Public Finance Materials
Chapter Five
Public Budget
5.1. Meaning of Public Budget
What is a budget?
The word “budget” comes from budget, a Middle English word for the king's bag
containing the money necessary for public expenditure. The budget is the most
potent instrument of the government in carrying out its policies.
The organization draws up a plan indicating how it expects money to flow in and
out. This plan is better known as a budget. You probably do the same at home,
planning how to use your income. You budget, your employer prepares a budget
and, of course, the country as a whole budgets.
Technically speaking, a government budget is a document that sets out how a
government in power in a particular country proposes to collect and spend money.
The proposals contained in a government’s budget reflect its policy priorities and
fiscal targets. In this way, the budget expresses the objectives and aspirations of a
government in power. In a democratic society, these objectives and aspirations
should, in theory at least, reflect those of the majority of the electorate.
Governments really have no money of their own.
No government in the world has infinite public resources at its disposal. At the
same time, there is a boundless array of needs to be met through public
expenditure. The budget thus always incorporates trade-offs between different
spending priorities. It includes value judgments about which services, and whose
interests, are most important. A government budget is therefore not simply a
technical document: it is also an important political instrument.
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“Public budgets are the instruments by which governments raise and allocate the
financial resources of the state. They are also the means by which governments
provide for basic necessities that relate to human rights. Public budgets are more
than a collection of numbers, they are a declaration of a community’s or nations
priorities”.
A budget is a statement of allocation of (scarce) resources to achieve an
organization's objectives for a specific time period. A budget is the financial plan
for how an organization will receive and spend money for a set time period (the
fiscal period).
A budget can be described as: a quantitative plan of action prepared in advance
of a defined period of time.
Let’s look at this definition more closely.
A budget is quantitative.
That means it must be stated in figures; in practice this usually means in sums of
money. A general statement of what you intend to do may be useful, but it’s not a
budget.
A budget is prepared in advance.
A budget must be drawn up before the period to which it refers. Figures produced
during or after the period may be important, but they are not part of a budget.
A budget relates to a particular period.
Budgets are drawn up for a certain specific period (often, though not always, one
year). An open-ended financial plan for the future isn’t a budget.
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A budget is a plan of action.
This is perhaps the most important point of all. A budget can’t be a definite
statement of fact, because it relates to something which hasn’t happened yet. It is
what the organization is planning will happen.
5.2. The Importance of Budget
In general below there is a brief discussion of some purposes that a budget can
serve.
The Budget as a Contract
The mayor and general assembly promise to provide funds to a department for
agreed-upon purposes. In this sense, the budget is a contract between the
policymakers and municipal departments. The budget also may be viewed as a
contract between the citizens and the municipality. That is, the citizens have agreed
to pay taxes so they can receive certain services from the municipality.
The Budget as a Management Tool
The budget serves as a statement of the decisions and responsibilities that translate
into specific programs and activities. As a management tool, a properly designed
budget can help you achieve administrative efficiency, economy, and honesty
through businesslike behavior. The budget increases management responsibility
and accountability.
The Budget as a Motivator
The budget motivates departments by setting forth targets and by serving as a
mechanism for obtaining involvement and commitment. The budget provides a
means for measuring accomplishments against goals and for comparing actual with
planned outcomes. Municipal staff is more likely to be effective and satisfied if
they have a clear sense of program purpose that enables them to better comprehend
where they are going and how they will get there.
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The Budget as a Financial Control Mechanism
The budget can serve as a means to define and assign responsibility for financial
control. A budget provides strong control over departmental expenditures and
reduces the administrative discretion of department heads.
The Budget as a Plan
The budget is the investment plan for your community. It coordinates choices so as
to achieve desired goals. The budget is an instrument for correlating executive and
legislative action. A budget should include a detailed specification of what
objectives are to be achieved by the proposed expenditures. As a planning tool, the
budget can suggest alternative methods of achieving these objectives.
The Budget as a Major Policy Tool
Whether you intend it to be or not the budget is a major policy tool. How you
decide to spend your community’s scarce resources is perhaps the most important
policy decision you will make during a fiscal year. Government resources are
always less than what is needed to accomplish all the community’s goals. You
must make decisions that contribute the most to municipal goals. Thus, budgeting
can be viewed as the process by which you make government policy.
The Budget as a Communication Mechanism
The budget document is the mechanism by which you inform citizens, municipal
officials, policymakers, potential investors, and others about community budgetary
issues, trends, and choices addressed in your budget. Your budget document
should communicate the significant information in the budget to the reader. In
addition, use narratives to describe the relationships among revenues, expenditures,
and programs.
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The Budget as an Operations Guide
Budget requests describe proposed activities, services, or functions that municipal
institutions will carry out. In the budget requests you should identify qualitative
and quantitative measures, or outputs, by which program performance and results
will be evaluated. You should also identify program beneficiaries, such as the
number of citizens served, and specify the number of employees required to carry
out each activity. When you provide these types of information, the budget that is
produced from the requests will serve as an operations guide. The budget of each
institution will not only identify the cost of each activity, but also the outputs to be
provided, the number of citizens who will benefit, and the staffing level required to
carry out the activity.
