CHAPTER TWO

BUDGET AND FINANCING

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.

2.1. Functions of Budget:

The functions of budget include 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 preparing
the annual revenues and expenditures forecast and end at the stages of approval by the higher government
body followed by its implementation.

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2.2. 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 its 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”.
2.3. 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.

2.3.1. 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

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collection of loans), external loan from multilateral and bilateral creditors mostly for capital projects, and
grants in the form of counterpart fund.

2.3.2. Expenditures Budget:

Government expenditures for administration and developmental activities are handled through the
expenditures budget. These expenditures are categorized into recurrent and capital expenditures. This
categorization gained acceptance since the Great Depression of the 1930s. the recurrent budget which
covers the current expenditures is financed in principle by taxation ( more broadly by domestic
revenue from tax and non tax sources), and the capital budget which covers the acquisition of newly
produced assets n the economy is financed through external borrowing and grants.

The acceptance to this categorization of expenditures is related to the general change in the
perception of deficit. Prior to the 1930s, budget deficits were considered to be reprehensible and indicate
bad financial management. Over the years, however, the cardinal rule of balanced budget was changed in
favor of cyclical budget, and functional finance.
This change in the rule of budgeting, in turn, resulted in several approaches to measuring and
understanding the deficit some of the concepts that were developed include:
a. the public debt concept of deficit,
b. the net worth concept of deficit,
c. the overall deficit, and
d. the concept of domestic deficit.

To illustrate these four approaches of measuring deficit, we can employ a simplified budget balance given
in Table -1 below:

Table-1: A Simplified Budget Balance

Revenues Expenditures
A. Tax and Non Tax Revenues C. Recurrent Expenditure
B. Net Borrowing D. Capital Expenditure
A+B C+D
The public debt concept of deficit defines budget deficit as the difference between revenue (A) and
recurrent expenditures (C) and capital expenditures (D) this measure A-(C+D) is equal to net borrowing
(B), and the budget is considered to be balanced if net borrowing remains unchanged from previous years
or is equal to zero. This approach illustrates, the understanding prior to 1930s, which emphasized
balanced budget as a prudent fiscal policy.
The emergence of active fiscal policy: The emergence of active fiscal policy (i.e. government could
borrow as long as that liability is matched by an increase in assets) right after the depression led to the
development of the net worth concept of deficit. Referring to the Table above, the net worth is defined as
the difference between recurrent expenditures and revenues (C-A), which is equal to the excess of net
borrowing over capital expenditures (B-D) this measure of deficit requires the division of expenditures
into current and capital budgets, with the latter being financed by borrowing.
The concept of the overall deficit or balance has several connotations and methods construction. The
common practice is to put revenues, expenditures, and borrowing as distinct groups as in Table 2. Each
budget category may then be related economic activity being computed as a ratio of GDP, which then
becomes a first approximation and an important single measure of the impact of government fiscal
operations.
Table- 2: The Overall Budget Deficit

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 The Overall Budget Deficit

A. Revenues

Tax revenues
Non Tax revenues
Grants

B. Expenditures
Recurrent Expenditures
Capital Expenditures

C. Overall Deficit (A-B)

D. Financing

1. Foreign Debt
2. Domestic Debt
Non Bank Borrowing
Commercial Banks
Central Bank
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

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 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 f 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:
a. The acquisition, reclamation, enhancement as laying out of land exclusive of roads, buildings
or other structures;
b. The acquisition, construction, preparation enhancement or replacement of roads, buildings
and other structures;
c. The acquisition, installation or replacement of movable plant, machinery and apparatus,
vehicles and vessels;
d. 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
e. The acquisition of share of capital or loan capital in anybody corporate;
f. 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.

2.3.3. Line Item Budget:

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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.

