The budget Deficit

A budget is a financial plan that outlines how available resources are to be spent on prioritised needs
over a period of time. A national budget is a financial statement that shows the financial revenues and
planned expenditure and how these are organised in the interest of the entire citizens. It outlines
spending measures of a government in terms of priority activities, projects, and programmes. It spells
out revenue raising measures in form of amount and sources to finance the activities.

A Budget is also a fiscal policy instrument which is prepared by executive branch of government and
passed by government.

It is a balance between the branches of government, the needs of the people and the capacity to provide
for those needs.

It is also a funding tool for economic developments and poverty reduction.

Cash limit the limit on the amount of cash that can be spent on certain specified service during one
financial year.

Supply Estimate A statement presented to Parliament of the estimated expenditure of a department

during a financial year, asking for the necessary funds to be voted.

Vote – an individual Supply Estimate

Budgeting and creating Public value

- the plan is formulated to meet its purpose
- express how the organisation will create public value

Strategic issues in Budgeting

The three points are:

 The level of income and borrowing which is what determines the capacity of the public
manager’s organisation (which will be less than the operational capacity)
 The planned expenditure and investment, which will be the resources that are to be converted
into goods and services that, are valued by public.
 Approval by the organisation’s highest level of governance (which may or may not include
publicly elected officials.)

Public budgeting has four stages:

Government will hold pre budget consultative meeting seek views from the technical and professional
bodies, business community seeking their views to incorporate in the budget.

Preparation; submission and approval; implementation and review; and reporting.

Government budget deficit

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Deficit is the difference between government spending and revenues, it arises when government
spending increases and tax revenue decline; the accumulation of deficits over time is the total public
debt. Deficit finance allows governments to smooth tax burdens over time, and gives governments an
important fiscal policy tool. Deficits can also narrow the options of successor governments.

Total Revenue and Grants

Unlike an enterprise, Government does not receive its income (called revenue) from the sale of goods
and service. Instead Government provides goods and service to the community for free and derives its
income from scheduled and compulsory contributions. Thus the receipt of government revenue does not
oblige the Government to deliver a specific service to customer or to repay the money it receives. This is
the general rule that applies to all revenue, but with some exception, the exceptions are normally found
in non –tax revenue.

As a general principle, revenue is shown in gross terms, meaning it is not netted out against the
expenditure it is supposed to fund. Thus revenue reflects the full magnitude and impact of government
revenue – raising operations.

Revenue is typical recorded in Government statistics when payment is received, not when payment is
due e.g. when tax payers are late on their tax payment, their arrears are not shown in the revenue
statistics. Only actual payments are shown.

Tax revenue is often the main revenue item. Taxes are compulsory payments collected by the
government to finance its operation. Taxes are broken down according to the type of activity on which
they are imposed e.g. taxes on income and profits, taxes on property, taxes on goods and services.

Non tax revenue includes rent from buildings, fees, fines and the operating surpluses of public
enterprises. Fees include charges for school tuition, license to operate a business, etc. Also included in
non-tax revenue are transfers of profits from the central bank to the Government.

Grants are voluntary payment made by foreign Governments, international organisations and
individuals. Grants differ fundamentally from revenue, because grants are neither predictable nor
sustainable, planning expenditure on the assumption that grants will be available runs the risk of serious
budgetary miscalculations.

Total Expenditure and Net Lending

Current Expenditure is the operating expenditure of the Government. It is sometimes called recurrent
expenditure, because it comes back year after year.

The term current expenditure differs from Government consumption as it is used in the National
accounts. Government consumption comprises wages and salaries and the purchase of goods and
services. It excludes all other current expenditure, such as transfers, subsides and interest payment,
which although they pass through the accounts of the Government, are considered as ultimately
redistributing private sector income.

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Capital Expenditure refers to purchase of land buildings and physical capital equipment meant to be
used for more than one year. Capital expenditure can include projects that take longer than one year to
implement.

Although capital expenditure is meant to be used in production, there is no guarantee that Government
capital expenditure contributed to economic growth, nor can one argue that capital expenditure is more
productive than current expenditure; examples of current expenditures believed to be productive are
outlays for health services and education.

Net lending is a special item. It consists of Government lending undertaken to achieve some policy
objective. Examples include subsidised loans to farmers, students or small business. it is called “net”
because the reimbursements that recipients make are netted out against new loan.

Controlling General Government Expenditure

It may seem that the Government has merely to estimate its expenditure and impose tax to cover it. But
this is not the case. Since goods and services in the economy are limited, the Government has to cut its
coat according to its cloth.

General government expenditure covers spending by both the Central and Local Government. But more
attention will be given to central Government over the economic cycle; revenue and expenditure should
be balanced. Where expenditure exceeds revenue, there is a deficit, and if it exceeds 3% of GNP makes
it more difficult to sustain growth since it puts upwards pressure on the rate of interest.

Furthermore, in adding to the national debt, it increases Government’s current interest payment.

National Debt

The total amount owed by Government to local citizens and foreigners at a particular moment in time is
called national debt. The money raised may have been spent on capital goods, which increases our
ability to produce goods. Interest has to be paid on the debt. A large national debt is a problem if

 Interest has to be paid to overseas citizens, so that balance of payment suffers.

