CHAPTER FOUR

4. Public Expenditure
Chapter Objectives
This is a chapter which deals with the expenditure of the government. We have noted on several
occasions that public expenditure side of the governmental activity received scant attention from
economic theorists until 1930's when depression spread throughout the world. The world
underwent a series of socio-economic and political changes. With the emergence of welfare ideals
of state craft, public expenditure started rising tremendously. There arose the necessity of a sound
theoretical guide line for public expenditure. With increasing state activities caused by depression,
post war economic reconstruction and public welfare programmes of government, the study of
public expenditure received increasing attention. Today, the study of public finance is not complete
without a proper analysis of public expenditure. Accordingly, in this chapter we deal with issues
like meaning of public expenditure, causes for the increments in public expenditure; canons,
theories and accountability in public expenditure, effects of public expenditure, and contents of
development expenditure will be discussed.
Thus, after studding this chapter students will be able to:
 Define public expenditure
 Realize why public expenditure increase from time to time
 State the different theories of public expenditure and make a comparison among the
different theories by considering their strong and weak sides
 Explain the effect of public expenditure both on production and employment
 Recognize what government expenditure could incorporate so as to achieve its objectives
of economic development.
Public expenditure refers to the expenses which the government incurs for its own maintenance as
also for the society and the economy as a whole. These days, some governments are incurring
expenditure to help other countries and that would also from a part of public expenditure. With
expanding state activities, it is becoming increasingly difficult to judge what portion of public
expenditure can be ascribed to the maintenance of the government itself, and what portion to the
benefit of the society and the economy.

1|Page
Historically, public expenditure has recorded a continuous uptrend over time in almost every
country. However, traditional thinking and philosophy did not favor the growth of public
expenditure. Instead, it considered market mechanism as a better guide in working of the economy
and allocation of its resources. It was argued that each economic unit was the judge of its own
economic interests and the government was certainly not able to decide on behalf of others.
Furthermore, while a private economic unit was guided by its own economic interests, the public
sector would have no such motivation. Accordingly, efficiency would be at low there. Had this
philosophy been practiced in its entirety, public expenditure would not have grown as rapidly as it
did. In reality, however, the problems of labor exploitation, economic and social injustice and such
like things assumed serious proportions and would not be ignored. The result was that along with
the advocacy of laissez faire, various socialist and welfare ideas also gained currency. And, of
course, the governments found that they could no longer remain silent spectators of the miseries
of the people.
4.1 Causes of Growth in Public Expenditure
Some of the basic causes of ever-increasing public expenditure have been mentioned in the theories
associated with the issue. However, under the changing situation of the modern world, many more
factors are at work behind the continuous growth of public expenditure. The most important causes
are the following.
i. Population growth. The growth in the numbers particularly in developing countries has
been a major cause of the continuous rise in public expenditure. Along with growth in the
numbers, the responsibility of government relating to public services has been multiplied.
To check the growth of population, again, the government has to incur a huge expenditure.
ii. Increasing urbanization. As the rural areas cannot subsist the growing population, there
is a continuous rush to the urban areas. The size of cities is becoming larger and larger,
while newer urban habitations are springing up. The maintenance of complexity of life
has, therefore, become costlier and the government has to squarely face the problem.
iii. Provision of economic overheads. Without the creation and maintenance of economic
overhead facilities, no country can develop. These facilities like provision of a good
system of transport and communication, generation of electric power, etc. require heavy
investment of capital which does not flow from private sector sources. Hence, government
has to assume these responsibilities if the basic requirements of development are to be

2|Page
 satisfied at all. Thus, public expenditure on account of economic infrastructure is of huge
size in developing countries.
iv. Maintenance of law and order. Along with the growth of population, urbanization and
complexities of modern economic and sociopolitical life, law and order problems have also
multiplied. The government responsibilities of internal protection of people from breach
of peace by antisocial elements have gradually become multi-sided requiring government
expenditure of more and more funds.
v. Welfare activities. Previously, public expenditure was limited by only a few functions of
government, viz, the defense, maintenance of law and order and administration. But,
presently, the countries have emerged as modern welfare states where the greatest good of
the greatest number is the main objective of statehood. The government now has to assume
such responsibilities as family and child welfare, social security like old age pension,
unemployment benefit, sickness benefit, etc. housing for the poor, welfare of handicapped
and backward classes, rehabilitation of displaced persons, subsidy on food and production
inputs, etc. Public expenditure on welfare programmes has, therefore, become tremendous
with the passage of time.
vi. Provision of public goods and utility services. Public goods are those that are consumed
equally by all. They cannot be sold in the private market. Defense and police services,
justice, roads, irrigation and flood control projects, public parks, etc. are all examples of
public goods. They involve huge investment and have to be provided by the government.
Moreover, there has been a growing trend of public utility services like railways and other
transport services, postal, telegraph and telephone services, electricity services, etc. coming
under the government sector. They all involve heavy expenditure on installation and
maintenance.
vii. Servicing of public debt. A substantial part of the huge expenditure program of
government is met from public borrowings. This is because resources cannot be mobilized
from taxation beyond a limit. Hence, modern states incur considerable internal and
external public debt. The repayment of debt and obligation to pay service charges become
huge.

