Chapter 5

Public Sector Resource Allocation

(GOVERNMENT BUDGETING)
 5.1. Meaning and purpose of government budget

– It is a reflection of not only taxation and public expenditure

policy, but also of a plan for future course of action.

– From the study of the budget, one can make an assessment

as to the extent to which it is designed to secure the
normative ideas of allocation, distribution, stabilization
and growth.
– According to Bastable, budget has come to mean the
financial arrangements of a given period, with the usual
implication that they have been submitted to the legislature
for approval.
• Though budget is a program for future action and is
generally framed for a year, it presents a picture of
the details of expenditure, taxation and borrowings
for three consecutive years, i.e.,
– the actual receipts and disbursements of the previous
year,

– the budget and revised estimates of the current year and

– the estimated receipts and expenditures of the coming

fiscal year.
A good budget should be:
1. One that will enable the legislature and the people to
appreciate the proposals of receipts and disbursements in
the context of prevailing state of economy of the country.
2. One that will draw up programs of action in such a manner
that the proposals can feasibly be translated into
realization.
3. A good budget is that it should depict a clear picture of the
state of performance relating to programs of the
government in the previous year so that it becomes
possible to see what have been achieved, what have been
the shortcomings and decide as to what course of action
should be adopted in the budget plan.
The budget undergoes through different stages of action.
• Firstly, the budget frame is structured.
– The government asks different departments to submit their proposed programs
of action for the coming year. After all are received, they are consolidated into
an overall budget plan.
• Secondly, the budget is presented in legislature for its approval.
– At this stage, the legislature carefully considers the proposals.
– There may be additions or alternations in budgetary provisions as considered
necessary by the legislature.
– After the budget is approved, the government is authorized to take action on the
budget.
• Thirdly, the implementation of the budgetary programs is the next
stage. Revenues are raised and public expenditures relating to the budget plan are
made.
• At last expenditures relating to the budget plan are made.
Purpose of government budget:
• The overall purpose is to use the budget as instrument of
government economic policy.
The following are the chief purpose of the budget.
▪ To achieve any purpose, a planning is necessary. A budget is
such a plan which explicitly mentions the programs that are to be
taken up in the course of the fiscal year.
▪ Secondly, implementation of a program requires availability of
necessary funds. The extent of availability depends upon the
budgetary sources of revenue. Hence, that program-structure has
to be built which can be supported by the funds. This is the
most important purpose of the government budget.
▪ Thirdly, to achieve efficiency in public expenditure, physical
targets of achievement are specified in the budget. In fixing the
physical targets, careful considerations is given to the factors of
efficiency in course of implementation of the programmes.
• Fourthly, most of the countries, particularly in developing
world, today have taken up their task of their economic
development in the phased manner of five-year plans and
long-drawn perspective plans.
• In order that the planned targets are achieved at the end of the plan
period, resources have to be found. The annual government
budgets are framed with an eye to the provision of necessary funds
for the purpose.
• Lastly, the government budget serves the purpose of public
accountability of funds to a considerable extent. The first
control is imposed at the budgeting framing level.
• Hence, budget serves as a powerful weapon of
financial control in respect of both collection of
revenues and disbursement of them.
5.2 Theories of government budgeting
A. The classical theory of balanced budget is based on the
assumption of full employment and the ‘laissez-faire’
doctrine.
– Under such a situation, the size of the budget is always small and
the budget should always be balanced.
– Another justification of the balanced budget is that Since deficit
financing through borrowing is easy, the practice of unbalanced
budget will encourage expansion of government activities as
against the classical notion of small budgets.
• There are two views regarding the balanced budget
theory.
– According to one view, the balancing of budget is brought about
by equating current revenues with current expenditure. There is no
role of borrowing in the budget.
– the other view of balanced budget, governmental receipts include
public debt also. The budget has, however, two parts – current
budget and capital budget, both of which are balanced. Thus,
current expenditures are financed by current revenues while capital
expenditures are financed by public borrowing. Thus, the overall
budget is balanced.
• The modern economists like Keynes, Hansen, Dalton and
others advocate that the objective of budget policy should
be to attain and maintain full employment.
B. The modern approach to flexible budget policy

• This approach is essentially a counter measure against economic fluctuations

of business cycle to which advanced countries are subjected.

• When depression and unemployment occurs in the economy due to

deficiency of effective demand, the need is to inject additional
purchasing power into the economy so that effective demand, hence
employment of production factors are enhanced.