2.4. THE BUDGET PROCESS IN ETHIOPIA:

Budgeting from the initial stage of forecasting the annual revenues and expenditures, to the final stage of
approval of the annual budget by the Council of Peoples Representatives, passes through a sequential and
an iterative process. This budgeting process includes:
 Preparation of the macro-economic and fiscal framework;
 Revenue forecast and determination of expenditure budget ceiling:
 allocation of expenditure budget between Federal and Regional governments;
 allocation of Federal government expenditure budget between recurrent and capital budgets:
 budget call and ceiling:
 budget review by MoF and MoED;
 Budget hearing and defense:
 Review and recommendation:
 Submission of the budget to the council of Ministers:
 Submission of the budget to the Council of Peoples’ Representatives:
 Notification and publication of the budget; and
 Allotment.

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The budget process thus includes al these stages, which obviously are sequential (one after the other) and
iterative. Peterson summarized the budget process into three phases: analyzing, fitting, and implementing.
The analysis phase is the assembly and integration of financial data which might include processes from
the formulation of macro-economic and fiscal framework to the allocation of expenditure budget between
Federal and Regional governments the fitting phase is the process of prioritizing activities to fit with
policy and reducing a budget to a ceiling. Referring to the budgeting processes outlined above this might
range from the processes of allocation of Federal government expenditures budget between recurrent and
capital budget down to the submission of the budget to the council of peoples’ Representatives. The final
paste, implementing, is distributing and using the allocation, i.e. the notification and publication of the
budget, allotment and the monitoring processes.
Budget being a one-year plan prepared for the coming fiscal year it requires a time schedule (deadlines)
for each and every processes that should strictly be adhered to. The time schedule is usually handled
through the budget calendar. In effect the budget calendar is the major instrument to manage the
budgetary process. Thus far we don’t have an authoritative and binding budget calendar that could force
al public bodies involved in the process f budgeting. The only dates proclaimed by law are the final
approval and notification dates of the budget. Financial proclamation 57/1996 states that “the budget
appropriation shall be approved by the council of peoples; Representatives by sine 30 th (July 6) and all
public bodies shall be notified by Hamle 7 (July 13). “the other deadlines in the process of budgeting will
be set by the MoF and MEDaC who are responsible for the preparation of the recurrent and capital
budgets, respectively. The MoF and MEDaC will notify the spending public bodies well ahead of time
about the important deadlines, the budget ceiling and other information through the budget circular. the
budgeting process usually took between six to eight months, and the MoF and MoED will release the
budget circular around November to December.

2.4.1. THE BUDGETARY PROCESS AT THE FEDERAL LEVEL:

The budget processes at the Federal level follows sequential and iterative the steps. These steps can be
explained with the help of the following Chart. Let us briefly explain these steps one by one here under:

Step one - Macro-Economic and Fiscal Framework:

The preparation of the macro-economic and fiscal framework is basically a component of the recently
initiated public investment program (PIP). It is a planning practice and as stated in Ministry of Economic
Development, the macro-economic and fiscal framework determines the overall level of government
expenditures based on policies related to the role of government in the economy, government deficits, and
priorities for resource allocation between regions and sectors. For the Federal government the framework
is a three years forecast and will be updated each year.
The framework is composed of macro-economic forecast and fiscal forecast. The macro-economic
forecast gives the forecast of Gross Domestic product based on past performance and estimates for future
years, and provides base line information in preparing the fiscal forecast. Financial Regulation 17/1997
gave the responsibility of preparing this framework to the Ministry of Economic development (MoED).
Whereas, the later, establish the level of total resources available for expenditure. it provides a more
detailed forecast of revenue (both Federal and Regional), end projection of expenditure. Given the policy
of no borrowing from domestic banks to finance budget deficit the level of expenditure mainly depend on
the amount of resources to be raised in the form of domestic revenues and external fund that include
counterpart funds. Once prepared by the concerned coordinating ministries, i.e. MoF and MoED, it will
be reviewed and approved by the Prime Minister’s Office (PMO).