3|Page
 viii. International obligation. Finally, the modern states have to maintain many international
socio-political and economic links. They have to maintain diplomatic relations, economic
links with international institutions like I.B.R.D. ( the International Bank for
Reconstruction and Development), I.M.F. ( International Monetary Fund) etc, Socio-
cultural and academic exchange relations, linkage with development programs of the type
of economic co-operation, gifts and donations, regional economic integration and
membership of other international organization like UNO (United Nations Organization),
etc – all these involve a considerable amount of public expenditure.

1.2 Public expenditure: Canons, Theories and Accountability

In the earlier part we vividly discussed public expenditure in relation to the reasons for its growth.
This part is devoted to canons and theories of public expenditure on the one hand and its public
accountability and control on the other. In the last part of the discussion, a section is devoted to
accountability of public expenditure.
4.2.1 Canons of public expenditure
As in the case of taxation, there are a number of canons for public expenditure also. Some of these
canons may be regarded as principles, while others are no more than general guidelines for the
public authorities to help them in their task of planning and execution of public expenditure
properly. Thus, Findlay Shirras suggests that public expenditure should be beneficial to society
while incurred economically and should not be wasteful or made without previous sanction. Other
economists have added a few more guidelines. Taking all of them into consideration, the following
will be the canons of public expenditure.
i. Canon of Benefit. Public expenditure should be so planned and implemented as to bring about
the greatest possible benefit to society. This canon is simply a reminder to the public
authorities that whatever they spend they should do it according to the principle of maximum
social advantage. What it means is that all such expenditures which do not bring benefit to
society should be avoided. Thus, all non-essential expenditures should be cut to the minimum.
Benefit from public expenditure may be identified with achievement of proper allocation of
economic resources, proper distribution of income and wealth in society and stability of price
level and growth of economy. This canon also points to the need of undertaking a cost-benefit

4|Page
 analysis of the competing schemes of public expenditure before the final selection of
investment project is made.
ii. Canon of economy. Public expenditure should be incurred carefully so that there is no
wastage of funds. Since resources are limited in the society, they have to be most properly
utilized. Economical use means most proper utilization. Hence the canon remains a constant
reminder that resources must not be misused or wasted. Most important reasons of wasteful
expenditure are faulty planning, faulty execution, corrupt practice and delay due to time lag
between plan and execution and, hence, escalation of prices. These types of wastage have to
be avoided at any cost. It must be noted here that benefit to society cannot come without proper
pursuit of the canon of economy.
iii. Canon of surplus. This canon requires that expenditure of public authorities should be kept
within the limits of current revenues. If possible, the expenditure should be less than the
earnings of government so that the surplus so generated can be used when there is unavoidable
deficit. Surplus can be generated either by controlling expenditure or by increasing current
revenues. Of late, however, there has been much change in the thinking around budget policy.
The occurrence of depression and the need for achieving price stability and economic growth
often requires deficit financing, i.e. excess of expenditure over current revenues. Hence, a
choice of surplus or deficit budget is decided by the merit of the case. This canon is, however,
an important reminder of the fact that the government should not overspend and run into debts
and that a deficit spending should be avoided as far as possible.
iv. Canon of sanction. This canon requires that the public authorities should not be allowed to
spend funds without having a previous sanction from appropriate authority for the purpose. It
also requires that funds sanctioned for a particular expenditure should not be diverted to a
different purpose and spent thereon. In a democracy, such sanctioning authority is vested on
the legislature. Since there are different agencies in the governmental set up for executing
public expenditure programs, detailed authorizations are worked out for different spending
agencies so that misuse and wastage of expenditure can be avoided. In order to deal with
emergency purposes of expenditure, some discretionary sanctioning power is also vested on
some important officials.
v. Canon of elasticity. Canon of elasticity requires that the rules of public expenditure should
not be too rigid to achieve the real purpose and that it should be allowed to vary according to

