Chapter Three

Public Finance in Ethiopia

3.1. Introduction
The word Budget originally meant the moneybag or the public purse. The word now means,
“Plans of government finances submitted for the approval of the legislature”. The budget reflects
what the government intends to do. The budget has become the powerful instrument for fulfilling
the basic objectives of government. The budget covers all the transactions of the central
government.
Budget is a time bound financial program systematically worked out and ready for execution in
the ensuing fiscal year. It is a comprehensive plan of action, which brings together in one
consolidated statement all financial requirements of the government. The budget goes into
operation only after it is approved by the parliament. A rational decision regarding allocation of
resources to satisfy different social wants requires considerable thinking and planning. Thus
budget is an annual statement of receipts and payments of a government.
3.2. Functions of Budget
Dear Learner, the functions of budget include the following:
 Proper allocation of resources: - to relate expenditure decisions to specified policy
objectives and to existing and future resources;
 to relate all major decisions to the state of the national economy;
 long term economic growth:- to ensure efficiency and effectiveness in the
implementation of government programs;
 To facilitate legislative control over the various phases of the budgetary process.
 equitable distribution of income and wealth and
 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 preparing the annual revenues and expenditures forecast and end at the stages of
approval by the higher government body followed by its implementation.
3.3. The Concept of Budgeting in Ethiopia
The government budget represents a plan/forecast by government of its expenditures and
revenues for a specified period. Commonly government budget is prepared for a year, known as
a financial year or fiscal year. In Ethiopia the fiscal year is from July 7 of this year to July 6 of
the coming year (Hamle 1-Sene 30 in Ethiopian calendar). Budgeting involves different tasks on
the expenditures and revenues sides of government finance. On the side of expenditure, it deals
with the determination of the total deals with the determination of the total size of the budget (i.e
total amount of money for the year), size of outlays on different functions, and the magnitude of
outlays on various activities; on the revenue side, it involves the determination of the size of the
overall revenue and foreign aid.
Furthermore, budgeting also address the issue of the budget deficit (i.e. the excess of outlays
over domestic revenues), and it’s financing. Budgeting is not solely a matter of finance in the
narrow sense. Rather it is an important part of government’s general economic policy. Budget is
not solely a description of fiscal policies and financial plans, rather it is a strong instrument in
engineering and dynamiting the economy and its main objectives are to devise tangible directives
and implement the long term, medium term, and annual administrative and development
programs”.
3.4. Budget Structures in Ethiopia
Budget structures are the formats that organize budget data. Budget data could be classified in
different ways and for different purposes. In the early days, for instance, budget classification
basically focused on providing a better understanding of the intentions and purposes of
government for which funds were planned and to be spent. Later on, the budget structures started
to be influenced largely by the issue of accountability. That is in addition to providing
information on what the government proposed to do, the budget structures indicate the full
responsibility of the spending agency. To this end the budget heads or nomenclatures the full
responsibility of the spending agency. To this end the budget head or nomenclature of the budget
are mostly mapped to each spending agency. This should not, however, imply unnecessarily
extended and detailed structure (or mapping). Perhaps, due consideration must be taken to make
the structure manageable and appropriate. The first classification of the budget is between
revenue and expenditure.
3.4.1 Revenue Budget
It represents the annual forecast of revenues to be raised by government through taxation and
other discretionary measures, the amount of revenues raised this way differ from country to
country both in magnitude and structure, mainly due to the level of economic development and
the type of the economy.
In Ethiopia, the revenue budget is usually structured into three major headings: ordinary revenue,
external assistance, and capital revenue. Hence, the funds expected from these three sources are
proclaimed as the annual revenue budget for the country. The revenue budget is prepared by the
Ministry of Finance (MoF) for the federal government and by Finance Bureaus for regional
governments.
Ordinary revenues include both tax and not tax revenues. the tax revenues being direct taxes
(personal income tax, rental income tax, business income tax, agricultural income tax, tax on
dividend and chance wining, land use fee and lease); indirect taxes (excise tax on locally
manufactured goods, sales tax o locally manufactured goods, service sales tax, stamps and duty);
and taxes on foreign trade (customs duty on imported goods, duty and tax on coffee export). Non
tax revenues include charges and fees; investment revenue; miscellaneous revenue (e.g. gins);
and pension contribution. The second major item in revenue budget is external assistance. It
includes: cash grants, these are grants from multilateral and bilateral donors for different
structural adjustment programs; and technical assistance in cash and material form. The third
item is capital revenue. This could be from domestic (sales of movable properties and collection
of loans), external loan from multilateral and bilateral creditors mostly for capital projects, and
grants in the form of counterpart fund.