Step Two- Determination of Federal Government Expenditure and Subsidy to

Regional Governments:

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After the revenue and expenditure of the government are estimated through the fiscal framework, the
PMO will decide on the shares of Federal government expenditures and subsidies Regional governments.
it is known that, following the decentralization policy, Regional governments took grants from the
Federal government in the form of subsidy.
Once the amount of subsidy is known, the allocation among regions is determined on the basis of a
formula. Initially the formula was composed of five parameters (population, level of development,
revenue generating capacity, utilization capacity, and land area). At present, how ever, the formula takes
account of three parameters: population, the level of development, and revenue generating capacity of
each region which are given a relative weight of 60%, 25% and 15% respectively. This allocation will fist
be prepared by MoED, then reviewed by the PMO and finally approved by the Council of peoples’
Representatives.
Step three: Allocation of Federal Expenditure between Recurrent and
Capital Budget

The practice in the allocation of recurrent and capital budget is to consider the latter as a residual. That is,
first the amount of budget necessary to cover such recurrent expenditures like pensions, debt servicing,
wages and non-wage operating costs will be determined. The balance will then be allotted to capital
expenditures. This will be performed by the PMO in consultation with MoF and MoED.
Step Four - Budget Call and Ceiling Notification:
This includes two items. They are:

a). Recurrent budget: MoF will release the budget ceiling to the line ministries in a budget call.
The budget call provides each ministry such information as the macro-economic environment, an
aggregate recurrent budget ceiling, and priorities to budget.

b). Capital Budget: MoED issues detailed capital budget preparation guidelines to spending
public bodies along with the ceilings provided to each line institution. MoED will set the ceiling for
each sector.
Step Five - Budget Review by MoF and MoED:

This includes two items. They are:

1. Recurrent Budget:

Prior to a formal budget hearing, spending public bodies will submit their budget proposals to the MoF-
Budget Department. In consultation with spending public bodies, MoF will prepare an issue paper on
Major issues at each head level in the proposed budget. Here, spending public bodies can submit above
the ceiling but need to have a compelling justification

2. Capital Budget:

The sector departments of MoED review the capital budget requests from different public bodies. At this
stage projects will be screened. If there exist a discrepancy between the respective sector department and
the public body, a series of discussions will be held to reach agreement. After such a process the various
sector departments of MoED will submit their first round recommendation to the Development Finance
and Budget Department of MoED. Then it will be consolidated and prepared for the capital budget
hearing and defense.

Step Six - Budget Hearing and Defense:

This includes two items. They are:

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 1. Recurrent Budget:

Spending public bodies defend their budget submission in a formal hearing with the MoF. The issue paper
will be the basis of the hearing. The hearing focuses on policies, programs and cost issues, when
necessary it might involve discussion down to line item. Spending public bodies could also challenge the
ceiling. Presenting the hearing will be ministers and/or vice ministers, heads of public bodies and the
MoF.

2. Capital Budget:

Spending public bodies will be called to defend their projects to a budget hearing convened by the PMO
which will be chaired by the prime Minister or the deputy Prime Minister or the their economic advisers.
The hearing customarily includes a review of status of the project, implementation capacity of the
institution, compatibility with the countries development strategy and policy, cost structure, and regional
distribution. A project description will be presented which includes objectives of the project, main
activities of the project, status of the project, total cost, past performance of the project, source of finance,
and whether the project is accepted or rejected by MoED. On the basis of the discussion the respective
sector departments of MoED in consultations with the spending public body will further refine the capital
projects.
Step Seven - Review and recommendation:

This includes two items. They are:

1. Recurrent budget:

After the hearing is over, the budget committee of the MoF will review the discussion and make a
recommendation. If there is an increase (over ceiling) this will go to the PMO for approval.

2. Capital budget:

After the hearing and defense with the PMO and MoED, sector departments of MoED will give a final
recommendation to the development finance and budget department of MoED. This will then be compiled
and put in appropriate formats for submission to the council of ministers.
Step Eight: Submission to the council of Ministers:

At this stage the two budgets (recurrent and capital) will be consolidated, and MoF will prepare a brief
analysis of the total budget.

1. Recurrent budget:

The recommended budget will be submitted to the deputy Prime Minister for economic affairs. This will
first be reviewed by ministers and vise ministers in economic affairs, and then presented to the Prime
Minister along with a brief. The Prime Minister may or may not make amendments and then the budget
will be sent to the council of Ministers for discussion.