5|Page
 the needs and circumstances. For example, if the economy suffers from unemployment and
deficiency of demand, there should not be a rigidity that the budget should be balanced. Under
such situation, the government should go for a deficit budget and inject additional purchasing
power into the economy so that effective demand is increased and factors of production are
employed on larger scale. Or in case of emergent situations like flood relief, sanctioning
authority should be vested with the lower rank spending unit since there is no time to secure
sanction from higher authorities. Flexibility of expenditure should be provided under such
circumstances.
vi. Canon of certainty. This canon requires that public authorities should clearly know the
purpose and extent of public expenditure. The spending unit should be certain as to the amount
and objective of public expenditure. This requires a proper expenditure plan well thought out
beforehand. The canon of certainty is followed through the preparation of budget. The budget
details the amount and purpose of expenditure for the whole financial year. It is through the
budget that the spending authorities have proper knowledge of the use of public funds. In the
absence of such a certainty, fiscal discipline cannot be maintained and there will be
unnecessary wastage and overspending.
4.2.2 Theories of Public Expenditure
Economists have offered a number of theories on public expenditure. The following theories of
public expenditure need special mention.
1. Classical theory of Minimum expenditure.
2. Principle of Maximum Social Advantage.
3. Principle of Maximum Aggregate Benefit.
4. Bowen's Benefit Theory of Public Expenditure.
5. Lindahl's Benefit Model of Voluntary Exchange.
6. Samuelson's Benefit Theory of Public Expenditure.
7. Musgrave's Optimum Budget Theory of Public Expenditure.

[Link] Classical Theory of Minimum Expenditure

Classical economists did not favor large public expenditure. According to them, that government
is best which governs the least. The 'laissez-faire' philosophy of Adam Smith implies that
individual is the best judge of himself and that he will be the best productive agent if he is left free

6|Page
to take his own decisions. Thus, classical economists wanted that the state activities should be
confined to the bare minimum, because interference with the free economy by the government
would hinder economic progress. Hence, evolving the proper theory of public expenditure was not
the concern of economists. They advocated the principle of sound finance, according to which
budget should always be balanced, i.e. public expenditure should not rise above or fall below
revenue earnings. Thus, according to classical theory, public expenditure must be limited to the
bare minimum and must not exceed public revenues.
The classical theory of minimum expenditure is based on the assumption of full employment on
the one hand and laissez-faire doctrine on the other. Since the economy operates at full
employment level, the problem of economy in the classical system is not attainment of growth.
The economy functions with maximum efficiency. Moreover, with the philosophy of ‘laissez-
faire’ followed, most of the economic activities are performed by the private sector. Under such a
situation, the size of public expenditure is always small and the budget should always be balanced.
If public expenditure becomes more and is financed by public borrowing, there will be withdrawal
of funds from private sector where they are more productively employed. Such diversion of
resources will cause a decline in overall economic efficiency.

[Link] Principle of Maximum Social Advantage

Dalton states the principle of Maximum Social Advantage in the following words: “Public
expenditure in every direction must be carried so far that the advantage to the community of a
further small increase in any direction is just balanced by the advantage of a corresponding small
increase in taxation and receipts from any other source of public income.
Public expenditure is made from the sources mobilized through taxation or borrowing. Thus, there
is a continuous transfer of resources from one section of people to another. The funds paid by tax
payers come to the public treasury. These funds go back to the people through public expenditure
programs. The principle of maximum social advantage lays down that public expenditure should
be so planned and, hence, revenue resources so raised so as to bring about benefit larger than
sacrifice and that the surplus of aggregate satisfaction in the society is maximum.
To judge whether the principle of maximum social advantage is secured or not, the following
points have to be considered. The character and composition of public expenditure is the most
important consideration. Large investment of expenditure means large sacrifice of tax payers. Even