3.4.2 Categories of Revenues to Government
 Revenue on the basis of Nature
The revenues on the basis nature can be classified as in the following table. Of these two types of
classifications of revenues the classification of revenues based on the nature is considered as the
ideal classification.
A. Tax Revenue
The revenue from tax includes the following.
I. Tax on Income
The Government imposes two types of taxes on income.
They are tax on:
a) Personal income, and
b) Corporation profits.
The personal income tax is levied on the net income of individuals, firms and other association
of persons. The tax on the net profits of the joint stock companies is known as corporation tax.
II. Taxes on Property:
It is the tax revenue from properties including rental income tax land use tax etc.
 III. Taxes on Commodities
The important taxes levied by the Government on commodities are:
a) Customs Duty,
b) Excise Duty,
c) Value Added Tax
d) Turnover Tax
 Customs Duty includes both import and export duties. These duties are le
vied when the goods cross the boundaries of the country.
 Excise duties are levied on the commodities produced in the country. Excise
duties now constitute the single largest source of revenue to the Union
Government.
 Value Added Tax is levied by the Government on the commodities sold at
specified percentage on the value of sales.
 Turnover Tax is levied by the Government on the sales which are not
covered under Vat.
B. Non-Tax Revenues
The following categories of revenue are included under non-tax revenue.
 Administrative Revenue
It includes the following:
I. Fees
It is the compulsory payment made by the individuals who obtain a definite service in return.
Fees are charged by the Government to bear the cost of administrative services rendered by it.
These services are rendered for the benefit of general public. It includes court fee, registration
fee, etc.
II. Licenses
A license fee is collected not for any service rendered, but for giving permission or a privilege to
those who want to do a special or specified work. It is charged on the grounds of control of
certain activities.
III.Fines and Penalties
Fines and penalties are imposed as a form of punishment for the mistakes committed such as
violation of the provisions of law, etc. The basic aim behind them is to prevent the people from
making mistakes. A fine is also compulsory like a tax, but it is imposed more as a deterent as a
source of revenue.
IV. Forfeitures
Forfeiture means the penalty imposed by the courts on the persons who have not complied with
the notice served by it or for the breach of contract or has failed to pay the dues in time, etc.
V. Escheats
The property of a person having no legal heirs and dying intestate, will be taken possession of by
the Government that is, the Government can take over the property cannot be considered as a
main source of revenue to the Government.
VI. Special Assessment
According to Prof. Seligman, special assessment means “a compulsory contribution levied in
proportion to the special benefit derived to defray the cost of the specific improvement to
property undertaken in the public interest “. Thus, it is a compulsory payment or contribution. It
is levied in proportion to the special benefits derived to bear the cost of specific improvement to
property. Whenever the Government has made certain improvements, somebody will bet
benefited. For example, irrigation facility, road and drainage facility, etc.
3.5. Budget Deficit
A budget is considered as surplus or deficit according to the position of the revenue accounts of
the government. Thus a surplus budget is one in which revenue receipts exceed expenditure
charged to revenue account regardless of the gap in capital accounts; while a deficit budget is
one in which expenditure is greater than current revenue receipts.
Budget deficit is the excess of total expenditure over total revenue of the government. The deficit
financing denotes the direct addition to gross national expenditure through budget deficits
whether the deficits are on revenue or capital accounts”. It implies that the expenditure of the
government over and above the aggregate receipt of revenue account and capital account is
treated as budget deficit of the government.
The meaning of deficit financing is different in different countries. In western countries, the
budget gap, that is covered by loans is called deficit financing because, if the government
borrows from the banks rather than from individuals the idle funds will be activated and there
will be an increase in the total public expenditure and thus there will automatically be an deficit
financing has been used in a different sense. Here it is used to denote the direct addition to gross
national expenditure as a result of budget deficit.
Thus deficit financing can be defined as “the financing of a deliberately created gap between
public revenue and public expenditure”. The government of Ethiopia has used deficit financing
for acquiring funds to finance economic development. When the government cannot raise
enough financial resources through taxation, it finances its developmental expenditure through
borrowing from the market or from other sources.
