliamentary authorization starts with discussions by
the parliamentary budget committee
 After the committee has reviewed the estimates, the budget proposals are tabled to
the parliament for debate and authorization.
3. Budget execution
 It is at this stage that actual revenue collections and service delivery takes
place
 Execution of the budget therefore is about the collection and accounting for
revenue, provision of services through the recurrent budget and
implementation of development projects
 Collection and accounting for revenue collections by the Kenya Revenue
Authority (KRA) and other ministries, departments, and agencies (MDAs).
 Maintenance of proper accounts for control and accountability

4. Monitoring, control and evaluation

 Mechanisms for control and monitoring are essentially:

 Periodic reporting and follow-up.
 Internal audits
 External audits
 Public Accounts Committee
 Budget Reviews and Adjustments
 Public Expenditure Tracking and Physical Projection inspection
 Evaluation

Budgeting Process in Kenya

a. In Kenya, the Public Financial Management Act, 2012 is the legal instrument which
provides the legal framework for the budget system with regard to revenue,
expenditure control and accountability. The Act is supposed to read in conjunction
with the 2010 Constitution.
b. The Act empowers the cabinet secretary for treasury to raise money by imposing
taxes, levies, fees and charges to mobilize funds to finance the budget. The Act also
empowers the cabinet secretary for treasury to draw money from consolidated Fund
and allocate it to various votes. It also provides powers for reallocation of funds
between votes.
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 c. The Public Procurement and Disposal Act, 2005 and its corresponding regulations
provide the legal framework for the procurement of goods and services using public
funds.
d. The Pay Master General’s Circulars: The paymaster General (PMG) issues circulars
from time to time including the budget implementation circular. It prescribes
directives to be followed by the Accounting Officers in the accounting and control of
government revenues and expenditures during the financial year.
e. The PFM sets the rules for how government at national and county levels can raise
and spend money. Along with the 2010 constitution, it is the main document that tells
the president, MPs, governors, senators and ordinary people what role they have to
play in decisions about how public money is used.
f. In Chapter 12, the Constitution says that "there shall be openness and accountability,
including public participation in financial matters." The constitution also says that the
budget must be presented to the National Assembly no later than April 30 and that the
Budget Committee of the Assembly must seek public input before making its own
recommendations. This means that every in early May, ordinary Kenyans have an
opportunity and a responsibility to tell Parliament what they think about the way
government is spending its money, and what they think government's spending
priorities should be. The government must release budget information to the public in
good time. Article 35 of the Constitution guarantees every citizen the right to state
information.
g. The PPM Act goes into more detail than the constitution, and provides additional
opportunities for participation. The public can comment on the overall direction the
budget should take before it is tabled, and should have opportunities to engage with
the Parliamentary Budget Office, which is a research office that advises government
on budget issues. But the public is also given the right to participate throughout the
entire budget process, which runs from the formulation of the budget, through its
implementation, to evaluation of implementation.

The Budget Policy Statement

 The PFM Act creates opportunities to participate at the national level and the county
level. At the national level, the PFM Act mentions very specific dates. The first
important date is February 15. This when the government must release what is known
as the Budget Policy Statement (BPS) to parliament.

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  The BPS is a statement by the government about its plans to raise and spend money in
the coming year and the main priorities it will spend on. It is not yet the detailed
budget proposal with all the specific numbers for each ministry. That document,
known as the budget proposal, or Budget Estimates, comes later. The law says very
clearly that the government shall seek and take into account the views of the public in
drafting the BPS. This means that before February, the government should create
some opportunities for ordinary citizens to give their views on what government
priorities should be. The budget year starts on July 1, so this statement is due 41/2
months before the new budget year begins.
 The statement comes to Parliament on February 15, but it must be made available to
citizens by the end of February. As soon as the BPS is published, citizens should read
it and check to see whether government is taking into consideration their priorities.
The government typically holds a public hearing by sector (like health, or education)
before the BPS is released. At these hearings, the public is supposed to be able to ask
questions and make suggestions.

The Budget Estimates

a. Parliament is supposed to debate and approve the BPS by the end of February. Then,
by the 30th April, the government must send its full proposed budget (Budget
Estimates) to Parliament. At the same time, both Parliament and the judiciary must
also send their proposed budgets to Parliament by April 30th.
b. Under the 2010 Constitution, Parliament and the Judiciary set their own budgets.
These budgets are no longer controlled by the Ministry of Finance, although the
Cabinet Secretary for Finance is given until May 15th to formally comment on the
submissions from Parliament and the Judiciary (This intended to make certain that
there is separation of powers in Kenya and to break from past experience, where
Parliament and the Judiciary were subservient to the executive).
c. If Parliament is not happy with the overall level of spending, revenues or the deficit, it
can try to adjust these issues when it debates and amends the Budget Policy
Statement. By the time of the budget proposal (Budget Estimates), however, it is
restricted to making changes that do not raise the deficit.