7|Page
then if it is a capital investment, the ultimate benefit may be much larger than the communities’
sacrifice. On the contrary, unremunerative public expenditure, even when amount is small, will
not achieve the principle. Secondly, the method of taxing to raise resources for expenditure has to
be judicious. The same amount may be raised from a number of alternative taxes. That method
should be employed which will result in least sacrifice. Thirdly, tax-expenditure programme
should be so structured as to result in increased productive capacity of community and, hence,
enhanced national income.
It is, therefore, important to see that public funds are not spent for the benefit of a particular group
only. In order that public expenditure contributes welfare to the whole community, they should be
made on protection of the country from foreign attack and result in increased production and
productivity, reduction of inter-personal and inter-regional inequality, maintenance of economic
stability and provision of future development.
The principle of maximum social advantage is derived from the principle of equi-marginal returns
as applied to an individual. Thus, if it is found that marginal utility from public expenditure on
medical and public health measures is greater than the marginal utility derived from the same
amount spent on provision of public parks, then the government should transfer the public funds
from the latter to the former account. This will maximize social advantage. As shown in figures
4.1 and 4.2, the limited amount of public expenditure totals OA and the amount O1B spent
respectively on public parks and medical and public health. Expenditure is measured along
horizontal axis and marginal utility along vertical axis. As clear from the figures, the allocation of
expenditure at OA results in lower marginal utility than at O1B. Hence, transfer of expenditure of
the amount AK (=BL) from public parks to the provision of medical and public health will raise
aggregate utility because the increase of utility area BLMD is larger than reduction of utility area
KACN. This is how equality in marginal utility from public expenditure in all directions will
maximize social advantage.

8|Page
 Figure 4.1 Public expenditure on Figure 4.2 Public
public parks expenditure on medical and
public health

The main defect of the theory is that it is not possible to measure precisely the difference in benefits
from different directions of public expenditure. However, a rough guidance is obtained and this is
what is important. Secondly, the requirement of the principle that expenditure should not be
specially made for a particular section of society is not followed in many underdeveloped countries
where special attention is paid to the benefits of backward sections of society in preference to other
communities.
[Link] Principle of Maximum Aggregate Benefit

Pigou's theory is also not different from that of Dalton. Like Dalton, Pigou also argues that
expenditure should be made in such a way that it leads to maximum welfare of the maximum
number. In his words, “expenditure should be pushed in all directions up to the point, at which
satisfactions obtained from the last shilling expended is equal to the satisfaction lost in respect
of the last shilling called upon government service.” Thus, Pigou brings in both taxation and
expenditure sides of the budget determination. His theory determines the size of the budget.
The principle of maximum aggregate benefit is the other name of "maximum welfare principle
of budget determination" discussed generally under taxation topics. Pigou's theory requires the
application of two rules, viz., (a) the principle of equi-marginal returns whereby individuals
maximize satisfaction by spending their income on different goods in such a way that marginal

9|Page
utility from each type of expenditure is equal and (b) the principle of quality between marginal
social sacrifice and marginal social benefit. This is illustrated in figure 4.3 where the size of the
budget i.e. the amount of public expenditure or, for that matter, taxation is measured horizontally
and marginal utility, i.e. benefit from public expenditure or marginal disutility, i.e. sacrifice from
taxation is measured vertically. Marginal social benefit and marginal social sacrifice are shown
by the curves EEl and TTl respectively. The net benefit is shown by NN1 curve. Thus, when the
amount of public expenditure or taxation increases from OC to OL, marginal social benefit from
expenditure is reduced from AC to KL, while marginal social sacrifice of taxation increases from
CD to LM. At OL amount of expenditure, MSB (Marginal Social Benefit) and MSC (Marginal
Social Cost) are equal because KL = LM. It is here that optimum size of budget is determined
and maximum aggregate benefit is secured to the society.
The theory, though excellent in outlook, is not practically applicable. There is neither a scientific
measure for MSB and MSC nor a convincing method of constructing utility graphs without
assuming the impracticable inter-personal utility comparison. However, the theory has enough
materials to guide the public authority in the direction of achieving greatest good of the greatest
number.

Figure: 4.3 maximum Welfare Budget

10 | P a g e
 [Link] Bowen's Model of Public Expenditure

Since social goods, by definition, are those goods and services which are consumed equally by all,
the cost of supplying them have to be contributed by all beneficiaries. However, every user cannot
be asked to contribute equal amount in meeting the cost of social goods because different
individuals will derive different amounts of satisfaction. Since social goods benefit everyone, the
amounts of benefit derived by different individuals are like joint products. Hence, it is the joint
contribution of all individuals that has to meet the cost of supplying social goods.
Suppose a public park is provided in a locality of 100 individuals. The benefit of public Park is
consumed equally by every one. Hence, the cost of supplying the benefit must be raised from the
aggregate contribution of 100 individuals. It must, however, be noted that each individual will pay
an amount equal to the marginal valuation he attaches to the social good, i.e. the public park
services. This follows from rules of economic efficiency. Since the capacity to enjoy benefit of
the public park, as in case of anything else, is different for different persons, they will attach
different marginal valuation to the benefit and will contribute different amounts for the
consumption of the same public good. How much amount of social goods is to be supplied by the
public authority will be determined at that level where marginal cost of supplying the social goods
becomes equal to the sum of marginal utilities received by the beneficiaries. Assuming that there
are only two individuals in society, viz., A and B and only one type of public goods, called X, the
following condition will hold for the determination of public expenditure or, what it means the
same thing, the amount of social goods to be supplied by the government.
MUA + MUB= MCx
Or PxA + PxB = MCx, Hence, TCx = QPxA + QPxB,
where MU stands for marginal utility derived from social goods, MC stands for marginal cost of
supplying social goods, A and B are consumers, X stands for the social good supplied, P stands
for price to be paid by the consumer, Q indicates quantity of social goods and TC stands for total
cost of supplying the quantity.
Bowen's model of determining public expenditure may be explained by the below figure where
units of social goods are measured along horizontal axis and the combined unit price including the
contributions of both A and B is measured in the vertical axis.

