UNIT TWO

BUDGETING
Section One
The Concept of Budgeting
Definition of Budget
The word Budget originally meant the moneybag or the public purse
The budget has become the powerful instrument for fulfilling the basic
objectives of government
The budget covers all the transactions of the 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
Budget is a guideline for decision making and center of government
revenue and expenditure for a specific period of time, usually a year
Thus budget is an annual statement of receipts and payments of a
government
Definition of Budget…ctd
Another type of financial plan which is slightly different from a
budget is vote on account
Vote on account pertains only to the expenditure side of government
budget and does not show the revenue side of the budget
Vote on account occurs only in care taker governments which are not
expected to present the budget in full manner
o There are two types of budget as far as the relative amount of
revenue and expenditure is concerned:
• Balanced budget: is a type of budget where anticipated revenue is
equal to anticipated expenditure
• Unbalance budget: is when there is imbalance between anticipated
revenue and anticipated expenditure
Definition of Budget…ctd
• There are two types of unbalanced budget known as surplus budget
and deficit budget
• Most classical economists preferred balanced budget or surplus
budget because the basic objective in classical economic thinking is
achieving high saving, and they assumed that as saving is higher
growth will be higher
• However, now a days, that is not the case as we find deficit budget in
most cases and this is because governments expend more for
development activities
• The governments finance the deficit in budget using different
methods such as borrowing and money printing
Advantages and Functions of Public Budgeting
• The advantages and functions of government budgeting can be discussed in
terms of four aspects
The first is that government budget can be used as an instrument of planned
implementation.
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
Budgeting helps to ensure efficiency and effectiveness in the implementation of
government programs, and it is also helpful to relate all major decisions to the
state of the national economy.
Advantages and Functions …ctd
 Secondly, budgeting helps proper allocation resources b/n competing needs
& to relate expenditure decisions to specified policy objectives and to
existing and future resources
 From a normative standpoint, the role of the budgeting process is to allocate
scarce resources to their most highly valued uses
 To accomplish this, the government must first assess the relative worth of
various programs to decide whether they should be produced in the public
sector
 Then the government must decide whether the resources are available for
the programs and to what extent. Some programs that appear worthwhile in
isolation may not be feasible within the context of, the overall budget if the
revenue cannot be generated at a reasonable cost
 Possible areas of public spending must be weighed against one another in
light of the opportunity cost of raising resources to pay for the program
Advantages and Functions …ctd
Thirdly, budgeting can be used as instrument for regulating the
economy
The objective of budget policy is to take corrective measures or to
adopt regulatory policies to remove imperfection or inefficiencies of
market mechanism
Budget policy is an important instrument to maintain a high level of
employment, reasonable degree of price stability and an appropriate
rate of economic growth
Besides, the budget policy is instrumental in the provision of public
goods and services
It means that the objective of budget policy is to ensure equitable
distribution of income and wealth
Advantages and Functions …ctd
• Fourth, budgeting can be used as an instrument for strengthening
public accountability in the use of resources
• Budgeting is an instrument for democratic control over the executive –
legislative control over the executive
• The executive cannot arbitrarily impose taxes on the people without
the sanction of the legislative – budget is expression of ultimate
legislative authority
• The executive is accountable to the legislative and it must control the
administrative agencies. Budget shows the development of two way
ladders of responsibility:
• Executive – Administrative Agencies
• Executive – Legislative
Qualities of a Good Budget
• A good budget has the following qualities. However, in practice,
governments with excellent budgetary systems may violate some of
these principles.
i. Comprehensive: the budget should clearly show the financial
position of the government in all aspects
ii.Clarity and publicity: the budget must be clear and it should get
publicity
iii.Reliable: the budget should be reliable as much as possible
iv.Exclusive: the budget should deal only with financial matters, not
other legislations
Qualities of a Good Budget…ctd
v. Unity: the budget mechanisms should be in unity. It should be
presented in gross terms, in terms of total revenue and total
expenditure
vi. Annual: it should cover one fiscal year
vii. Accurate: the revenues and expenditures should be accurately
estimated
 Section Two
Budgetary Cycle and the Budgeting Process