• This objective can be realized through a deficit budget policy; because such
a budget will put additional purchasing power into circulation and the
aggregate consumption expenditure will increase. This will raise prices and
profit prospects of the business community which will employ available
unutilized production factors to increase production and meet the increased
demand.
• on the other hand, when the economy, suffers from inflation due to
excess purchasing power over and above the amount necessary to deal
with the transaction of available goods and services at prevailing
prices, the necessity is to pump out the excess amount from the
economy.
• This can be done by surplus budget which will raise more revenues
like taxes and borrowings and lower down government expenditures.
The process will cure the ills of inflation and bring about economic
stabilization.
• When there is neither inflation nor unemployment, the budget should
be balanced.
• The main difference between classicists and
modem economists in so far as the principle of
government budgeting is concerned lies with their
views on savings and investment.
• To the classical economists, saving is always equal
to investment because the former is automatically
converted into the latter. In such a system, there is
no unemployment.
• To the modern economists, however, savings and
investment need not be equal. They are
determined by different factors and, more normally,
they are different.
• When S > I, deficiency of effective demand
develops and unemployment occurs due to fall in
production. The economy is then faced with
depression.
• When I > S, the aggregate purchasing power in the
economy increases and the available output cannot
absorb it at the prevailing price level. Thus, there
becomes inflation.
• It is only when S = I, the stabilization function of the
economy remains undisturbed and the society
suffers neither form unemployment nor from
inflation.
• Under such circumstances, the modem theory
argues, the budget policy of government should be
flexible, allowing for balanced budget when there is
neither inflation nor unemployment i.e., when
savings and investment are equal and for
unbalanced budget when the economy suffers from
either inflation or unemployment, i.e., when
savings and investment are unequal.
 5.3. Budget Framing

• A government budget is framed in the shape of a

financial plan which is a statement of income and
expenditure relating to various economic and other
activities that the government intends to perform in
the coming period.

• The structure of budget frame may be different in

different countries.
i. Revenue and Capital budget.
▪ Many countries, particularly the less developed ones,
prepare budget in two parts, viz., the revenue and capital
budgets mainly because the government has to spend
enough resources on economic infrastructure without which
development process cannot start.
• Capital budget in these countries separates the revenue
expenditure items of capital account from those of current or
revenue account.
• The main sources of government revenue are taxes and
borrowings from internal sources on one hand and loans and
grants from other governments and international agencies on
the other.
• In the revenue budget, the current expenditure is met out of
domestic taxation, while the expenditure on capital account
is made out of domestic and foreign borrowings.
• Government obligations for some extra-ordinary
expenditure particularly in the initial stages of
development arise on account of economic
overheads like roads and railways, electricity
generation, schools and hospital buildings and
facilities and other investment projects which
require special revenues and are generally financed
by borrowing.
• Such expenditures and receipts are shown in the
capital budget.
Table 4.1 Revenue and Capital Budget
Revenue Budget Capital Budget
Items of receipts items of items of receipts items of
Expenditure Expenditure
a. Taxes on income a. Administrative a. Loans and a. Public works
and general services recoveries
b. Taxes on b. Social services b. Market loans b. Construction of
property power generation
plant.
c. Custom duties c. economic services c. Small savings c. construction of
roads and railways
d. Union excise d. community d. External loans d. Flood control
duties services works
e. Non-tax e. Maintenance of e. Other receipts e. Irrigation canals
revenue road and railways. etc.
etc.
f. Other revenues. f. Total revenue f. Total capital f. Total capital
Total revenue expenditure receipts expenditure
receipts
• Since capital projects are very important as they will form
the sources of regular flow of productive services in
future, the long drawn financial plan and its consequence
on the economy over years ahead can be read from the
capital budget.

• Such a separation of the budgets secures expenditure

discipline and, hence, the lenders can form a clear idea
about the solvency or otherwise of the country.
ii) Incremental and Zero-base Budgets.
• The budget, in order to be meaningful, should be appraised
occasionally and requests for grant of fund should be properly
reviewed.
• The review is necessary at both administrative and legislative levels.
• But, there is a general tendency to confine the exercise of scrutiny
within the area of changes proposed for particular budget items
rather than to extend over every aspect of the whole programme
structure.
• Past levels of expenditure are taken as given and only new additions
or reductions from the past outlay are examined.
• This is what is known as 'incremental budgeting' which should not
be allowed to be in vogue since it cannot ensure proper allocation of
economic resources.
• Such a focus on increases and reductions can well lead to hardening
of the bureaucratic arteries, maintain old programmes that go
unexamined simply because no substantial changes are called for in
the budget’.

