Lecture 14
Government Budgeting
14.0 Introduction
The budget is the most important economic policy tool of a government and provides a
comprehensive statement of the priorities of a nation. This lecture introduces the budget
and some related core concepts and terminology. The following sections consider the
definition and components of the budget, and the objectives of budgeting as proposed by
current public expenditure management theory.
14.1 Definition and components of the budget
The word budget developed from bougette or ‘small bag’ in middle French. The first
traceable legal definition of the budget is contained in a French decree of 1862: ‘The
budget is a document which forecasts and authorises the annual receipts and expenditures
of the State…’ (Stourm, 1917). Government budgeting is the critical exercise of
allocating revenues and borrowed funds to attain the economic and socia l goals of the
country. It also entails the management of government expenditures in such a way that will
create the most economic impact from the production and delivery of goods and services
while supporting a healthy fiscal position.
Sources of income vary substantially between countries. They usually include direct taxes,
which are levied on income or capital, for example income tax. Such taxes are called
direct because it is normally assumed that the real burden of payment falls directly on the
person or firm that is immediately responsible for paying them. By contrast, indirect taxes
such as sales taxes or excise taxes on alcohol and tobacco are so-called because it is
assumed that the real burden of paying the tax will not fall on the firm immediately
responsible for paying it but rather that it will be passed on to the customer. Other
sources of government income might consist of user charges for certain services, foreign
aid and income from investments or commercial activities.
In considering its revenue raising options, the government has to weigh advantages and
disadvantages. For example, boosting reliance on sales taxes makes taxation more
regressive. This means that a poor person will pay as much tax as a rich person when
purchasing an item of clothing or food, as sales tax does not take account of income
differentials. On the other hand, income taxes are progressive when they apply higher
rates to individuals with a higher level of income. But where the formal economy is small,
excessive taxation of a few high income individuals can undercut investment, which
hampers growth and employment creation. Over time, this might erode the tax base and
reduce the ability of government to raise revenues. Raising an adequate amount of
revenues, while at the same time preserving equity and stimulating economic growth, can
be a difficult balancing act.
On the expenditure side of the budget, government allocates funds to various functions
such as health care, education, agriculture, justice, defense and so on. This is called the
functional classification of expenditures. The share of total expenditures allocated to each
sector is a key indicator of spending priorities for a given year and of shifts in priorities
over a period of time. In terms of the economic classification of expenditures a distinction
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can be made between current and capital expenditures. Current expenditures, as noted
in lecture one, are on goods and services that are consumed immediately, for example
wages of civil servants or supplies of learning material for schools. Capital expenditures
comprise money spent on the purchase of goods that can be used to produce other goods,
for example machinery or infrastructure. The balance between current and capital
spending is important. When a clinic is built and equipped to service a community
(a capital expenditure), then government has to make sure that it sets aside sufficient
funds to run the clinic on a day to day basis, which requires budgeting for wages,
medicines and the like (current expenditures).
When government spends more money than the available revenues, it can either raise taxes
or budget for a deficit and cover the shortfall with borrowed money. There is a wide
range of alternate deficit measures, but the conventional deficit is widely quoted as perhaps
the central indicator of fiscal health. This deficit measure is defined as the excess of
government’s total expenditure over total revenue. There is no absolute figure that can
indicate whether the deficit is too large, which depends on the size of the economy. For this
reason, the deficit to Gross Domestic Product (GDP) ratio is used to indicate the share
of national income that will have to be used to finance the deficit. Although the appropriate
size of the deficit depends on a variety of factors that determine sustainability on a
case by case basis, a widely accepted benchmark is three percent of GDP. However, some
go further and demand balanced budgets where revenues are equal to expenditures.
Changes in the deficit do not have to be the result of a shift in fiscal policy, but can also
reflect the business cycle, for instance. Consistently growing deficits, however, give
cause for concern:
Government borrowing can put upward pressure on interest rates so as to ‘crowd out’
private sector investment. In other words, when government uses most of the capital
available on the borrowing market, less is available for the private sector to borrow
in order to expand its activities. This can dampen economic growth.
Deficit spending is expensive. Because government will have to put aside a proportion
of funds to service its stock of debt, there will be less money for service delivery.
Reductions in service delivery programs affect vulnerable groups in society that are
most dependent on the state.
It is unfair if extensive borrowing forces future generations to make sacrifices so that
they effectively pay for spending that we enjoy today. This problem is exacerbated
when borrowed funds are not invested productively.