2. Capital Budget:

A brief analysis of the capital budget will be prepared by MoED on the final recommended budget and,
along with the consolidated capital budget, will be submitted to the council of ministers. MoED will

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defend the budget in the council. The council of ministers may make some adjustment and the draft
capital budget will pass the first stage of approval.

Step Nine - Submission to the Council of Peoples’ Representatives:

Once approved by the council of ministers, the Prime Minister will present both the recurrent and capital
budget to the council of peoples’ representatives. The budget will then be debated based on the
recommendation of the budget of the committee.

Step Ten - Notification and Publication:

The approved budget will then get the legal status through the publication in the ‘Negaret gazeta.’
Spending public bodies will then formally be notified of their approved budget by line items from MoF
and MoED for recurrent and capital budgets, respectively. MoF will notify spending public bodies
through Form 3/1. Likewise, MoED will inform through Form 3/2. Both Forms will be copied to the
Treasury Department of the MoF which disburse funds to spending public bodies. Until Form 3/1 is
released spending public bodies are authorized to spend one-twelfth of the previous year’s budget with no
provision for new expenditures (e.g. new staff posts) in the case of recurrent budget. For capital budget
spending public bodies are authorized to use approved budget for ongoing projects even when Form 3/2 is
not released.

The final stage of the budgetary process is to request spending public bodies to prepare adjusted work
plan and cash flow for the approved budget. The adjusted work plan and cash flow will be verified by
MoF-for the recurrent budget-and by MoED-for the capital budget, and then will be sent to the treasury
Department of the MoF.

Step Eleven - Supplementary Budget:

In the course of the budget year supplementary (additional) budget will be proclaimed when
necessary, following almost the same process as the initial budget preparation. Likewise budget
reallocation will be made mainly based on performance.

2.4.2. THE BUDGETARY PROCESS AT THE REGIONAL LEVEL:

It is quite difficult to present the budget process at the Regional level in the way discussed for Federal
Budgeting. At present the budget process followed by regions is not uniform. Hence, let us discuss the
process of budgeting in a more general terms without referring to a particular region.

The process is more or less a mirror image of the Federal budget process. In place of MoF the Regional
Finance Bureau (RFB) is responsible for the preparation of the recurrent budget. While the Regional
planning and Economic Development bureau (RPEDb) is responsible for the capital budget. At the higher
level the Regional council is the one responsible for the appropriation of the region’s budget. One
significant deviation is, the regional budget process starts at the woreda level and goes up to Zone and
Region levels.

1. Pre-ceiling Budgeting:

Pre-ceiling budgeting is the budgeting practice at the woreda and zone levels before the region receives
its subsidy/grant from the Federal government. The process is as follows: the woreda prepares a budget
with no indicative or final ceiling from the Zone or the Region. The Finance Office will consolidate the

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budget of the sectoral offices and submit to the woreda council. The woreda executive committee will
then form a budget committee to review the budget. This budget will be sent to the zone through two
channels: one, the woreda counsel submit the budget to the zone executive committee,: second, the
woreda sectoral offices send to the zone sectoral departments. The zone executive committee will then
form a budget committee that will be chaired by the head of the Finance Department, to review the
woredas’ and zones’ budget proposal.

In passing the budget to the region it will again be through two channels. The zone executive committee
submits to the Region executive committee and the zone sectoral departments will submit to the region
sectoral bureaus. The sectoral bureaus then prepare a budget submission to the Region Finance Bureau.

2. Post-ceiling Budgeting:

Following the notification of the subsidy from the Federal government, the regional public expenditure
envelope will be determined based on the Federal subsidy, local revenue and local borrowing. Once the
expenditure envelope is set, then it will be split up between recurrent and capital expenditures. The
practice is similar to the Federal government, i.e. the allocation begins with recurrent expenditures and
the balance of the envelope will be reserved for capital expenditures.

After this stage, different regions fallow different approaches to allocate recurrent expenditure between
salary and organization and management, and to allocate capital expenditure among the different sectors.
In some regions the budget will be prepared up to line items at the region level, where as in some regions
a lump sum will be allotted to zones that will be in turn allocated to woredas,. At last, the budget will be
published in the region’s ‘Negarit gazeta’.