 Taxes have to be increased to meet interest payment.

Financing of the Budgeting Deficit

Receipts lead to increased public debt, which must eventually be repaid. Payments lead to reduced
public debt.

Government not only spends on single – use goods but also on goods, which render service over long
periods. Capital spending, on such items as roads, university building, etc is more fairly financed by
borrowing, the repayment of capital then partly falls on future beneficiaries.

Regular yearly income comes from two main sources.

 Miscellaneous receipts, chiefly interest loans, rents and charges on goods and services.

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 Taxation

Government domestic borrowing takes the form of:

 Short term loans from the sales of Treasury Bills

 Medium and long term loans are obtained by selling stocks like Local Registered Stocks (LRS).
 “Non Market” borrowing

Budget deficit is the amount by which government’s total expenditure exceeds the revenue raised from
tax and other government receipts.

The impact of Financing the Budget Deficit

The macro economic impact of Government deficit depends on the way the deficit is financed.

 Foreign borrowing – excessive foreign borrowing leads to an external debt Problem.

 Domestic bank borrowing - Excessive bank borrowing often results in inflation.
 Domestic non-bank borrowing - Excessive non-bank borrowing produces high real interest rates
and crowds out private sector investment.

FISCAL POLICY AND THE BUDGET

Fiscal Policy and Monetary Policy

A feature of fiscal policy is that a government must plan what it wants to spend, and so how much it
needs to raise in income or by borrowing. It needs to make a plan in order to establish how much
taxation there should be, what form the taxes should take and so which sectors of the economy the
money should come from. The taxation aspects are set out in the budget.

Fiscal policy- the government’s policy on government spending, taxation and borrowing.

Spending: the government spends money at national and local level to provide goods and service such
as health service, public education, a police force, roads , buildings and so on.; and to pay the
administrative work force

Taxation: expenditure must be financed and government must have income.

Borrowing: the government must borrow the amount by which the expenditure exceed its income

Monetary Policy can be made to act as a subsiding support to fiscal policy and demand management.
Since budgets are once a year events, a Government must use non – fiscal measures in between budgets
to make adjustments to its control of the economy.

 A policy of low interest rates or the absence of any form of credit control might stimulate bank
lending which in turn would increase expenditure (demand) in the economy.
 High interest rates might act as a different to borrowing and so reduce spending in the economy.

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  Strict credit controls ( e.g. restrictions on bank lending) might be introduced to reduce lending
and so reduce demand in the economy.

Alternatively monetary policy might be given prominence over fiscal policy as the effective approach by
Government to achieving its main economic policy objectives.

The use of debt finance can affect the market equilibrium rate of interest and the willingness of investors
to make private investments.

Does it affect the poor?

The economic implication of a budget deficit are they absorb funds from the credit markets and
contribute to decline in national saving, the decline in national saving can increase real interest rates,
reduce private investment, reduce economic growth and decrease future living standards.

- Each year more and more tax revenues are devoted to paying interest on the national debt instead of
providing goods and services to citizens.

- Increase in demand for loanable funds by the government to finance a deficit can increase market
interest rates. The market demand for loanable funds is composed of the demand for credit by
households, business firms, state and local governments, and the federal government.

- Inflation which is increases in the general level of prices of goods and services

Debt Finance
Debt finance is the use of borrowed funds to finance government expenditures.

Those who lend funds to the government for the purpose of financing government expenditures usually
do so under their own free will. In return for the funds that they lend to the government, they receive a
bond, or some other note of government indebtedness, that embodies the promise of the government to
repay the loan with interest at some future date.

Presumably, the interest payment received by these individuals adequately compensates them for the
consumption and alternative private investments that they could have enjoyed had they chosen not to
buy the government securities.

On the other hand, as the debt is paid off by the government, some form of alternative finance is
necessary, unless the government decides to retire the debt through issuance of additional debt.

If taxes are used in future periods to pay off the debt, citizens will be forced in those future periods to
reduce their consumption and saving to compensate those who voluntarily gave up their income in the
past to buy the government securities. In other words, debt finance can be used to postpone the burden
of taxation.

Financing deficit and Welfare of the people.

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- A budget deficit or surplus reflects an imbalance between expenditures and revenues. Deficits
increase the federal debt and also can contribute to higher market interest rates and increased
inflation. Borrowing to finance public expenditures postpones the tax burden to the future. A budget
surplus adds to national savings and can lower interest rates and increase investments.

- Repayment of internal debt represents mainly a redistribution of income within the nation, away
from taxpayers and toward citizens who hold government securities.

- Deficit decreases the well-being of citizens who are taxed to pay off the principal and interest on
past debt.

- To pay interest on the debt and return the principal, the government usually increases taxes;
taxpayers in the future undergo reductions in consumption or saving.

- Using borrowing to finance government expenditures implies lower current taxes for citizens in the
year deficits are incurred, but that greater portions of future tax revenue be used to pay interest on
debt instead of being used to provide government services.

- Current generations of taxpayers will shift the burden of taxation for government goods and services
they enjoy to future generations of taxpayers.

- The deficits also can reduce living standards of future generations by contributing to reduced
industrial investment and lower economic growth.