• This deficiency of incremental budgeting is done away with by what

is called ‘Zero-base budgeting’.

• Since every outlay in the budget has some attainment objective,

either short-run or long-run, it is necessary to regularly examine
the expenditure components in the light of anticipated results.

• In the case of budgeted expenditure having been associated with long

term objective, the time-bound expected result-component should be
examined occasionally.
• This is what is done by Zero-base budgeting.
• It is not necessary, however, that each and every programme be
reviewed afresh or restructured anew every year under the zero-base
budgeting, though such necessity might arise in case of some of the
programmes.
• But it does require that programmes should not go unscruitnished in
any case for a long period.
• Such budgeting is a new technique of bringing the spending agencies
under a regular scrutiny and accountability.
• Zero-base budget, therefore, acts as a constant reminder of the
necessity of utmost efficiency in public expenditure and in resource
allocation programmes.
iii) Plan and non plan budgets
• Most of the underdeveloped and developing countries pursue planned
economic development through periodic plans.
• The basic aim of economic planning is to achieve repaid development
in different sectors and to raise per capita income, remove poverty,
unemployment and regional disparity so that social justice can be
achieved.
• Ethiopia practices five-year plans. A part of the budgetary receipts
and expenditures is devoted to the administration and implementation
of the plans.
• The part of budgetary receipts which goes to finance the plan
expenditure and the outlays on planned developmental heads
constitute the plan budget, while the remaining part of the budgetary
resources and expenditures is referred to as the ‘Normal’ or ‘Non-plan
budget.’
 iv) Balanced and Unbalanced Budget.
• Government budget may be balanced or unbalanced.
• Unbalanced Budget may be either a surplus budget or a deficit
budget.
• When the government revenues are equal to government expenditures,
the budget is balanced and when they are not equal, the budget is
unbalanced. P. E. Taylor explains the nature of budget balance in the
following terms.
(a) A budget is balanced if during the budget period revenue receipts are exactly
equal to cost payments.
(b) If revenue receipts for the budget period are greater than cost payments, the
difference is budget surplus and
(c) if revenue receipts for the budget period are less than cost payments, the
difference is budget deficit.
• In the advanced countries, a balanced budget is pursued at a time
when the economy suffers neither from inflation nor from
unemployment or depression so that the objective of maintaining full
employment with price stability is achieved.
• When the economy suffers from inflation, a surplus budget is operated
while a deficit budget is pursued when the economy suffers from
unemployment.
• The developing and underdeveloped countries suffer normally from
idle resources and, to make their proper use, additional expenditures
are incurred and, hence, they mostly pursue deficit budgets.
5.4 Modern Classification of Budget
• The Economic Commission for Asia and Far East explains
this necessity in the following words.
• The systems of classification provide information on the
working of budgetary process.
• Since such a process has a multitude of functions and
objectives, different types of classification are needed,
either singly or in combination, to serve the purpose of
appropriation, programme management and review,
evaluation of plan implementation, and financial and
economic analysis.
• The various ways in which the public sector transactions
can be classified as

A. by organization,

B. by object,

C. by function,

D. by their economic character,

E. by programme and,

F. by origin of the purchases affected by the government.

Functional Classification.
• A better idea of government expenditure is obtained from functional
classification since it goes by purpose of expenditure rather than by
departments of government.
• As the United Nations says, “It classifies public expenditure by
specific governmental function such as defense, health, education,
promotion of agriculture, etc”.
• Since the resources of government are limited and since the functions
of government are many, the latter are essentially competing
objectives.
• Therefore, it is important to determine the extent of budgetary
resources that can be earmarked for each of these purposes of public
expenditure.
• This is what the functional classification does.
Economic Classification
• Economic classification seeks to categorize the government
receipts and expenditures into different classes of
economic significance so that the pattern of resource
allocation and its impact on the rest of the economy can be
readily grasped.
• This classification shows how expenditure for a particular
purpose, say, health, is divided between such classes of
economic significance as current expenditure on goods and
services, capital formation, current transfers, capital
transfers and loans.
Table 5.2 Current and Capital Budget