The Appropriations Bill

 When the budget is passed in Kenya, it is done through what is known as an
Appropriations Bill. This is basically just a bill that shows the total amount of money

21
 that Parliament is approving for each Ministry, Department and Agency (or each
"vote," as they are known). So, once Parliament has made changes to the budget
proposal, the Cabinet Secretary for Finance should lay an Appropriations Bill in
Parliament specifying the funds to be used over the next year.
 Once approved, this becomes the Appropriations Act, and represents the final
approved budget. The constitution states clearly that if the Appropriations Bill is not
likely to be passed before the New Year starts, the National Assembly can authorize
spending up to one-half of the amounts that have been proposed for the coming year.
This is designed to avoid the government being shut down due to lack of money.
 NB: the issue has already led to lawsuits in Kenya. The courts have ruled that, in
general, this procedure can only be used if the Appropriations Bill has been tabled in
Parliament, but is not likely to be approved on time. It cannot be used if the Treasury
has failed to table any Appropriations Bill.

Monitoring
 The PPM Act mandates government to provide information to the public about actual
spending and whether it is consistent with the approved budget at specific times
during the year. The final budget is supposed to be published 12 days after it is
approved by Parliament. This document, the final "enacted" or approved budget, is
the basic document that any citizen needs to be able to track government spending
through the year. This is the governments promised spending.
 After the new budget year begins on July 1, there should be a report on spending after
every three months (a financial quarter). The government has 45 days after the end of
the 3 month period to produce and publish a report on how it actually spent as against
what is promised to spend. These reports are essential reading for citizens who want
to know whether, for example, the government has really spent what it said it would
on hospitals.
 In early November, the government must publish the Budget Review and Outlook
Paper. This reviews spending from the previous year and takes another look at the
broad economic assumptions in the Budget Polity Statement for the current year to
update them. This is another chance to see if government has met its goals for
spending. It is also a chance to see if the economic situation is changing in Kenya,
meaning that there is more or less money available for citizen priorities.

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  'The law also states that the Controller of the Budget must provide the public with
information about the implementation of the budget at national and county level
throughout the year. The controller of Budget should let citizens know if government
is spending money the way it is supposed to, and should also prevent government
from spending money in unlawful ways.

Public debt and grants

a. The law requires government to report information about its debts on an annual basis
at the same time as the BPS. No more than two weeks after tabling this report, it must
be made available to the public.
b. In addition, there should be a report every four months on loans to the government, so
that no one is caught by surprise at the end of the year by changes in what is owed and
what has been paid during the year.
c. The law also establishes a Public Debt Management Office to mange government’s
approach to borrowing and to keep the cost of that borrowing to a minimum. The
Public Debt Management Office is also responsible for collecting and providing
information on government debt.
d. Each year, the level of debt must be agreed in the BPS, which must be approved by
the National Assembly. Loans may only be contracted to pay for allocations approved
by Parliament.
e. Cabinet Secretary for Finance must approve any grant or donation that goes to any
national government entity. The law also says that the grant must be accounted for
using national accounting systems. The law also prevents government agencies from
starting to spend money from grants before the money has been appropriated by the
National Assembly, or the Cabinet Secretary has otherwise given written approval.
This is designed to avoid a situation where a grant is supposed to come but is delayed,
and the government then has to borrow to cover the costs of the grant until it arrives.

Adjustments to the Budget

There are three ways in which the government can respond to unexpected circumstances.

i. First, accounting officers are allowed to make small changes to their budgets of up to
10% of the total. In other words, they can shift money between different areas within
their ministry or "vote" with the approval of the National Treasury, but they do not
need to return to Parliament for approval.

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 ii. For routine changes to the overall budget that result from the normal inability to fully
plan for the future, the Constitution provides for a supplementary budget. This must
be approved by Parliament within two months after the money is spent through a new
appropriations act, and it may not exceed 10% of the total budget for the year unless
special permission has been granted by Parliament.
iii. Finally, in the case of disasters, the PPM Act creates a Contingencies Fund. This may
be used only in extreme circumstances where an unforeseen event "threatens damage
to human life or welfare". The Contingencies Fund is also maintained with 10 billion
Ksh. Money from the Contingencies Fund may be used in a disaster without
parliamentary approval, but the Cabinet Secretary must table a report explaining its
use within two months for Parliament to approve it.