11 | P a g e
The demand schedules for social goods of A and B are shown by the lines aa and bb respectively.
The line tt shows the aggregate demand schedule of both A and B. Let SS be the supply schedule
of social goods which are assumed to be produced under conditions of increasing cost. Since the
same amount of social good will be consumed by both A and B, the aggregate demand schedule,
tt is made up of vertical addition of aa and bb.

Figure 4.4: Bowen Model

The equilibrium output will be determined at OQ because it is at this level of production that
the aggregate demand schedule and aggregate supply schedule intersect at point P, where the
equilibrium price will be PQ. This is the combined unit price which will be contributed by
both A and B. Of the unit price PQ, A contributes QR and B contributes QN, their respective
demand prices. If the output is less than this, say, OC, the demand price or the combined
contribution will be much larger (CG) than the supply price (CE). Since the combined offer
price exceeds the unit cost, this will lead to increase in supply of social goods. If, on the other
hand, supply is more than OQ, say, OD, the unit cost (DK) exceeds the combined offer price
(DL). This will lead to reduction in supply of social goods. In this way, equilibrium output is
established at OQ.
At OQ level of output, the marginal cost of supplying social goods is PQ which is equal to the
sum of QN and QR, the marginal utility to B and A respectively. The total cost of supplying OQ
amount of social good equals OQPU which is covered by A's contribution OQRV plus B's
contribution OQNW since OQRV + OQNW = OQPU.

12 | P a g e
 [Link] Lindahl’s Model of Voluntary Exchange

The voluntary exchange model of public expenditure theory is concerned with what Erik Lindahl
calls 'purely fiscal' problem of providing for the satisfaction of public wants. It does not concern
itself with the problem of just distribution of income. This is taken as given.
The determination of public expenditure and taxation is to be made on the basis of individual
preferences. For this purpose, says Lindahl, three sets of decision are necessary, i.e. the
determination of total amount of public expenditure and taxes, allocation of total public
expenditure among various social wants, and allocation of total taxes among various individuals.
All these have to be done simultaneously.
To understand Lindahl's model, let us assume a community of two individuals 'A' and 'B' and one
type of social good. Since each of 'A' and 'B' consumes the total amount of social goods supplied
but receives different amounts of benefit from it, their benefit shares may be considered joint
products. Hence, the cost of supplying social goods is a joint cost which has to be allocated to the
supply price of joint products. Thus, if 'A', the purchaser of his benefit share, is willing to
contribute x percent of the total joint cost, B will be called upon to contribute the rest, i.e. (1-x)
percent for purchasing his own benefit share. Thus, one will have to pay more if the other
contributes less so that the joint contribution of both A and B covers total cost of supplying the
social good. It follows that A's offer to contribute certain percentage of total cost may be looked
upon as B's supply schedule of social goods; and B's offer may be similarly interpreted from the
view point of A.
Lindahl's model of simultaneous determination of optimum public expenditure, i.e. optimum
amount of social goods and of the cost allocation among benefit shares, i.e. tax share of different
individuals may be diagrammatically explained in the following figure.
We measure quantity of social goods along horizontal axis, percentage of total cost contributed by
'A' along left vertical axis and percentage of total cost contributed by 'B' along right vertical axis.
The total unit cost of supplying social goods is OV. The curve aa is the demand schedule of
individual 'A'. The demand schedule of individual 'B' is given by the curve bb, calculated by
inverted scale on the right axis. The demand schedule of 'A' may be viewed as supply schedule of
'B' and the vice versa. Thus, `A' will be willing to contribute 100 percent of cost for output OD,
which will be available free to 'B'. At the output level OG, individual 'A' is willing to contribute
75 percent of the cost (GS) and, hence, the output is available to 'B' at 25 percent of cost (RS) since

13 | P a g e
the vertical distance between upper horizontal axis and B's supply schedule at this level of output
is RS percent. However, B will be willing to contribute 50 per cent, i.e. RT because T is the point
on his demand schedule. Thus the total contribution of both A and B will exceed the cost of
supplying the social good by ST percent (25 percent). This is an indication of their preference for
larger scale of social goods. The optimum level of social goods is given by' OE at which' A'
contributes EQ percent and B contributes PQ percent of cost and, hence, the combined contribution
is exactly equal to the total cost of supplying this level of output.