2.5. 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.

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2.5.1. Methods of Financing Deficit:

There are four important techniques through which the Government may finance its budgetary deficits.
They are as follows:

1. Borrowing from central bank

2. The running down of accumulated cash balances
3. The government may issue new currency
4. 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.

2.5.2. 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.

2.5.3. Effects of Deficit Financing:

Deficit financing has both positive and negative effects in the economy as under:

1. 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.

2. 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 favour of business class

3. Faster growth: Country is able to implement the developmental plans through deficit financing
thereby attaining faster growth.

4. 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.

5. Credit creation in banks: Inflationary forces created by deficit financing are reinforced by
increase credit creation by banks.

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 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.

2.5.4. 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.

2.6. Categories of Revenues to Government:

The revenues of the Government can be classified into two ways. They are:
1. On the basis of mode of collection and
2. On the basis of nature of revenue.

Let us see these classifications one by one here under:

2.6.1. Revenue on the Basis of Mode of Collection:

It can be shown with the help of the following chart:

Revenue on the Basis of Mode of Collection

Revenue on Revenue by Revenue Partly

Compulsion Voluntary by Compulsory
Payment and partly
[[[ Voluntary

1. Taxes 1. Income from 1.Special

2. Fines Public Property Assessments
3. Penalties (Rent, etc.) 2. Escheats
4. Forfeitures 2. Income from 3. Printing of
5. Tributes and Public Enterprises currency
indemnities 3. Fees 4. Grants-in-aid
arising out of 4. Licenses
war or other 5. Gifts
6. Compulsory

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 Loans
2.6.2. Revenue on the basis of Nature:

The revenues on the basis nature can be classified as in the following Figure 1.2.

On the basis of Nature of Revenue

Tax Revenue Non-Tax Revenue

Administrative Commercial Others

Tax on Tax on Tax on Revenues Revenues
Income Property Commodities Issue of
1.Fees Prices on
2.Licences goods and
currency
3.Fines
4.Forfeityres
services
5.Escheates
6.Special
Assessments
Personal Corporate
Tax Tax

Borrowings Gifts and Grants

1. From general
Customs Excise Turnover Public (Issuing of 1. With in the
Bonds etc Country
Tax Tax 2. From other
Tax Countries 2. From other
3. From other Countries
Institutions (IMF,
World Bank, etc)

Value
Added
Tax

Figure 1.2.

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 Of these two types of classifications of revenues the classification of revenues based on the nature is
considered as the ideal classification. Let us explain these items one by one.
2.6.2.1. Tax Revenue:

The revenue from tax includes the following:

1. Tax on Income: The Government imposes two types of taxes on income.

They are:

a). Tax on personal income, and

b). Tax on 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.

2. Taxes on Property:
It is the tax revenue from properties including rental income tax land use tax etc.

3. 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
levied 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 a
specified percentage on the value of sales.

 Turnover Tax is levied by the Government on the sales which are not
covered under VAT.

2.6.2.2. Non-Tax Revenues:

The following categories of revenue are included under non-tax revenue.

Administrative Revenue: It includes the following:

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(1) 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.

(2) 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.

(3) 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 than as a source of revenue.

(4) 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.

(5) 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 of a person who
dies without having any legal heirs or without keeping a will. But, it cannot be considered as
a main source of revenue to the Government.

(6) 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 get benefited. For example, irrigation facility, road and
drainage facility, etc.
Because of this, the value of the property in the neighborhood will rise. This rise in the
value will provide an unearned increment. Hence, the Government has a right to appropriate a
part of this unearned increase. This appropriation is called as special assessment.

(7) Gifts and Grants: Gifts are voluntary contributions from Non-Government donors to the Government
for various purposes like drought relief, defense, national relief, promotion of family planning,
etc. Grants are usually given by one Government to another. For example, in a federal set up, the
Union Government provides grants to the State Governments to carry out their functions and
fulfillment of obligations. Moreover, the Government of one country may receive grants from
other country.

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