Budgeting at the County government level

a. The counties are also captured in the PFM Act. Counties have two main sources of
funding: revenues they raise on their own, and revenues that are transferred to them
by the national government. The revenues from national government, which must be
at least 15% of revenues collected by national government, will be the larger share. It
is possible for counties to receive funding from loans or grants from donors as well.
b. The Commission on Revenue Allocation makes recommendations for the share of
revenues that the national government should keep, and the share that must be given
to the counties as a group. It is also responsible for making recommendations for the
way that the total revenues for counties are shared among all 47 counties. The CRA
has proposed a formula to divide the total share of revenues between the counties.
c. The CRA must send its recommendations at least six months before the beginning of
the financial year (that is, by the beginning of January), unless the CS for Finance and
the CRA agree to a later date.
d. Although the CRA makes a recommendation on the total share of revenues that go to
counties, and the amount that goes to each individual county, the actual decision
remains with the Senate and the National Assembly. Every five years, the Senate and
the National Assembly must agree on how money will be shared among counties. In
other words, they must agree to a general formula or set of criteria for sharing
resources between counties.
e. The actual sharing of resources must be approved by parliament annually through a
Division of Revenue Bill and a County Allocation Revenue Bill. The constitution

24
 requires these two bills to be presented to parliament no later than when the overall
budget estimates are presented (by April 30). However, the PFM Act moves this up so
that they are to be presented with the BPS statement (by February 15th) .These bills
are to be approved within 30 days of tabling in parliament.

Transfer of funds to counties

The law states that these transfers for counties must be sent at the beginning of every quarter,
and no later than the 15th of the quarter. Making it a legal requirement that money be
distributed regularly at a set time allows citizens to monitor whether national government is
meeting its responsibilities to counties.

Treasury Control Budget:

a. The treasury control budget involves the preparation, approval, and monitoring of
government expenditures.
b. It ensures that government spending remains within allocated limits and aligns with
policy objectives and financial regulations.
c. The treasury or finance ministry is responsible for overseeing the treasury control
budget process.
d. The treasury control budget is crucial for maintaining fiscal discipline and ensuring
that government spending is in line with available resources.
e. It involves the preparation of detailed budgets, including revenue estimates and
expenditure plans, which are reviewed and approved by the treasury or finance
ministry.
f. The treasury control budget provides a framework for monitoring and controlling
government spending throughout the fiscal year.
g. It helps prevent overspending, ensures funds are allocated to priority areas, and
promotes efficient resource allocation.

Revenue Control:
 Revenue control involves the management and oversight of government revenues.
 It includes the collection, recording, and monitoring of various revenue streams, such
as taxes, fees, and tariffs.
 The objective of revenue control is to ensure efficient collection, accurate accounting,
and effective utilization of government revenues.

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  Revenue control measures are implemented to safeguard against revenue leakages,
fraud, and mismanagement.
 Effective revenue control involves establishing robust systems for revenue collection,
such as efficient tax administration and improved customs procedures.
 Regular monitoring and auditing of revenue collection processes help identify any
discrepancies or irregularities.
 Revenue control measures also include implementing anti-corruption measures and
promoting transparency in revenue-generating activities.

The Accounting Officer:

a. The Accounting Officer is a senior official responsible for the financial affairs of a
government department or agency.
b. They oversee budget execution, expenditure control, financial reporting, and
compliance with financial regulations.
c. The Accounting Officer is accountable for the proper use and management of public
funds within their organization.
d. The Accounting Officer holds a position of significant responsibility within a
government department or agency.
e. They are accountable for the proper management and utilization of public funds
allocated to their organization.
f. The Accounting Officer ensures that financial transactions are conducted in
accordance with relevant regulations and policies.
g. They are responsible for financial reporting, including the preparation of accurate and
timely financial statements.

The Controller and Budget Officer:

a. The Controller and Budget Officer are individuals or positions responsible for
financial control and budgetary matters within a government entity.
b. They work closely with the Accounting Officer to ensure financial transactions are
properly authorized, recorded, and reported.
c. Their role includes maintaining financial discipline and compliance with budgetary
regulations.
d. The Controller and Budget Officer play a vital role in overseeing financial control and
budget management within a government entity.

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 e. They assist in the formulation and implementation of budgetary policies and
procedures.
f. These officers monitor expenditure, review financial reports, and provide advice on
financial matters to management.
g. They also ensure compliance with budgetary guidelines and financial regulations.

Auditor General:
a. The Auditor General is an independent position tasked with auditing and examining
government financial operations.
b. They assess the financial statements, transactions, and internal controls of government
departments and agencies.
c. The Auditor General's reports provide an objective assessment of the government's
financial management, highlighting any irregularities or weaknesses.
d. Their findings and recommendations help improve financial governance,
transparency, and accountability in the public sector.

Consolidated and Public Accounts Committee:

 Consolidated accounts are financial statements that consolidate the financial
information of all government departments and agencies.
 They provide a comprehensive view of the government's financial position and
performance.
 The Public Accounts Committee (PAC) is a parliamentary committee responsible for
scrutinizing the government's financial management, including the consolidated
accounts.
 The PAC reviews the Auditor General's reports, examines financial irregularities, and
holds the government accountable for the use of public funds.

