CHAPTER FOUR

4. GOVERNMENT BUDGETING
 Meaning: It is a reflection of not only taxation and
public expenditure policy, but also of a plan for future
course of action.
 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,

that is:
 the actual receipts & disbursements of the
previous year,
 the budget & revised estimates of the
current year and 1
 the estimated receipts and expenditures of
the coming fiscal year.
A good budget should be one
a) 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.
b) It should be one that will draw up
programs of action in such a manner
that the proposals can feasibly be
translated into realization.
They should not be over-ambitious and
should be within the means, financial 2

and otherwise.
 Itshould 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 passes through different
stages of action.
 Firstly, the budget frame is structured.
 The government asks different departments to
3
submit their proposed programs of action for
the coming year and consolidated into an
 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.
 If approved, the government is authorized to

take action on the budget.

 Thirdly, the implementation, Revenues are
raised and PEs relating to the budget plan are
made.
 The last stage, a scrutiny/inspection 4and
Parliamentary Committees look after how best
financial abuse can be prevented.
 Importance of Public Budget
 To avoid arbitrary use of resources

 Avoid corruption.

 To achieve regional balance by reallocating funds

Principles of Budgeting
 Canon of Exclusiveness: this canon suggests that

public budget should exclude matters out of finance.

 Canon of Unity -according to this principle revenue

should be recorded in a revenue account and

expenditure ought to be recorded in the expenditure
account.
 Canon of Periodicity -this rule implies that

government should prepare a yearly plan of revenue

and expenditure.
5
 Canon of Specification: this means the type, and

amount and time of collection ought to be

 Objective of Budgeting
 Building of economic overheads

 Balanced development

 Poverty reduction

 Full employment and price stability

 Check on misuse of public goods

 Development of human capital

Procedure of Budgeting
 Budget preparation

 Approval of Budget

 Execution of Budget

 Auditing of Budget

6
 Theories of Government Budgeting
 There are two theories of government budgeting :
 the classical theory of balanced budget and
 the modern theory of ‘Managed Budget.

1. Classical theory: This follows philosophy of ‘laissez-

faire’
where by private sector plays a great role.
Under such a situation, the size of the budget is always
small and the budget should always be balanced.

 If there is budget deficit and it is financed by public

borrowing, it will withdraw funds from private sector
where they are more productively employed. Such
diversion of resources will bring down over all
7
economic
efficiency.
 Modern Theory: called Managed Budget does not
agree with the classical assumption of full
employment.
 It follows that the normal situation is one of less

than full employment [Keynesian] in an economy

and hence to ensure employment of unutilized and
idle resources, a flexible budgetary policy is
needed.
 The modern approach to flexible budget policy 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 8into
the economy so that effective demand, hence
 When there is inflation, too much money
is collected from the economy
( Revenues, taxes & borrowings are
greater than PE) to bring economic
stabilization.
 When there is neither inflation nor

unemployment, the budget should be

balanced.
 Generally, whether the budget should be

balanced or a deficit or a surplus should

be decided by the prevailing economic
circumstances. Hence, the modern 9

theory is called the principle of

 The main difference between classicists
and modem economists in principle of
government budgeting is concerned 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 and hence no unemployment.

 To the modem economists, however,

10

savings and investment need not be

o When savings become more than
investment, deficiency of effective
demand develops and unemployment
occurs due to fall in production and leads
to depression.

o When investment becomes more than

saving, the aggregate purchasing power
in the economy increases and the
available output cannot absorb it at the
prevailing/existing price level. Thus, there
becomes inflation. 11

o
 Itis 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

12
unemployment, i.e., when savings and
investment are unequal.
 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.
i) Revenue and Capital budget
 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 13

foreign borrowings.
 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.

14
 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.
 It is, therefore, very important for

developing countries to frame such a

type of budget.

15
 ii) Plan and non plan budgets: The
basic aim of economic planning is to
achieve repaid development in different
sectors like agriculture, industry, power,
transport, etc.
 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

16
administration and implementation of
 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.’
 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
17
full employment with price stability is achieved
iii). Balanced and Unbalanced Budget
 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 deficit18

budgets.
 Modern Classification of
Budget
 Modern budgeting recognizes this need

and attempts to classify the budget from

different analytical angles.
 The systems of classification provide

information on the working of budgetary

process.
 different types of classification are

needed, either singly or in combination,

to serve the purpose of appropriation,
programme management and review, 19
evaluation of plan implementation, and
 The various ways in which the public sector
transactions can be classified are
(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.
 Accordingly, from different analytical view

points, we may classify the budget in the

following ways.
i. Functional Classification: “It classifies public
expenditure by specific governmental function 20
such as defense, health, education, promotion of
ii. Economic Classification: seeks to categorize the
government receipts and expenditures into
different classes of economic significance.
 Economic classification broadly categorizes

public expenditure into two classes,

 viz., current expenditure and capital expenditure.