3.5.1 Methods of Financing Deficit
There are four important techniques through which the Government may finance its budgetary
deficits. They are as follows:
A. borrowing from central bank
B. the running down of accumulated cash balances
C. the government may issue new currency
D. borrowing from market or from external sources
Under the first method, government borrows from central bank as per budgetary policy. In the
second source, government spends from available cash balance. In the third measure,
government issues new currency for financing deficit. The last method is that government
borrows from internal and external sources to finance its deficit.
3.5.2 Objectives of Deficit Financing
1. Deficit financing has generally been used as a method of meeting the financial needs of the
government in times of war, when it is considered difficult to mobilize adequate resources.
2. Keynes advocated deficit financing as an instrument of economic policy to overcome
conditions of depression and to raise the level of output and employment.
3. The use of deficit financing has also been considered essential for financing economic
development especially in under developed countries.
4. Deficit financing is also advocated for the mobilization of surplus idle and unutilized
resources in the economy.
3.5.3 Effects of Deficit Financing
Deficit financing has both positive and negative effects in the economy as under:
A. Inflationary Rise in Prices
The most serious disadvantage of deficit finance is the inflationary rise of prices. Deficit
financing increases the total volume of money supply. Unless there is proportional increase in
production this can lead to inflation. When deficit financing goes too far it becomes self-
defeating. There was inflationary pressure during the decade due to deficit financing.
B. Effects on Distribution of Wealth and Income
The real income of wage earners gets reduced and that of entrepreneurs/ businessmen increased,
leading to distribution of wealth in favor of business class
C. Faster Growth
Country is able to implement the developmental plans through deficit financing thereby attaining
faster growth.
D. Change in Pattern of Investment
Deficit financing leads to encouragement for investment in certain fields like construction,
luxury consumption inventory holding and speculation. This may lead to investment in
undesirable fields.
E. Credit Creation in Banks
Inflationary forces created by deficit financing are reinforced by increase credit creation by
banks.
Among various fiscal measures, deficit financing has been assigned an important place in
financing developmental plan and various developing countries including Ethiopia resort to
deficit financing to meet budgetary gaps.
3.5.4 Deficit Financing in Ethiopia
Deficit financing in Ethiopia was mainly resorted to enable the Government of Ethiopia to obtain
necessary resources for the plans. The levels of outlay laid down were of an order, which could
not be met only by taxation or through a revenue surplus. The gap in resources is made up partly
through external assistance. But when external assistance is not enough to fill the gap, deficit
financing has to be undertaken. The targets of production and employment in the plans are fixed
primarily with reference to what is considered as the desirable rate of growth for the economy.
When these targets cannot be achieved through resources obtained from taxation and external
borrowing, additional resources have to be found. Deficit financing is the easier option. It is
important to emphasis the fact that deficit financing cannot create real resources which do not
exist in the economy.
3.6. Pattern of Revenue Sharing
Ethiopia has chosen the federal structure in which a clear distinction is made between the union
and state functions and sources of revenue, but residual powers, belong to the center, although
the states have been assigned certain taxes, which are levied and collected by them, they also
share in the revenue of certain federal taxes. In addition, the states receive grants-in-aid of their
revenue from the federal government, which further increase the amount of transfers between the
two levels of government. The transfer of resources from the central government to the states is
an essential feature of the present financial system.
3.6.1 Distribution of Revenues between Central and States
The present federal fiscal system in Ethiopia is of a recent origin. The distribution of revenues
between the centre and states is followed on the basis of "constitution of Ethiopia” and
proclamation no.33/1992-proclamation “to define sharing of revenue between the central
government and the national/regional self governments”. The articles 96, 97, 98, 99 and 100 of
the constitution of Ethiopia make a clear demarcation of areas where the central alone or state
alone have authority to impose taxes. It contains a detailed list of the functions and financial
resources of the center and states.
3.6.2 Objectives of Revenue Sharing
The sharing between the central government and the National/Regional Governments shall have
the following objectives:
1. Enable the central government and the national/regional governments efficiently carry out
their respective duties and responsibilities.