1. Current Expenditure 1. Capital Expenditure

a. Consumption expenditure a. Gross capital formation
b. transfer payment b. Capital transfers
c. Total current expenditure c. Investment in shares
(a + b) d. Loans and advances
a. Consumption Expenditure e. Repayment of public debt
i. Salaries and wages Total capital expenditure
ii. Goods and services = (a + b + c + d + e)
i. Less outside sales a. Gross capital formation
ii. Net consumption expenditure i. Buildings and other
= (i) + (ii) – (iii) construction
a. Transfer payment ii. Machinery and equipments
i. Interest payment iii. net increase in stock
ii. Grants to local bodies Total G.C.F = (i) + (ii) + (iii)
iii. Subsidies b. Capital transfers
iv. Income account of household i. Grants for capital formation to
Total transfer payment = total bodies
(i + ii + iii + iv) ii. Other capital transfers
Total cap. Transfers = (i) + (ii)
c. Loans and advances
i. Capital formation
ii. Current consumption
Total = (i) + (ii)
Programme Budgeting Classification.
• Under this classification, the budget would frame a programme
structure to attain a particular objective and specify spending to attain
it.
• We may think of all those expenditures allocated to the set of
programmes under a particular objective as belonging to a total
spending agency which is responsible for attainment of the objective.
• If, for example, the objective is poverty removal, these expenditures
would constitute the poverty removal programme.
• It is important to note that since these expenditure agencies are inter-
related, some programmes expenditure would draw support from a
number of agencies.
• To explain the anatomy of programme budgeting, let us take the
following example.
Table 4.3 General Objective: Poverty Removal
1. Current Expenditure 1. Capital Expenditure
Specific objective No.1 Increase of earning capacity
programs a. Elementary and secondary education
program
b. Enrollment incentive program
c. Teachers training program
d. Adult literacy program
e. Vocational education program
f. Labour mobility program
g. Skill formation program
h. Job placement program
Specific objective No. 2 Income maintenance
Programs a. Employment insurance program
b. Social security programs like retirement and
disablement benefits
c. Consumption subsidy program
d. Public distribution program
e. Price support program etc.
Specific objective No. 3 Community Improvement program
Programs a. Low income housing program
b. Area development program
c. flood control program
d. consumers’ co-operative program
e. market improvement program
Specific objective No. 4 Agriculture Improvement Program
Programs a. Input supply program
b. Irrigation improvement program
c. Flood control program
d. Land reforms program
e. Agriculture wage restructuring program, etc
• In this way, there may be as many specific objectives as would be
helpful in securing the general objective of purpose
• . A more detailed programme budgeting will break down each of these
programmes into what are known as programme elements.
• For example, 'Enrolment Incentive Programme' may be broken down
into such programme elements as (a) supply of school uniform,
(b) free tuition and free supply of books, (c) scholarship scheme and
(d) mid-day meal scheme.
• Such a programme element is considered as the smallest unit of
analysis.
• A fully developed system of programme budgeting requires
expenditure to be allocated against each of these programme elements.
Performance Budgeting Classification.
• The scientific treatment to budget making is well
demonstrated in the programme and performance budgeting.
• The approach is essentially managerial in outlook.
• Burkhead defines performance budget as one which
presents the purposes and objectives for which funds are
requested, the costs for programmes proposed for achieving
these objectives and quantitative data measuring the
accomplishments and work performance under each
programme.
• The difficulty of functional budget to detect whether the
anticipated benefits from expenditure is really materialized
is overcome by the performance budget.
• Its main purpose is to measure the benefits and to relate
them to costs incurred.
• The targets to be achieved during the budget period are set
as objectives.
• Thus, a determination of attaining a specific amount of
benefit from a particular outlay inevitably takes into
consideration some sort of cost-benefit analysis on the basis
of either past performance or comparative study of the
relevant market situation.
5.5 Budget as an Instrument of Economic Policy
• Government budget is an important instrument of economic
policy in both developed and developing countries.
• In the DCs, the economy operates at full employment level
and, hence, there does not exist unemployed resources.
• But the economy is subjected to trade cycle and, therefore,
occasionally faces the problems of depression or
unemployment and inflation or pressure of excess
purchasing power.
• In the LDCs, the economy operates at less than full
employment level and, hence, the main problem is how to
attain economic growth. In these poor countries, growth
process is faced with a number of problems. They are
allocational, distributional and stabilisational.
• The following are the important ways in which the
government budget can influence the economy of a country.
(1) Revenue Raising Device.
• The government requires enough revenue to discharge its
fiscal responsibility.
• Modern countries have increasingly become welfare states
with larger and larger state activities coming under the fold
of public sector.
• Hence, resources have to be found in sufficient quantity.
Budget secures this purpose through a financial plan.