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 THE STRUCTURE OF EXPENDITURES AND ITS GROWTH OVERTIME

In the context of public finance, the examination of expenditure structure and patterns
involves analyzing how governments allocate their financial resources and the factors that
influence their spending decisions:

Structure of Expenditures: The structure of government expenditures refers to the

composition or breakdown of spending across different sectors or categories. This includes
areas such as healthcare, education, defense, infrastructure development, social welfare,
public administration, and debt servicing.

a) Healthcare: Expenditures on healthcare include funding for hospitals, clinics,

healthcare personnel, medical equipment, pharmaceuticals, and public health
programs. Governments allocate resources to ensure access to quality healthcare
services and promote public health.
b) Education: This category includes spending on primary, secondary, and tertiary
education, as well as vocational training and educational infrastructure. Governments
invest in education to promote human capital development, improve literacy rates,
and enhance workforce skills.
c) Defense: Expenditures on defense encompass military personnel salaries, defense
equipment, research and development, and national security initiatives. Governments
allocate resources to ensure national security, protect territorial integrity, and maintain
defense capabilities.
d) Infrastructure Development: This category involves spending on transportation
networks, energy infrastructure, telecommunications, water supply, and sanitation
systems. Governments invest in infrastructure development to facilitate economic
growth, enhance connectivity, and improve quality of life.
e) Social Welfare: Expenditures on social welfare programs aim to provide support to
vulnerable populations and address social issues. This includes funding for social
assistance programs, poverty alleviation initiatives, unemployment benefits, housing
subsidies, and programs for the elderly, children, and persons with disabilities.
f) Public Administration: This category covers expenditures related to the functioning of
government institutions, including salaries of public officials, administrative
expenses, and governance initiatives. It ensures the effective functioning of public
administration and the delivery of public services.

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 g) Debt Servicing: Governments may allocate resources to debt servicing, including
interest payments and repayment of principal on public debt. This category reflects
the government's financial obligations and its ability to manage debt sustainability.

By understanding the expenditure structure, policymakers can gain insights into the
government's priorities and resource allocation strategies.

Factors Influencing Expenditure Patterns:

a. Economic Development: The level of economic development within a country can
influence expenditure patterns. Developing countries may prioritize spending on
infrastructure, education, and healthcare to foster economic growth and human capital
development. In contrast, more developed countries might allocate more resources to social
welfare programs, research and development, and environmental sustainability.

b. Social Priorities: Government expenditures are often influenced by social priorities and
the needs of the population. This can include addressing income inequality, reducing poverty,
providing healthcare and education, ensuring social security, and promoting sustainable
development. Social priorities may vary based on the specific needs and challenges faced by
a country or region.

c. Political Considerations: Political factors, such as the ideology of the ruling government,
public opinion, and electoral cycles, can shape expenditure patterns. Governments may
allocate resources to sectors or programs that align with their political agenda or to gain
public support. Additionally, the influence of interest groups and lobbying efforts can affect
spending decisions.

d. Demographic Changes: Changes in the demographic composition of a population can

impact expenditure patterns. For example, an aging population may lead to increased
spending on healthcare and pensions, while a youthful population may prioritize investments
in education and employment generation.

e. External Factors: External factors, such as international commitments, global economic

conditions, and donor assistance, can also influence expenditure patterns. International
obligations or agreements may require governments to allocate resources to specific sectors
or programs. Economic crises or changes in global market conditions may necessitate
adjustments in spending priorities.

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 Growth of Expenditures Over Time: Analyzing the growth of government expenditures
over time provides insights into the changing dynamics of public finance. Factors such as
economic growth, inflation, population growth, and policy decisions can contribute to the
expansion or contraction of expenditure levels. Understanding expenditure growth patterns is
crucial for evaluating fiscal sustainability, assessing the effectiveness of public spending, and
identifying areas where resource allocation may need adjustment.

By examining the structure and growth of government expenditures and considering the
factors influencing expenditure patterns, policymakers can make informed decisions
regarding resource allocation, fiscal planning, and the prioritization of public investments to
meet the needs of the population and achieve broader socio-economic objectives.

The major current operating expenditures of the government

The major current operating expenditures of a national government can vary depending on
the country and its specific priorities. However, there are several common categories of
operating expenditures that are typically significant for most national governments. These
major current operating expenditures include:

a) Personnel Costs: Personnel costs encompass salaries, wages, and benefits of

government employees, including civil servants, teachers, healthcare professionals,
police officers, and military personnel. These costs are often a significant portion of
the government's operating budget.
b) Social Welfare Programs: Expenditures on social welfare programs include funding
for social security, welfare benefits, unemployment benefits, pensions, healthcare
subsidies, and other forms of assistance provided to individuals and families in need.
c) Education: Education expenditures cover funding for schools, teachers' salaries,
educational materials, infrastructure development, and other educational programs
and initiatives aimed at providing quality education and improving literacy rates.
d) Healthcare: Healthcare expenditures involve funding for hospitals, clinics, healthcare
personnel, medical supplies and equipment, pharmaceuticals, vaccination programs,
public health initiatives, and healthcare subsidies for the population.
e) Defense and Security: Expenditures on defense and security include funding for
military operations, defense equipment and technology, salaries for military
personnel, intelligence agencies, law enforcement agencies, and national security
initiatives.