2. Assist national/ regional governments develop their regions on their own initiatives;
3. Narrow the existing gap in development and economic growth between regions;
4. Encourage activities that have common interest to regions.
3.6.3 Basis for Revenue Sharing
The sharing of revenue between the central government and the National/ Regional governments
shall take in to consideration the following Principles:
1. Ownership of source of revenue;
2. The national or regional character of the sources of revenue;
3. Convenience of levying and collection of the tax or duty;
4. Population, distribution of wealth and standard of development of each region;
5. Other factors that are basis for integrated and balanced economy.
3.6.4 Categorization of Revenue
According to "Constitution of Ethiopia” and Proclamation No.33/1992-Proclamation, revenues
shall be categorized as Central, Regional and Joint. That is there are three lists given in the
Articles. They are as follows:
A. Central List,
B. Regional List, and
C. Joint/Concurrent List
The important sources of revenue under "Constitution of Ethiopia” and The Proclamation
No.33/1992-Proclamation “To Define sharing of Revenue between the Central Government and
the National/Regional Self Governments” are explained below
A. Central List
The sources of revenue are given under Federal/Central List are as follows:
I). Duties, tax and other charges levied on the importation and exportation of goods;
II). Personal income tax collected from the employees of the central Government and the
International Organizations;
III). Profit tax, Personal income tax and sales tax collected from enterprises owned by the
Central Government. (Now sales tax is replaced with VAT and Turnover taxes).
IV) Taxes collected from National Lotteries and other chance winning prizes;
V). Taxes collected on income from air, train and marine transport activities;
VI). Taxes collected from rent of houses and properties owned by the central Government;
VII) Charges and fees on licenses and services issued or rented by the central Government;
B. Regional List
The following shall be Revenues for the Regions:
I). Personal income tax collected from the employees of the Regional Government and
employees other than those covered under the sources of central government.
II) Rural land use fee.
III) Agricultural income tax collected from farmers not incorporated in an organization.
IV) Profit and sales tax collected individual traders.
V) Tax on income from inland water transportation.
VI) Taxes collected from rent of houses and properties owned by the Regional Governments;
VII) Profit tax, personal income tax and sales tax collected from enterprises owned by the
Regional Government:
VIII) With prejudice to joint revenue sources, income tax, royalty and rent of land collected from
mining activities.
IX). Charges and fees on licenses and services issued or rented by the Regional Government;
C. Joint/Concurrent List
The following shall be Joint revenues of the Central Government and Regional Governments.
I. Profit tax, personal income tax and sales tax collected from enterprises jointly owned by the
central Government and Regional Governments;
II. Profit tax, dividend tax and sales tax collected from Organizations;
III. Profit tax, royalty and rent of land collected from large scale mining, any petroleum and gas
operations;
IV. Forest royalty.
The domestic balance concept is a family of the overall budget deficit and became prominent
after the oil price increases in 1973/74. The basic argument being, in countries that had large
revenues, expanded incomes from government expenditures placed strains on the domestic
economy and spurred inflationary pressures. In such cases, budget surpluses will have an
expansionary effect. Under such circumstances the overall budget deficit or surplus measure
would be misleading to guide government policy. In fulfilling the requirements of oil producing
countries and others in similar circumstances, the technique of splitting the domestic balance is
the component of the overall balance from which external budget transactions have been
excluded.
The separation of recurrent and capital budget should, therefore, be viewed in terms of the net
worth argument above. The definition of these two budgets has been a common problem in most
countries, however. The problem relates to delineating, which specific expenditures need to be
included in the recurrent budget and which ones in the capital budget. In practice three criteria
have been in use to define budget into capital and recurrent. These are sources of finance, object
of expenditure, and nature of activity. Capital budgets were originally defined by western
governments by the source of finance, i.e., capital expenditures are financed from loan not
current revenue. The object of expenditure refers to the particular activities to be performed with
that budget like, formation of fixed assets, study and design, salaries of civil servants, etc. the
third criteria, the nature of activity, refers to whether the activity is short term (i.e. project) or
ongoing (that may not terminate in a specific period), and objective specific.
In Ethiopia the definition of recurrent and capital budgets follow some combination of these
criteria. That is:
1. Recurrent budget is to be covered by domestic revenue from tax and non-tax sources. But the
economy could borrow to meet its capital budget.
2. The financial proclamation 57/1996 and financial regulations 17/1997 defined capital budget
based on the object of expenditure. Accordingly capital budget equals capital expenditure
which equals fixed assets and consultancy services.
3. Short-term activities that are project in nature are included in capital budget while those
activities that are recurring and continuous in nature are put in the recurrent budget. In some
instances activities with a very long life period have been entertained in the capital budget.