5.3. Principles of good budgeting
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 trade-offs between different policy options.
Predictability: Spending agencies should have certainty about their allocations in
the medium term to enable them to plan ahead. Stable funding flows support
departmental planning and efficient and effective delivery.
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.
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.
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5.4. Objectives of budget
Budget is an important tool of financial administration and an effective means of
enforcing fiscal policies. The main objectives of a budget are the following.
a) Proper allocation of resources: - to relate expenditure decisions to specified
policy objectives and to existing and future resources.
b) To relate all major decisions to the state of the national economy.
c) Long term economic growth: - to ensure efficiency and effectiveness in the
implementation of government programs.
d) To facilitate legislative control over the various phases of the budgetary
process.
e) Equitable distribution of income and wealth and
f) Securing economic stability and full employment.
It implies that the objective of budget policy is to take corrective measures or to
adopt regulatory policies to remove imperfection or inefficiencies of market
mechanism. Besides, the objective of the budget policy is to make provision of
social goods or the process by which total resources are divided between private
and social goods. It means that the objective of budget policy is to ensure equitable
distribution of income and wealth. This may be termed as distribution function.
Third objective of budget policy is to maintain a high level of employment,
reasonable degree of price stability and an appropriate rate of economic growth.
To implement its economic functions government raises revenues through taxation.
Fees and charges, and spend them on different programs and activities. This
process of rising revenues and spending by government is performed through
budgeting. Budget thus stands for the yearly plans/forecasts of government
revenues and expenditures. The budgeting process starts from the initial stage of
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preparing the annual revenues and expenditures forecast and end at the stages of
approval by the higher government body followed by its implementation.
5.5. Types of Public Budgets
There are two basic types of budgeting in Governmental unit: (a) Revenue
budgeting and (b) Expenditure budgeting. Expenditure budgeting reflects what
activities are going to be done and at what cost in a particular year. On the other
hand, revenue budgeting is the identification of revenue sources and determining
the amount of revenue from each source.
a) Revenue budgeting
Budgeting governmental revenues are considered as Revenue budgeting. Although
governmental revenues and expenditures are not as interdependent as business
revenues and expenses, the availability of revenues is a necessary prerequisite to
the incurring of expenditures. Some states and local governments may operate at a
deficit temporarily, but it is generally conceded that they may not do so for several
consecutive periods. Thus, wise financial management calls for the preparation of
revenues budgets, at least in rough form, prior to the preparation of detailed
operating plans and finalizing appropriations budgets.
Revenues are a term that has a precise meaning in governmental accounting. The
GASB states that the term revenues “means increases in (sources of) fund financial
resources other than from inter fund transfers and debt issue proceeds.” For
purposes of budgeting inflows of financial resources of a fund, it does not seem
particularly valuable to distinguish among revenues, as defined by the GASB; inter
fund transfers, and debt issue proceeds, other than to keep budgeting terminology
consistent with accounting and financial reporting terminology.
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Sources of revenue and other financial inflows available to a given local
government are generally closely controlled by state law; state laws also establish
procedures for the utilization of available sources and may impose ceilings on the
amount of revenue a local government may collect from certain sources. Sources
generally available for financing routine operations include property taxes, sales
taxes, income taxes, license fees, fines, charges for services, grants or allocations
from other governments, and revenue from the use of money or property.
b) Expenditure budgeting
Expenditure can either be a recurrent expenditure or a capital expenditure. The
former refers to expenditures spent for payment of salaries and other office
expenditures that are incurred periodically. Such expenditures do not generate
revenue. Capital expenditures, however, are designed for economic development
like the construction of infrastructure, etc. They are usually one-time and massive
expenditures.
Under expenditure budgeting therefore, there are two kinds of budgets: the
recurrent budget and the capital budget. Expenditure can either be a recurrent
expenditure or a capital expenditure.
The recurrent budget: refers to expenditures spent for payment of salaries and
other office expenditures that are incurred periodically. Such expenditures do not
generate revenue. The recurrent budget is prepared at federal level: spending
public bodies by their Administration and Finance Departments.
The Capital expenditures budget, however, are designed for economic
development like the construction of infrastructure, etc. They are usually one-time
and massive expenditures. Under expenditure budgeting therefore, there are two
kinds of budgets: the recurrent budget and the capital budget. Accounting
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principles for business enterprises and for proprietary funds of governments
require the cost of assets expected to benefit more than one period to be treated as
a balance sheet item rather than as a charge against revenues of the period. Capital
budgeting is the process of planning for future purchases above a certain cost
threshold or extended life span. This budget is typically accompanied by a Capital
Improvement Plan that describes a timeline for acquisition and payment of debt.
5.5. Planning, Programming, Budgeting Systems (PPBS)
PPBS are a budgetary system in which a strong link is established between plans of
the government, programs formulated to accomplish plans, and the resource
allocation pattern. PPBS offers a different approach to policy making involving the
specification of objectives, formulation of programs, a critical and systematic
examination of alternatives, analysis over the long-term, and application of
quantitative techniques. The PPBS involves three levels of management: Policy
management, Resource management and Program management.