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 f) Public Infrastructure: Operating expenditures may also include funds allocated for the
maintenance, operation, and management of public infrastructure, including
transportation networks, energy systems, water supply, sanitation facilities, and public
buildings.
g) Public Administration: Costs associated with public administration encompass the
functioning and operation of governmental institutions, including salaries for public
officials, administrative expenses, governance initiatives, and public service delivery.
h) Debt Servicing: Governments often allocate funds for debt servicing, including
interest payments and principal repayments on public debt.

Government’s policy regarding current operating expenditures

The government's policy regarding current operating expenditures maybe summarized as
follows:

a) Limit the growth of current operating expenditures with provisions for inflation
adjustments;
b) Encourage cost reduction measures in operation, particularly overhead expense items;
c) Provide adequate maintenance funds for infrastructure facilities; and
d) Control the growth of spending for personal services within the level that can be
sustained by available resources.

The capital outlays of the national government

The capital outlays of the national government are appropriations spent for the purchase of
goods and services, the benefits of which extend beyond the fiscal year and which add to the
assets of government, including investments in the capital stock of government-owned or
controlled corporations and their subsidiaries.

The capital outlays of the national government may be broadly classified as follows:
infrastructure outlays, equity contributions to government corporations, capital transfers to
local government units, and other capital outlays.

Capital expenditures, particularly those classified as capital goods or durable goods to be

used for non-military and productive purposes, such as construction of roads and bridges,
dams, power and irrigation works, schools and hospitals, are generally desirable because of
their high multiplier effect on the economy, i.e., they stimulate the growth and expansion of
economic activities of the private sector and facilitate the integration of industries.

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Capital outlays refer to the expenditures made by the national government on long-term
investments in physical infrastructure, assets, and projects that have a lasting impact on the
country's development. These expenditures are typically aimed at improving economic
productivity, enhancing public services, and promoting long-term growth. Here are some
common categories of capital outlays by the national government:

a) Infrastructure Development: Capital outlays often involve investments in

infrastructure projects such as transportation networks (roads, railways, airports,
seaports), energy systems (power plants, renewable energy projects),
telecommunications networks, water supply and sanitation systems, and public
buildings (schools, hospitals, government offices).
b) Public Facilities: Capital outlays may include the construction, renovation, or
expansion of public facilities such as schools, hospitals, universities, research centers,
libraries, sports complexes, cultural centers, and public parks.
c) Housing and Urban Development: Governments may allocate capital funds for
housing projects, urban development initiatives, and slum upgrading programs to
improve living conditions, provide affordable housing, and promote sustainable
urbanization.
d) Industrial and Economic Development: Capital outlays can support initiatives aimed
at promoting industrialization, economic diversification, and job creation. This may
include investment in industrial parks, special economic zones, technology hubs, and
support for entrepreneurship and small business development.
e) Agriculture and Rural Development: Governments may allocate capital funds for
agricultural infrastructure, irrigation systems, rural roads, agricultural research
facilities, and programs that aim to enhance agricultural productivity, promote
sustainable farming practices, and improve the livelihoods of rural communities.
f) Education and Research: Capital outlays may be directed towards the construction or
renovation of educational institutions, research centers, laboratories, and libraries to
enhance the quality of education, support research and innovation, and foster human
capital development.
g) Health Facilities and Equipment: Capital outlays can include investments in the
construction, expansion, or upgrading of healthcare facilities, including hospitals,
clinics, medical centers, and the procurement of medical equipment and technology.

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 h) Environmental Conservation and Sustainability: Governments may allocate capital
funds for environmental protection, conservation initiatives, and projects aimed at
addressing climate change, such as renewable energy projects, waste management
systems, and conservation of natural resources.

How governments determine the allocation of capital funds for different categories of
capital outlays
The allocation of capital funds for different categories of capital outlays is determined
through a comprehensive decision-making process that involves various considerations. The
factors and processes that governments typically take into account:

1. Development Priorities: Governments identify their development priorities based on

national development plans, policy objectives, and the needs of the country. These
priorities can include infrastructure development, industrialization, education,
healthcare, agriculture, and other sectors critical to economic growth and social
welfare.
2. Strategic Planning: Governments engage in strategic planning to assess the country's
infrastructure gaps, economic potential, social needs, and long-term development
goals. This involves conducting feasibility studies, analyzing data and trends, and
consulting with experts and stakeholders to identify priority areas for capital
investments.
3. Budgeting Process: The allocation of capital funds is typically done through the
government's budgeting process. Governments allocate funds based on the available
financial resources, revenue projections, fiscal constraints, and debt sustainability
considerations. Budgetary decisions are often guided by the government's policy
agenda, economic conditions, and the need to balance competing demands for
resources.
4. Project Evaluation and Cost-Benefit Analysis: Governments employ project
evaluation techniques and cost-benefit analysis to assess the potential impact and
feasibility of capital projects. This involves evaluating the economic, social, and
environmental benefits, as well as the costs, risks, and sustainability of each project.
Projects with higher expected returns and positive social impact are generally given
priority.
5. Public Consultation and Stakeholder Engagement: Governments often seek public
input and engage with relevant stakeholders during the decision-making process. This