Excessive deficits are associated with inflation. Some governments have resorted to
‘printing money’ in order to meet debt servicing obligations. However, this strategy is
difficult to pursue when the central bank enjoys entrenched independence from the
government both legally and in practice.
14.2 Principles of good budgeting
According to the World Bank (1998), the following are principles of good budgeting:
i. Comprehensiveness: The budget must cover all the fiscal operations of
government, encompassing all public expenditure and revenues, to enable full and
informed debate of the tradeoffs between different policy options.
ii. Predictability: Spending agencies should have certainty about their allocations in
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the medium term to enable them to plan ahead. Stable funding flows support
departmental planning and efficient and effective delivery.
iii. Contestability: No item in the budget should have an automatic claim to funding.
All policy and attached funding should be regularly reviewed and evaluated in order
to ensure prioritization and optimal performance of spending agencies.
iv. Transparency: All relevant information required for sound budgetary decision
making should be available in an accessible format, and in a timely and
systematic fashion. Budget information needs to be accurate, reliable and
comprehensive.
v. Periodicity: The budget should cover a fixed period of time, typically one year,
and the process of compiling the budget should follow a clear and reliable schedule
that is agreed upon and published in advance.
14.3 Objectives of budgeting
If resources were limitless, we could all get whatever we want from the government. There
would be no need to budget. In reality, spending needs are inevitably beyond available
funding. Governments have to make choices about the allocation of scarce resources to
meet competing needs in society. Budgeting is effective in facilitating this process when it
forces awareness of overall fiscal constraints, enables the prioritisation of spending in line
with policy objectives and supports the efficient implementation of policies. man
Objective Requirements
Aggregate Budget totals should be the result of explicit, enforced decisions; they
fiscal discipline should not merely accommodate spending demands. These totals
should be set before individual spending decisions are made, and should
be sustainable over the medium term and beyond.
Allocative Expenditures should be based on government priorities and on
efficiency effectiveness of public programs. The budget system should spur
reallocation from lesser to higher priorities and from less to more
Operational effective programs.
efficiency Agencies should produce goods and services at a cost that achieves
ongoing efficiency gains and (to the extent appropriate) is
competitive with market prices.
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14.4 The budget process
14.4.1 Actors in the budget process
Within the executive arm of government, the role of the ministry of finance ministry or
treasury is to coordinate and drive the budget process in accordance with a schedule. The
ministry of finance has the economic expertise to prepare macroeconomic projections.
These are important in order to assess the amount of money that will be available for
spending. The finance ministry also plays a crucial role in formulating fiscal policy,
guiding the drafting of the budget and later in monitoring budget implementation. Various
spending departments are ultimately responsible for expenditures within their
jurisdiction, such as health, education, agriculture and so on. Spending departments will
often try to extract as many resources as possible, whereas the role of the ministry of
finance is that of the guardian of the public purse. Other actors include:
Legislature: The role of the legislature is to scrutinize and authorize revenues and
expenditures and to ensure the budget is properly implemented. This is because
legislators are aware of their constituencies’ priorities and needs when considering
the budget.
Independent audit institutions (auditor generals or audit courts) carry out audits
of government accounts in order to determine whether government did in fact
implement that budget as passed by the legislature. Some of them also consider
whether this was done efficiently and effectively.
Civil society organisations, covering the full spectrum from think tanks to
community-based organisations provide independent research from a perspective
that is not covered by conventional analyses. One example is the work on the impact
of the budget on vulnerable groups such as women or children that civil society
groups have pioneered, sometimes in collaboration with the legislature.
The media has an important role to play in ensuring that the central issues in
budgetary debates are widely understood. In order to play this role, journalists
require full access to the legislature and its committees and all relevant
documentation should be available to them.
International financial institutions and donor agencies play a powerful role in
the budget process of developing countries with particularly grants, technical
assistance and high levels of foreign debt. To be supportive of sound budget
practices, donor funding needs to be transparent and predictable and full
information on such funding should be given in the budget.
14.4.2 Stages of the budget process
Budgets have to be passed regularly, usually on an annual basis in order to ensure that the
government continues to operate. The budget process is governed by a timeline that can be
separated into four different stages, namely, drafting (or preparation), legislative approval,
implementation and audit and evaluation. It is important to note that in real life budget
cycles overlap. At any one time a number of different budgets are at different stages of the
budget process. The overlapping nature of budgeting means that the maintenance of fiscal
oversight can be a complex challenge.