• The receipts side of the budget clearly mentions the sources
and the extent of funds for the purpose of financing state
activities.
(2) Building of Economic Overheads.
• The main reason of underdevelopment, of the poor countries
is absence of proper economic infrastructure.
• Without proper transport and communication system, large
scale generation of electric power, establishment of basic
and key industries and proper training facilities for workers
and entrepreneurs, industrial development is not possible.
• Similarly, agricultural production and productivity cannot
improve in the absence of proper irrigation facilities, flood
control measures, technological improvement with research
and development activities, etc.
• These facilities must be provided by the government. The
cost of supplying these services is heavy and cannot be
raised directly from the beneficiaries.
3) Diversion of Resources to More Useful Production.
• Free market mechanism leads to production of those goods
which give maximum profit to private enterprises. Hence
private investment is generally concentrated on the
production of luxury commodities.
• It is, therefore, necessary to divert resources to the
production of more useful goods and services, particularly
of the kind of mass consumption ones. This can be done by
government interference through the budget.
• Imposition of heavy tax on harmful and less essential goods
and tax exemption or tax concessions granted to more
essential goods and services can divert resources to the
production of right kind of goods and services.
• Grant of facilities through budgetary expenditure can also
do the same job.
4) Proper Allocation of Resources.
• Most efficient allocation of resources is given by the
equality between marginal cost and price which is possible
only under perfect market conditions.
• Underdeveloped countries seriously suffer from
malallocation of resources.
• The general market conditions in private sectors are set by
existence of monopoly, monopolistic competition and
oligopoly.
• To correct this misallocation, the government has to
interfere either in the form of production subsidy or supply
of goods and services by public authorities so that the gap
between average revenue (i.e. price) and the marginal cost
is reduced as far as possible.
(5) Balanced Development.
• Underdeveloped countries suffer from regional
imbalance in economic development.
• Left to the private sector which is motivated by
profit maximization, the industries will be located in
the urban and already-developed areas.
• The government can correct this geographical
imbalance by setting up public sector industries in
backward areas.
(6) Income and Employment.
• Since underdeveloped countries are low income
economics, people live in poverty and, hence, saving and
investment is very low.
• Income of the people can be increased only through
increased productivity and production.
• Budgetary provisions can go a long way to achieve this.
• When agricultural technology is improved through
budgetary programmes, the income of the people engaged
in agriculture rises.
• People get gainful employment in the sector.
• Improvement in small scale industries in the rural areas and
setting up of public sector industries in the backward
regions will increase employment opportunities in these
industries.
(7) Saving and Investment.
• In underdeveloped countries, the level of saving and
investment is very low. Moreover, without increased saving
and investment, economic growth cannot be achieved.
• Due to low level of income, marginal propensity to consume
is very high and, hence, the mass people cannot save. Public
saving is, therefore, necessary. Taxation of various types
serves this purpose.
• The saving and investment of private individuals are also
influenced by the savings-investment related tax
concessions and other budgetary subsidy programmes.
(8) Poverty Removal
• Poverty removal programme is a part and parcel of the
budget in underdeveloped countries. All expenditure
measures are designed in such a way that they directly or
indirectly influence reduction of poverty in the economy.
• when budgetary resources are spent on account of
education, whether general or technical and vocational or
on health measures, land reforms, flood control and
irrigation, etc, an important objective is to remove poverty
of people.
(9) Full Employment and Price Stability.
• An important function of the budget is to secure the
objective of full employment and price level stability.
• We have seen how this should be done in the case of
depression and inflation.
• When the economy, on the other hand, suffers from
neither inflation nor deflation, the budget is to maintain full
employment and prevailing prices through judicious
programmes of public expenditure and taxation.
• In this case, a balanced budget is helpful in developed
countries. In the underdeveloped economies where
resources are not fully employed public expenditure
programmes and tax incentive measures are put into
operation to secure full employment.
(10) A Check to Misuse of Public Funds.
• Since budget is a financial plan relating to public revenues
and public expenditures for the budgeted period, it
imposes definite restraints on the tax collectors n spender.
• The legislature and the people know from the study of
budget how the revenues will be raised and how will they
be spent.
• Revenue mobilization and public expenditure activities will
be put to scrutiny of the legislature and also of the
members of public.
• In case of inefficiency or misuse in the task of budgetary
performance, the executive agencies will be accountable.
This will definitely put a check on the improper use and
mishandling of public funds.