 Current expenditure

 A. Consumption expenditure

 b. transfer payment

 c. Total current expenditure (a + b)

 a. Consumption Expenditure

i. Salaries and wages

ii. Goods and services
21
iii. Less outside sales
iv. Net consumption Expenditure = (i) + (ii) – (iii)
 b. Transfer payment
 i. Interest payment

 ii. Grants to local bodies

 iii. Subsidies

 iv. Income account of household

 Total transfer payment =

 (i + ii + iii + iv)

Capital expenditure
 a. Gross capital formation

 b. Capital transfers

 c. Investment in shares

 d. Loans and advances

 e. Repayment of public debt

22
 Total capital expenditure


 a. Gross capital formation
 i. Buildings and other construction

 ii. Machinery and equipments

 iii. net increase in stock

 Total G.C.F = (i) + (ii) + (iii)

 b. Capital transfers

 i. Grants for capital formation to total bodies

 ii. Other capital transfers

 Total cap. Transfers = (i) + (ii)

 c. Loans and advances

 i. Capital formation

 ii. Current consumption

 Total = (i) + (ii)

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 Programme Budgeting Classification
 Iii.

 Under this classification, the budget would

frame a programme structure to attain a

particular objective and specify spending to
attain it.
 Eg. objective is poverty removal, these

expenditures would constitute the poverty

removal programme.
iv. Performance Budgeting Classification.
defined
 one which presents the purposes and

objectives for which funds are requested, the

costs for programmes proposed for achieving
these objectives and quantitative data 24

measuring the accomplishments and work

 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. 25
In the underdeveloped countries, the
economy operates at less than full
employment level and, hence, the main
problem is how to attain economic
growth/ development
and growth/development process is faced
with a number of problems related with ;
 allocation

 distributional and

 stabilization

26
 However, well designed government
budget can solve these problems in the
following ways.
 (1) Revenue Raising Device. The

government requires enough revenue to

discharge its fiscal responsibility. Given
the available resources, budget secures
generation of revenue 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 27

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 28

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 and the budget has a
tremendous influence on the whole
economy.
 (3) Diversion of Resources to More

Useful Production. Free market

mechanism leads to production of those
goods which give maximum profit to
private enterprises. 29

 Hence private investment is generally

 Itis, 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.
[allocation of resources!!] 30
 (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
the existence of monopoly, monopolistic
competition and oligopoly.
The government can correct this misallocation
either in the form of production subsidy /supply
of G/S and this can narrow the gap [P-MC].
 (5) Balanced Development:

Underdeveloped countries suffer from regional 31

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, via;
 Subsidy
 Tax
 Facilities
 (6) Income and Employment: Income of the

people in LDCs can be increased only through

increased productivity and production. 32
 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.

 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.
 The budgetary provisions of 33

employment-related tax concessions

 (7) Saving and Investment: In
underdeveloped countries, the level of
saving & investment is very low.
 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.

34
The saving and investment of private
individuals are also influenced by the
savings-investment-related tax concessions
and other budgetary subsidy programmes.
Capacity and willingness to work, save and
invest of the people is increased through
various human capital formation measures
and creation of employment opportunities.
These are all done through budgetary
expenditures.
8) Poverty Removal: Poverty removal
programme is a part & parcel of the budget
35
in UDCs countries.
All expenditure measures are designed in such a way
that they directly or indirectly influence reduction of
poverty in the economy.
Direct budgetary programmes for poverty removal are
those of increasing employment opportunities &
creation of community assets like;
employment insurance,
social security,
consumption subsidy,
public distribution system & price support
programmes, low-income housing,
area development, input supply,
agricultural wage restructuring,
etc. 36
 (9) Full Employment and Price
Stability
 An important function of the budget is to

secure the objective of full employment

and price level stability.
 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.
 All these measures should clearly put in

the government budget. 37

(10) A Check to Misuse of Public Funds.
Since budget is a financial plan relating to public
revenues and PEs for the budgeted period, it
imposes definite restraints on the tax gatherer
and public funds 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/inspection 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 38
a
check on the improper use and mishandling of