Figure 4.5 Optimum public expenditure and tax shares

Not more than OE will be produced because the combined contribution will fall short of the cost
of production for any larger amount. Thus, at OK scale of output, 'A' will be willing to contribute
KL percent and the supply price of the social good to 'B' is NL. But, because his demand schedule
point lies at M, 'B' will offer to contribute only NM percent. Thus, as much as ML percent of the
cost of supplying this output will remain uncovered. If, now, 'A' contributes KC Per cent and 'B'
contributes NC per cent so that OK amount can be supplied, both will be paying larger than what
they are willing to pay. Hence both 'A' and 'B' will vote for smaller amount of social goods. In the
same way it can be shown that both the individuals will vote for larger amount of social goods at
the -level of supply lesser that the optimum scale of OE output.
We assumed in the beginning a single type of social goods and two tax payers only in order to
simplify the solution. If we now relax these assumptions and allow for a number of social goods
and many tax payers, the theoretical validity of the model will not be affected though some
complexity will arise.

14 | P a g e
 [Link] Samuelson's Benefit theory of Public Expenditure
The most recent benefit theory of Public expenditure comes from Samuelson as a critique of the
voluntary exchange model of Erik Lindahl. The voluntary exchange principle has a partial
equilibrium approach in which satisfaction of social wants is considered independently of private
wants. Samuelson considers it an inadequate explanation and thinks that the problem must be
restated in terms of general equilibrium. This is what he has done in his theory of public
expenditure. In his general equilibrium approach to optimal allocation of public and private goods,
Samuelson takes into account both the allocation and distribution aspects to build up a unified
system.
Application of market principle to the pricing of social goods to determine optimum allocation of
resources becomes the starting point of Samuelson's theory. In the case of a private good, marginal
utility and marginal cost are equal for all consumers. Since utility schedules of individuals are
different, such equality and, hence, efficient level of output will be attained with different
consumers consuming different amounts of output at the same price. It follows that the aggregate
demand schedule will be the horizontal summation of individual demand schedules. However, in
the case of public goods which are, by definition, consumed equally by all, different individuals
will pay different prices for the same quantity of output. Here the sum of marginal utilities to
consumers will be equal to the marginal cost. It follows that the individual demand schedules will
be vertically added in this case. Thus under such circumstances, “even if all preferences are
revealed, there is no single best solution analogous to the pareto optimum in the satisfaction of
purely private wants. Instead, we are confronted with large number of solutions, all of which are
optimal in the Pareto sense.”
4.2.3 Control and Accountability of Public Expenditure
The necessity to control public expenditure in order to check misuse of public funds and ensure
their efficient utilization is only obvious. Control does not necessarily mean reduction. “It means
that expenditures are justified in terms of the whole welfare of society and in terms of the financial
means at the disposal of government. Control implies that expenditures are economic by which we
mean that resources not unlimited in quantity are devoted to their most productive uses.”
Control of public expenditure is sought to be ensured multi-dimensionally at a number of stages.
The most important means of control are (a) budgetary control (b) legislative control, (c) executive
control, (d) audit control, and (e) parliamentary control.