While from theoretical point of view the PPBS have gained a superior power
among academicians, it suffers a lot from problems in implementing it. First,
implementation of PPBS raised the question of feasibility of specifying
objectives and the application of the cost-benefit analysis for assessing
alternatives. The goals and objectives with which the budgeter is concerned are
more tangible. However, areas of government’s activities that do not lend
themselves to easy specification are often left unattended in the formulation of
annual plan of action. In addition some objectives of agencies are stated in so an
obscure manner that they can hardly be used as a basis for action therefore creating
administrative inconveniences and becoming no operational. The other major
problem area is that relating outputs to objectives is difficult and that
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consideration of direct or identifiable measures only may not reveal the magnitude
of unintended effects.
5.6. Zero-based Budgeting (ZBB)
Zero-based budgeting was an idea that first became popular in the 1970s. Zero-
base budgeting, also known simply as ZBB, has had a long and sometimes
controversial history in the public sector. Zero-base budgeting first rose to
prominence in government in the 1970s when U.S. President Jimmy Carter
promised to balance the federal budget in his first term and reform the federal
budgeting system using zero-base budgeting, a system he had used while governor
of Georgia. ZBB, as Carter and budget theorists envisioned it, requires expenditure
proposals to compete for funding on an equal basis – starting from zero.
In theory, the organization’s entire budget needs to be justified and approved,
rather than just the incremental change from the prior year. Zero-based budgeting
requires that the existence of a government program or programs be justified in
each fiscal year, as opposed to simply basing budgeting decisions on a previous
year’s funding level. Zero-based budgeting is often encouraged by fiscal watchdog
groups as a way to ensure against unnecessary spending. Zero-based budgeting, or
some modified version of it, has been used in the private- and public- sectors for
decades.
The usual practice is called incremental budgeting, which starts with the previous
year’s budget for each agency or program and makes a decision about what to
increase and what to leave the same. In zero-based budgeting, each agency or
program prepares several “decision packages” with different levels of services and
spending, which are then collected and prioritized by those who prepare the
budget. Because of the enormous amount of documentation required, and the need
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to get a budget prepared for the next fiscal year in a timely manner, zero-based
budgeting has not been used very much in the public sector.
In the most literal sense, ZBB implies constructing a budget without any reference
to what has gone before, based on a fundamental reappraisal of purposes, methods,
and resources. The distractive and essential feature of ZBB is its focus on the total
budget request. Existing activities are examined along with proposed new
activities. ZBB places a premium on offering decision makers a range of choices
among alternative funding levels. It is explicitly not assumed that present activities
must necessarily be continued. Given revenue constraints, an existing activity may
be reduced or eliminated entirely to make way for new activities, or one program
may be cut back to permit another to expand.
There are three basic elements of ZBB:
(1) Identification of "decision units"
(2) analysis of decision units and the formulation of "decision packages,":
and
(3) Ranking
1. The decision unit
The decision units are the lowest-level entities for which budgets are prepared.
Such units must be identified and defined as a necessary first step in implementing
ZBB. One important requirement is that each decision unit must have an
identifiable manager with the necessary authority to establish priorities and prepare
budgets for all activities within the decision unit.
ZBB calls for an analysis, which most truly deserves the name "Zero base" - a
reexamination of the purposes, activities and operations of the decision unit. In
this analytic phase questions such as the following are addressed: what would be
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the consequences if the decision unit were entirely eliminated? How can the
decision unit's purposes be achieved in a more cost effective manner?
2. The decision packages
Following the zero - base review of purposes, activities, and operations, the
decision unit manager then segments the decision unit's activities into a series of
"decision packages".
The decision unit manager formulates, in priority order, a series of decision
packages which together equal the sum total of his budget request for the decision
unit. Each decision package consists of a discrete set of services, activities, or
expenditure items.
The first package contains those activities, or portions of activities, deemed highest
in priority. The second package contains the next most important items, and so on;
the costs and consequences of each package are documented for higher - level
review.
3. Ranking
The third basic element of ZBB is "ranking". This is the process in which a
manager reviews all decision packages (from all decision units reporting to him)
and establishes their relative priority. A "ranking table is prepared, listing all
decision packages in descending order of priority.
The priority-ordered set of all decision packages for the entire organization is then
reviewed in light of the probable level of funding available to the organization.
Packages which can be funded within the available total are included in the
organization's formal budget request; those which fall “below the line" are dropped
from the budget request - unless the organization chooses to seek an increase in the
total funding level.
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Advantages and disadvantages of ZBB
One distinct advantage of this budget strategy is that programs will be evaluated
and assessed. Thus, continuation of existing programs is not guaranteed. In other
words, programs which are no longer needed will be discontinued and the level of
service required to deliver a program can be rationally increased or decreased.
On the other hand, development of a zero-based budget generates massive volume
of paper work because the unit must be specified, approved by legislative, and so
on. Further, the process may not be compatible with policy areas such as defense
and security and other governmental activities and programs that have societal
mandate. Lastly, the process does not necessarily compare service with service
cost. For example, certain community programs have high cost but may provide
services to the least number of people while some other programs may cost as
much (or less in some cases) but provide services for a significantly greater
number of people.
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