33
 can include consultations with communities, industry representatives, interest groups,
and experts to gather feedback, identify needs, address concerns, and ensure that
capital investments align with the interests and aspirations of the population.
6. Institutional Framework and Regulations: Governments establish institutional
frameworks, regulations, and oversight mechanisms to ensure transparency,
accountability, and efficient allocation of capital funds. This includes processes for
project appraisal, procurement, contract management, and monitoring to prevent
corruption, promote fair competition, and ensure value for money.
7. International Agreements and Donor Support: In some cases, the allocation of capital
funds may also be influenced by international agreements or donor support.
Governments may receive financial assistance or loans from international
organizations, bilateral partners, or development banks for specific projects aligned
with development goals or conditionalities set by the donors.

How government expenditures are categorized by cost structure

Government expenditures can be categorized by cost structure based on how the costs are
incurred and classified. This categorization provides insights into the spending patterns and
helps analyze the financial management of government resources. Here are the common
categories of government expenditures by cost structure:

1. Current Expenditures: Current expenditures refer to the day-to-day operational

expenses of the government. They are recurring in nature and typically include
personnel costs (salaries, wages, benefits), maintenance and operating expenses,
consumables, and other routine expenditures necessary for the delivery of public
services. Current expenditures are essential for the functioning of government
agencies and the provision of ongoing services.
2. Capital Expenditures: Capital expenditures involve investments in physical assets and
infrastructure that have long-term benefits and contribute to economic development.
These expenditures are typically associated with the acquisition, construction, or
improvement of fixed assets such as buildings, roads, bridges, schools, hospitals, and
other infrastructure projects. Capital expenditures are aimed at expanding and
upgrading public infrastructure, promoting economic growth, and enhancing the
quality of public services.
3. Transfer Payments: Transfer payments refer to expenditures that involve the
redistribution of income or resources from one group or sector of the population to

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 another. These payments do not directly result in the acquisition of goods or services
by the government. Examples of transfer payments include social welfare benefits,
pensions, unemployment benefits, subsidies, grants, and financial assistance provided
to individuals, households, or other entities.

The significance of categorizing government expenditures by cost structure lies in

several factors:

a) Financial Planning and Budgeting: Categorizing expenditures by cost structure helps

governments in financial planning and budgeting processes. It allows for a better
understanding of the composition of spending and helps in setting priorities,
allocating resources, and estimating future funding needs.
b) Resource Allocation: By categorizing expenditures, governments can make informed
decisions about resource allocation. They can analyze the proportion of funds
allocated to current expenditures, capital investments, and transfer payments. This
helps ensure a balance between maintaining ongoing operations, investing in long-
term development, and addressing social welfare needs.
c) Policy Evaluation and Analysis: Categorization enables policymakers and analysts to
assess the impact and effectiveness of different types of expenditures. By studying the
allocation of funds across current expenditures, capital investments, and transfer
payments, governments can evaluate the outcomes and performance of specific
policies, programs, and projects.
d) Fiscal Sustainability: Categorizing expenditures by cost structure aids in monitoring
fiscal sustainability. Governments need to manage their current expenditures, such as
personnel costs, within sustainable levels to avoid budget deficits or excessive debt.
Analyzing the distribution of costs helps identify areas where cost containment
measures or efficiency improvements may be necessary.
e) Accountability and Transparency: Categorization enhances accountability and
transparency in public spending. It allows for clearer reporting and disclosure of
expenditures, making it easier for citizens, oversight bodies, and auditors to track and
scrutinize how government resources are allocated and utilized.

By categorizing government expenditures by cost structure, policymakers and stakeholders

gain a comprehensive understanding of spending patterns, enabling effective financial

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management, policy evaluation, and informed decision-making regarding resource allocation
and fiscal sustainability.

Measures governments take to ensure fiscal sustainability in managing current

expenditures
Governments can implement several measures to ensure fiscal sustainability in managing
current expenditures:

a. Expenditure Review and Efficiency Measures: Governments can conduct regular

expenditure reviews to identify areas of inefficiency, duplication, or wasteful
spending. This involves analyzing current expenditure patterns, evaluating the cost-
effectiveness of programs and services, and identifying opportunities for streamlining
operations, reducing redundancies, and improving efficiency.
b. Performance-Based Budgeting: Governments can adopt performance-based
budgeting, which focuses on outcomes and results rather than simply inputs and
activities. This approach involves linking funding decisions to measurable
performance indicators and setting targets for service delivery and efficiency
improvement. It encourages agencies to prioritize high-impact programs and allocate
resources based on their demonstrated effectiveness.
c. Public Sector Pay and Benefits Reform: Governments can review and reform public
sector pay and benefits to ensure they are competitive, equitable, and sustainable. This
may involve reassessing salary structures, implementing performance-based
incentives, rationalizing benefits, and considering options such as flexible work
arrangements or alternative staffing models to optimize personnel costs.
d. Targeted Subsidies and Social Programs: Governments can improve the targeting and
efficiency of subsidies and social programs. This can be achieved by conducting
comprehensive means testing or income verification to ensure that benefits are
received by those who genuinely need them. Additionally, implementing conditional
cash transfer programs or providing support in the form of vouchers or direct
assistance can help ensure that subsidies reach the intended beneficiaries while
minimizing leakage and reducing fiscal burden.
e. Rationalizing and Prioritizing Public Services: Governments can assess the scope and
coverage of public services to identify areas where rationalization or prioritization is
needed. This involves evaluating the necessity and effectiveness of services,
considering alternative service delivery models (such as public-private partnerships or

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 outsourcing), and reallocating resources to focus on high-priority areas that have the
most significant impact on citizens' well-being.
f. Medium-Term Expenditure Frameworks: Governments can develop medium-term
expenditure frameworks (MTEFs) that provide a multi-year perspective on
expenditure planning. MTEFs help improve fiscal discipline and sustainability by
setting expenditure ceilings and ensuring that spending commitments align with
available resources, revenue projections, and long-term fiscal objectives.
g. Enhanced Financial Management and Monitoring: Strengthening financial
management systems and controls is crucial for fiscal sustainability. Governments can
implement robust financial management practices, including effective budget
execution, expenditure tracking, and monitoring mechanisms. This helps prevent
overspending, detect irregularities, and ensure transparency and accountability in the
management of current expenditures.
h. Debt Management and Contingency Planning: Effective debt management is essential
for maintaining fiscal sustainability. Governments should establish prudent debt
policies, monitor debt levels, and ensure debt servicing obligations are met.
Additionally, contingency planning and risk management frameworks can help
governments prepare for unforeseen events or economic shocks, minimizing the
impact on current expenditures and overall fiscal stability.

By implementing these measures, governments can enhance fiscal sustainability by

optimizing current expenditures, improving efficiency, prioritizing high-impact programs,
and ensuring effective financial management and oversight. It is important for governments
to take a comprehensive and proactive approach to fiscal sustainability to maintain sound
public finances in the long term.

Expenditure Patterns
Expenditure patterns refer to the distribution and allocation of funds by governments across
various categories of spending. These patterns provide insights into how governments
prioritize and allocate resources to different sectors, programs, and services:

a) Social Services: Governments allocate a significant portion of their expenditures to

social services, including healthcare, education, social welfare, and housing. These
sectors often receive substantial funding to ensure the well-being of citizens, provide
access to essential services, and promote social development.

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 b) Infrastructure Development: Infrastructure development is a key area of government
expenditure. Governments invest in the construction, maintenance, and improvement
of transportation networks, energy systems, water supply and sanitation,
telecommunications, and public facilities such as schools, hospitals, and
administrative buildings.
c) Defense and Security: Governments allocate funds for defense and security purposes,
including military spending, law enforcement, border control, and intelligence
agencies. These expenditures aim to ensure national security, protect citizens, and
maintain peace and stability.
d) Debt Servicing: Governments allocate a portion of their budgets to debt servicing,
which includes interest payments and repayment of principal on outstanding loans and
bonds. Debt servicing is necessary to honor financial obligations and maintain
credibility in financial markets.
e) Economic Development: Governments often allocate funds for economic
development initiatives, including support for industries, business incentives, research
and development, entrepreneurship programs, and job creation. These expenditures
aim to promote economic growth, attract investment, and enhance competitiveness.
f) Public Administration: Expenditures related to public administration cover the costs
associated with running government institutions, including salaries and benefits of
public servants, administrative expenses, governance reforms, and capacity building.
These expenditures support the effective functioning of government and the delivery
of public services.
g) Subsidies and Transfers: Governments provide subsidies and transfers to individuals,
households, or businesses to support specific sectors or address socio-economic
challenges. These can include agricultural subsidies, energy subsidies, unemployment
benefits, social assistance programs, and grants for research and innovation.
h) Interest Payments: Governments allocate funds for interest payments on loans and
bonds issued to finance public expenditures. These payments represent the cost of
borrowing and servicing the accumulated debt.