15 | P a g e
(a) Budgetary Control. Budget preparation is the most primary stage of expenditure control.
Budget is a well thought-out plan of governmental activities during the coming year and speaks of
much more than a mere statement of income and expenditure of public authorities. It specifies the
functions and objects of public expenditure. How much of the public funds is to be spent for which
particular purpose, and which particular department, what should be attainment of physical targets
against the specific expenditure amount and what should be the allocation of funds for the use of
a particular department are all specified in the budget frame. The budget also presents a comparable
picture of the revenue earnings and expenditure of the outgoing year along with the estimates of
such financial operation for the coming year. The difference between the two, if any, has to be
convincingly explained. Hence, a budgetary exercise of this kind serves as a control of public
expenditure in many ways. In recent years, the practice of breaking up of public expenditure in
terms of major heads, minor heads and sub-heads has provided added means of controlling
expenditure.
(b) Legislative Control. After the budget plan is prepared, it has to be presented in the legislature
for its approval. There occurs debate in the legislature where the members seek clarification and
justification of expenditure programmes. After critical study of the budget plan, expenditures
estimated originally may be curtailed or enhanced or kept unchanged according to the merit of the
case. When the legislature is satisfied, it gives approval to the budget plan. During the legislative
scrutiny of the budget, the details of expenditure, department-wise and ministry-wise are
discussed. Thus, it is a very important stage of expenditure control.
(c) Administrative Control. The rules and regulations ensure that no amount is spent without
proper sanction or diverted to some other purpose for which it is not sanctioned. There is elaborate
body of rules to fix responsibility on specific executive personnel for the funds spent. The rules
ensure that there is no fraud or misuse or misappropriation or any other kind of leakage during the
execution of public expenditure programmes. It is not only that the government official through
whom is the public fund directly spent in the project work is responsible to his head of the
department but also that the latter is responsible to higher authority.
(d) Audit Control. The next stage is scrutiny of accounts and audit control. There is the system of
both internal and external audit. Every department has its accounts section which scrutinizes all
accounts of expenditure and ensures that public funds are spent according to rules of propriety,
economy and efficient utilization.

16 | P a g e
However, audit reports are less than vocal relating to efficiency of public expenditure. This
shortcoming is sought to be removed through economic and functional classification of public
expenditure and practice of performance and program budgeting which have an in-built
mechanism to ensure efficient use of public funds.
(e) Parliamentary Control. The last of these stages of expenditure control is the parliamentary
right to enquire into any particular item of expenditure deal. There are two committees constituted
by the parliament to go into such scrutiny. They are (i) Public Accounts Committee and (ii) the
Estimates Committee. Public accounts committee is entrusted with the responsibility of examining
audit reports and appropriation accounts. They also examine profit and loss accounts of
government undertakings and autonomous bodies. They follow up cases of impropriety,
unauthorized and illegal expenditure, misuse and misappropriation and go into further
investigation if necessary. Estimates committee locks into the financial operation of the executive
and suggests measures to achieve maximum economy of expenditure consistent with maximum
efficiency. The parliamentary committees pinpoint the erring officials, examine them and suggest
follow-up measures for suitable punishment to them.
4.3 Effects of public expenditure on production and distribution
4.3.1 Effects on Production and Employment
The expenditure of the Union Government on development is meant to promote production and
employment in the country. Expenditure on agriculture and allied services, industries and
minerals, water and power development, transport and communication and other expenditures on
community and social development by the Union and State Governments help directly to raise the
level of production and employment in the country. Further, the enormous expansion in
expenditure by the Union and State Governments is to boost demand for goods and services and
thus to boost production. The level of production and the level of employment in any country
depends upon three factors, viz.,
a. Ability of the people to work, save and invest,
b. Willingness to work, save and invest, and
c. Diversion of economic resources as between different uses and localities.
It is possible to influence all these factors through public expenditure either for the better or for
the worse.
Ability to Work, Save and Invest. If public expenditure can increase the efficiency of a person to

17 | P a g e
work, it will promote production and national income. Public expenditure on education, medical
services, cheap housing facilities and recreational facilities will increase the efficiency of persons
to work. At the same time, public expenditure can promote income of the people. Finally, public
expenditure, particularly repayment of public debt, will place additional funds at the disposal of
those who can invest. Thus, it will be seen that public expenditure can promote ability to work,
save and invest and thus promote production and employment.
Willingness to Work, Save and Invest. The effects of public expenditure on the willingness-as
different from ability to work and save and invest on production are not clear enough. Pensions,
interest on loans, provident fund and other government payments provide security and safety to a
person, and therefore, reduce the willingness of persons to work and save; why should a person
work hard and save when he knows well that he will be looked after by the government when he
is not in a position to earn an income?
Diversion of Economic Resources. Public expenditure has far-reaching effects on the utilization
of economic resources as between alternative uses. Public expenditure can bring about a better
allocation of economic resources as between the present and the future. In a free capitalist society
very little provision is made for the future. This is because people prefer the present rather than
the future and, therefore, they do not make adequate provision for the future. The State on the other
hand, is the custodian of the interests of the future generations also and, therefore, has to see that
adequate provision is made for the future. Public expenditure on transport, irrigation and other
projects which yield both immediate return as well as social and economic benefits for generations
to come, are some examples. Secondly, the government spends money in the conservation of
economic resources which are very essential for the future. Thirdly, the government spends money
for encouragement of research and invention, promotes education and training, looks after public
health and sanitation and also takes the responsibility of social security measures. It is necessary
to emphasize that the diversion of economic resources in all these ways will greatly increase
production.
Generally, the effects of public expenditure on production and employment are favorable.
Taxation, taken alone, may check production; but public expenditure, taken alone, should almost
certainly increase it. The development expenditures of the Central and State Governments aim at
raising the level of production and employment in the country. It is possible that production will
be adversely affected if public expenditure is carelessly planned, but it will positively stimulate