 Since fiscal year 1994/95 efforts have been exerted to identify many such projects that have
been categorized under recurrent budget (projects in Education, health and Agriculture
sectors). The exercise does not seem complete, as there are projects with recurring nature
(e.g. Agricultural Research) though attempts have been made to isolate the investment
components.
The Expenditure Budget includes the following two types of Budgets:
1. Recurrent Budget, and
2. Capital Budget.
1. Recurrent Budget
Financial proclamation 57/1996 and financial regulation 17/1997 defined only the capital budget,
implicitly defining the recurrent one as a residual. To common practice, however, is to include in
the recurrent budget expenditures of recurrent nature (like salaries of civil servants) and fixed
assets with a multi-year life.
The recurrent budget is structured by implementing agencies (public bodies) under four
functional categories: administrative and general services, economic services, social services,
and other expenditures. All public bodies then fall under one of these functional categories. The
budget hierarchy will then be down to sub agencies.
2. Capital Budget
Capital budget is budget for capital expenditures. Financial proclamation 57/1996 defined capital
expenditure as “an outlay for the acquisition of improvements to fixed assets, and includes
expenditures made for consultancy services.” Financial regulations 17/1997 further provided a
detailed definition of capital expenditures to mean:
i. The acquisition, reclamation, enhancement as laying out of land exclusive of roads, buildings
or other structures;
ii. The acquisition, construction, preparation enhancement or replacement of roads, buildings and
other structures;
iii. The acquisition, installation or replacement of movable plant, machinery and apparatus,
vehicles and vessels;
iv. The making of advances, grants or other financial assistance to any person towards him/her
on the matters mentioned in (a) to (c) above or in the acquisition of investments; and
v. The acquisition of share of capital or loan capital in any body corporate;
vi. Any associated consultancy costs of the above.
Capital budget could thus broadly be described as an outlay on projects tat result in the
acquisition of fixed assets and the provision of development services (Ministry of planning and
Economic Development, 1993:4). It should therefore be need that, capital budget as a wider
coverage than simple outlays in fixed investments, since it includes expenditure on development
services like agricultural research and transfer payments related to a project.
The capital budget is presented under three functional groups viz., economic development, social
development, and general development. Economic development includes production activities
(agriculture, industry, etc.), economic infrastructure facilities (mining, energy, road etc.),
commerce, communication, and so on. Social development includes education, health, urban
development, welfare and so on. General development include services like cartography,
statistics, public and administrative buildings, and the like.
 Line Item Budget
Capital budget, on the other hand is prepared by activity/project. This will be performed by
categorizing projects spectrally at the top, then grouping them by programs and sub-programs.
For instance, the “National Fertilizer project” is detailed as follows under the sector agricultural
development.
700 Economic Development
710 Agricultural Development
712 Peasant Agriculture Development
712/02 Crop Development
712/02/02 National Fertilizer Project
Ultimately, however, the budget for both recurrent and capital will be presented by line items (or
code of expenditures). Thus, the budget for the sub agency or department in the case of recurrent
will be prepared by such line items as salaries, office supplies, etc. Similarly, the capital budget
for projects will be prepared by such line items as surveys and designs, equipment and
machinery, operating cost, and so on.
Ultimately, however, the budget for both recurrent and capital will be presented by line items (or
code of expenditures). Thus, the budget for the sub agency or department in the case of recurrent
will be prepared by such line items as salaries; office supplies, etc. Similarly, the capital budget
for projects will be prepared by such line items as surveys and designs, equipment and
machinery, operating cost, and so on.
Line item budget has a number of advantages: First, it promotes control since the budget is
detailed down to particulate expenditure items. The use of the budget of one line item for another
may require the verification of MoF and MoED. So, the spending public bodies will not have the
right to spend the budget as they want. Second, it is simple to manage. The major drawback of
line item budget, however, is it fives more emphasis to inputs not outputs. At present, however,
the civil service Reform Program in its component of budget reform is trying to address the issue
of output. To move from the existing input based (line item) budgeting to that of cost center and
performance budgeting, efforts are being made to consolidate the recurrent and capital budgets
by line item (i.e. to use the same line items for both recurrent and capital budgets) and to map the
budget into the organizational structure of the implementing bodies.
Preparing the budget this way by line items is usually referred to as line item budgeting. Hence,
our recurrent and capital budgets are prepared by line items. Budget request and disbursement
are then performed by line items.