Stage 1: Budget Drafting
The drafting or preparation stage is concerned with compiling a draft budget that can be
submitted to the legislature. This stage is mostly internal to the executive, but it does not
have to be a secretive affair. The first step is to set fiscal policy and estimate available
revenues in order to establish the total resource envelope that will be available for
spending. Based on the policy framework of the government the finance ministry issues
indicative expenditure ceilings for each department. This leads up to negotiations
between spending departments and the ministry of finance about the allocation of funds
across different functions. A consolidated draft budget has to be reviewed and approved at
the highest political level, such as the president or cabinet, which will also make
final decisions on especially contentious issues that could not be resolved before. Once a
comprehensive budget has been drafted, it has to be approved by the legislature to become
effective.
Stage 2: Legislative Approval
During the legislative stage, parliament scrutinizes the expenditure and revenue proposals
of the executive. Its options are to approve or reject the budget, to amend it, or, in a few
cases, to substitute the draft tabled by the executive with its own budget. In some
countries, the legislature passes separate legislation for appropriations and changes to the
tax code; in others it considers a unified budget bill. The exact form of legislative
approval is less important than the fact that it must be comprehensive. Legislative
authorization of all public spending and taxation ensures the rule of law in public finance.
Stage 3: Budget Implementation
Implementation of the budget commences with the beginning of the fiscal year. The
execution or implementation stage of the budget process is done by the executive. The
ministry of finance usually plays a leading role in assuring that funds are apportioned to
spending departments in line with the approved budget. Sometimes, however, in many
developing countries, cash constraints lead to certain expenditures being cut below voted
and other unplanned adjustments to approved spending. Funds might be shifted to
purposes other than those that were approved. Improvised budget cuts tend to adversely
affect vulnerable groups that have a weak political voice, and who are most dependent on
government initiatives. Frequent adjustments to budgets can reflect the uncertainties
that are characteristic of the macroeconomic environment, but ‘continuous’ or
‘repetitive budgeting’ is also a symptom of a weak and ill-disciplined budget system.
To ensure that its authority is not undermined by excessive adjustments, the legislature
might find it useful to keep a close eye on implementation through scrutiny of actual
spending during the fiscal year. Any significant adjustments to the budget should be
captured in adjustment or supplemental appropriations that are tabled in the legislature
for approval.
Stage 4: Audit and Evaluation
An independent audit institution such as an audit court or auditor general, analyses
government accounts and financial statements. In most countries, the audit of accounts is
followed by the consideration of audit findings by the legislature. If the process is
effective, any recommendations based on audit findings are reflected in future budgets,
which allows for continuous improvements in public spending and generally public
financial management. Audit reports need to be produced and tabled in the legislature as
speedily as possible to ensure their relevance and accuracy. Long delays undermine
accountability, because officials who are responsible for a loss of public money may have
moved on or retired by the time an incident receives attention. Delays may make it more
difficult to pursue disciplinary measures. The interest of the public is also likely to focus
on more current matters. The timely submission of audit reports requires that departments
produce their financial statements in time for the audit institution to meet the deadline.
The relevant financial management legislation usually prescribes when and in what form
the necessary information has to be submitted by departments to the auditors.
14.5 Role of Parliament in Approving Government Budget
The role of parliament in approving the budget differs sharply across different countries.
Some are powerful players in the budget process, and significantly shape budgets. Others
generally approve the budget as tabled by the executive without any changes. A number of
factors combine to determine the role and impact of the legislature in the approval stage of
the budget process.
A legislature needs sufficient constitutional powers over budgets in order to
influence decision making, notably powers to amend the budget proposal tabled by
the executive. But formal constitutional powers alone are not enough.
A thorough review of financial proposals requires time for scrutiny and a properly
timed budget process, where the budget is tabled sufficiently in advance of the
beginning of the fiscal year.
Parliamentary expertise on the budget is most likely to develop in specialised
committees, in particular a dedicated budget committee. Sectoral committees can
contribute valuable subject expertise.
Legislative decision making also should be based on full access to relevant and
high quality information and parliament should have the ability to independently
analyze budgetary information.
Constitutional and technical capacity to engage with budgets is not likely to be
utilised unless the legislature has a degree of political independence from the
executive.