Factors that influence the distribution of expenditure patterns in different countries

The distribution of expenditure patterns in different countries can be influenced by a variety
of factors. These factors can vary based on the country's economic conditions, political

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environment, social priorities, and specific challenges it faces. The key factors that can
influence the distribution of expenditure patterns:

a. Economic Conditions: The state of the economy plays a significant role in

expenditure patterns. Countries with high levels of economic development and strong
fiscal capacity may allocate more funds towards infrastructure development, research
and development, and other initiatives aimed at promoting innovation and economic
growth. Meanwhile, countries with emerging economies or facing economic
challenges may prioritize social services, poverty alleviation, and investment in basic
infrastructure.
b. Demographic Factors: Demographic factors, such as population size, age structure,
and urbanization rates, can influence expenditure patterns. Countries with large
populations may allocate significant resources to healthcare, education, and social
welfare programs. Aging populations may require increased spending on pensions and
healthcare for the elderly. Urbanization can lead to increased infrastructure
investments to support growing cities and improve living conditions.
c. Political Priorities and Ideology: The political priorities and ideology of a government
have a strong influence on expenditure patterns. Different governments may have
varying views on the role of the state, the level of social welfare provision, and the
importance of different sectors. Political parties and leaders may have specific policy
agendas that shape expenditure patterns to reflect their priorities, such as emphasizing
defense, education, or environmental sustainability.
d. Social Development Needs: Countries with higher levels of poverty, inequality, or
social challenges may allocate a larger proportion of their expenditures to areas such
as education, healthcare, and social welfare. Governments may prioritize poverty
reduction, improving access to basic services, and narrowing socio-economic
disparities.
e. External Factors and International Commitments: External factors, including
international commitments and agreements, can influence expenditure patterns.
Countries may allocate funds to meet obligations under international treaties, such as
commitments related to climate change mitigation, disaster response, or development
assistance to other nations. International economic conditions, such as borrowing
costs or donor support, can also influence expenditure decisions.

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 f. Fiscal Constraints and Debt Sustainability: Fiscal constraints and debt sustainability
considerations shape expenditure patterns. Governments must balance their spending
with available revenue and borrowing capacity. High levels of public debt or budget
deficits may require prioritizing expenditure adjustments, including reducing
subsidies, implementing austerity measures, or seeking external financial assistance.
g. Public Opinion and Social Demand: Public opinion and social demand can influence
expenditure patterns through political pressure and citizen expectations. Governments
often respond to popular demands for improved services, increased investment in
specific sectors, or addressing pressing social issues. Public consultations, advocacy
groups, and civil society play a role in shaping expenditure priorities.
h. Technological Advancements and Innovation: Technological advancements and
innovation can influence expenditure patterns by creating new opportunities, changing
industry dynamics, and influencing government policies. Governments may allocate
funds towards research and development, digital infrastructure, and initiatives to
foster innovation and technological advancements in sectors such as healthcare,
energy, and transportation.

Role of public opinion in shaping expenditure patterns

Public opinion plays a significant role in shaping expenditure patterns as governments are
responsive to the preferences and demands of their citizens. Ways in which public opinion
influences expenditure patterns:

a. Policy Priorities: Public opinion helps shape the policy priorities of governments.
Governments consider the issues that are important to the public and allocate
resources accordingly. If there is strong public support for increased spending on
education, healthcare, or infrastructure, governments are more likely to prioritize
these areas in their expenditure patterns.
b. Budgetary Allocations: Public opinion can influence the allocation of budgetary
resources to different sectors. Governments take into account public sentiment and
demands when making decisions on funding levels for various areas such as social
services, defense, infrastructure, and environmental initiatives. Public opinion can
lead to increased funding in areas where there is strong public support or decreased
funding in areas where there is widespread public dissatisfaction.
c. Social Welfare Programs: Public opinion plays a crucial role in determining the level
of funding and design of social welfare programs. Governments consider public

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 sentiment and the perceived need for assistance in addressing poverty, unemployment,
healthcare access, and other social challenges. Public opinion can influence the extent
of financial support, eligibility criteria, and the types of benefits provided through
social welfare programs.
d. Public Goods and Services: Public opinion shapes the provision of public goods and
services. Governments take into account public preferences when deciding on the
level of investment in areas such as education, transportation, environmental
protection, and cultural programs. Public opinion can influence the scale and quality
of public goods and services provided by governments.
e. Taxation and Revenue Policies: Public opinion can influence taxation and revenue
policies, which in turn shape expenditure patterns. Governments consider public
sentiments regarding tax rates, tax structures, and preferences for specific revenue
sources. Public opinion can impact decisions on tax breaks, exemptions, or increases
in revenue-generating measures.
f. Public Consultation and Participation: Governments often seek public input and
engage in consultations to gather opinions and preferences on expenditure priorities.
Public consultations, surveys, town hall meetings, and other forms of participatory
mechanisms provide opportunities for citizens to express their views on budgetary
allocations. Governments take into account the feedback received during these
processes to shape expenditure patterns.
g. Political Accountability: Public opinion plays a role in holding governments
accountable for their expenditure decisions. If citizens perceive that governments are
not adequately addressing their priorities or misallocating resources, public opinion
can lead to pressure for change. Public dissatisfaction can influence elections,
political campaigns, and policy debates, prompting governments to respond by
adjusting their expenditure patterns to better align with public preferences.

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Cost benefit and cost effectiveness analysis

Fiscal functions and institutions in Kenya

Kenya’s tax system

Mechanisms of tax collections

Comparison of tax systems in East Africa

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