18 | P a g e
production if carefully planned.
4.3.2 Effect of public expenditure on distribution of income
These days, every government aims at reducing inequalities of income. Public expenditure (as part
of fiscal policy) can be used by the government to achieve this aim.
While taxes, particularly progressive direct taxes, have the effect of reducing the incomes and
wealth of the higher income groups, public expenditure has the effect of raising the incomes of the
lower income groups. Government's expenditure on education, public health and medicine,
housing, etc., is directed to help the poor and the lower income classes (who make use of
government schools and hospitals). At the same time, social security schemes are run by the
government for the benefit of the working classes so that they may be protected from
unemployment, accidents, sickness and old age. Thus, public expenditure, if carefully planned and
executed, will help in redistribution of income in favor of the poor provided, of course, taxation is
used to reduce the incomes and wealth of the higher income groups.
4.4 Public expenditure and control of inflation
Inflationary pressures may be considerably lessened if government expenditure is reduced. This
may be taken as a simple and direct solution, but for the fact that, in the majority of cases, the most
serious type of inflation has always been due to enormous government expenditure. This type of
situation may be due to war when large sums are spent for military purposes or due to preparations
for war during peace time. However, the government can suitably change and adjust its expenditure
during an inflationary period so that the inflationary pressure may be reduced. For instance, all
those schemes which may be justified during a period of depression and low level of employment
may be omitted during an inflation. At the same time, the government can postpone the
construction of social capital such as post offices, schools, etc., which will increase the size of
income of people but will not contribute to the increase of goods. Secondly, the government can
give subsidies to those industries which are producing inflation-sensitive goods so as to accelerate
their production or to enable producers to sell them at lower prices.
4.5 Content of Development Expenditure
Development expenditure of the government should aim at stimulating and supplementing
private initiative and enterprise. It is possible-and some governments of developing countries
have attempted to do so-to eliminate the private sector altogether and plan for the entire

19 | P a g e
economy as a whole. There is some advantage in that. But many may not like a communist
pattern of economic development which is rapid, of course, but may prove to be nevertheless
ruthless and inhuman. In a democratic setup, with parliamentary institutions, emphasis will
have to be not on the elimination of the private sector but the setting up of a mixed system
in which private enterprise will be given active encouragement and, at the same time, the
government will become an interested and active participant in development activities.
a. Stimulating private initiative. Development expenditure of the government will take the
form of stimulating private initiative and enterprise. Direct stimulation is done by the
Government helping the private sector through loans, subsidies, tax concessions and
exemptions and providing market and other information and research facilities. The
government can set up special banking and financial institutions whose main aim will be to
provide finance for medium and long-term periods at low rates to help the private sector
industries with adequate finance. In many underdeveloped countries, the government will
have to set up a strong commercial banking system with a central bank at the top. These are
direct methods of helping the private sector to expand and develop.
b. Provision of social and economic overheads. Indirect stimulation of the private sector
may be done by the government through the provisions of social and economic overheads -
education and public health will come under the first head, and provision of power,
transportation, communication, etc., will come under the second head. The private sector
industries would reap enormous benefits of economies of production from these facilities
provided by the government. Social and economic overheads are necessary and essential
prerequisites for economic growth. In fact, there are many competent authorities who would
like governments of underdeveloped countries to provide only these facilities and leave the
rest to the private sector.
c. Public enterprises. The government will have to start and run such undertakings which
the private sector may be unwilling to undertake, either because profit margins are low or
almost nothing, or because they require huge capital investment and a long time to yield
returns. These enterprises may not be appealing to the private sector from the commercial
point of view but may be of great significance from the point of view of economic welfare
of the community as well as that of economic progress. In this group will come all the key
and basic industries, development of irrigation resources, electric power, etc. In fact, any

20 | P a g e
industry which is necessary for the country and which will help in the growth of the economy
can be taken up by the government. The idea, however, is not to compete with the private
sector but really to supplement and complement it.

21 | P a g e