Budgeting and Programming

There is a strong r/sh b/n gov’t budget & gov’t programs
Government has different programs and these programs must be
related with the budget. In other words the budgeting and
programming must go hand in hand.
The previous year’s budget determines the programs which are being
conducted currently and the current year’s budget shapes the programs
which are to be recommended in the budget under preparation.
This is because; most of the time, the lifetime of programs is more than
one year and require subsequent funding in subsequent years
Budgeting and Programming…ctd
In a static world we can assume there is no change in population,
technology, etc. & in such a situation the r/sh b/n programming &
budgeting is very simple
But it is unrealistic to assume to be in a static situation b/c we live in
a world of dynamic situations where d/t variables change
These changes affect the smooth implementation of gov’t programs
So, there should be through consideration & flexibility in the
budgeting process. That is why in many countries the budgeting and
programming processes take many months.
Phases of the Budget Cycle
• The budget cycle has four phases
Phase 1: Budget preparation
At the beginning of the budget cycle the budget office makes a budget call.
The budget call shows the necessary information to be provided by the
units such as technical information, reports to be provided by the units and
forms to be filled by the units.
Together with the budget call, a specific letter is sent. This letter shows the
economic assumptions on which the budget is going to be prepared – for
instance, whether national income is going to increase or decrease and the
amount of increase or decrease, the price level increase, etc.
This forms the basis for the estimation of the costs of the materials and
supplies.
Phases of the Budget Cycle…ctd
The budget preparation starts at operating levels
The budget office conducts a discussion with departments & agencies
regarding their requirements for the coming year, & the acquired
information forms the framework for the budget for the next year.

In addition, there are budget hearing meetings, which are internal to
the budget office.

These meetings are not given publicity because there are Senior
Budget Examiners attending the meetings. Budget hearing meetings
can also be conducted informally.
Phases of the Budget Cycle…ctd
The budget officers of each operating units attend the meetings and
defend their estimates which they have submitted.

The budget examiners ask so many questions regarding the estimates

and in responding to these questions the budget officers of the
operating units can take assistance of their technical staffs.

On the basis of the budget hearing meetings, the examiners propose
recommendations and it will be transmitted to the concerned body
for approval.
Phases of the Budget Cycle…ctd

Phase 2: Budget approval

The proposed budget needs to be approved by the parliament

This bill to be presented to the parliament is called appropriation bill

 The parliament discusses on this bill and parliamentary members can

express their ideas and suggest changes

This bill has to be voted and endorsed by the parliament

Phases of the Budget Cycle…ctd
Phase 3: Budget apportionment
It is a procedure for release of budget authorizations
After the budget is endorsed by the parliament, there comes the
issue of budget authorization.
Budget authorization is related with the authority to spend the
endorsed budget.
There is some difference in budget authorization. Some budget
authorizations are directly given to the spending agencies and
departments, while budgetary items such as military expenses are
given to the President or the Prime Minister
Phases of the Budget Cycle…ctd

 Budget apportionments are cumulative in nature that an amount

which is not used in one period is available for spending in latter
periods of the same fiscal year

But the agencies must report the current status of cumulative

apportionments, expenditures, etc.
Phases of the Budget Cycle…ctd
Phase 4: Auditing – the resource control
• In most countries, there is an office called General Audit Office (GAO).
The function and responsibility of this office is settlement of the
accounts of public funds.
• There are different types of auditing conducted by this office:

a) General auditing: is examination of accounts of administrative

offices which have been entrusted with public funds
• The General Auditing Office examines the legality of all the
transactions of administrative offices
Phases of the Budget Cycle…ctd
b) Commercial auditing: is mainly used in case of government
enterprises and corporations.
• These enterprises maintain their accounts on commercial basis in
forms such as balance sheets and profit and loss accounts.
• The General Auditing Office examines the legality of such accounts.
c)Comprehensive auditing: this type of auditing is used for agencies
and departments which have established their systems of accounting.
• The General Auditing Office examines the legality of the transactions
of such agencies and departments based on the criteria set by their
system of accounting.
Phases of the Budget Cycle…ctd
• After auditing the General Auditing Office sends a report to the
parliament and the parliament can conduct investigations about the
financial matters
 Section Three
Structure and Components of a Budget
Receipt
Government Accounts
• The three most important kinds of government accounts are
consolidated fund, contingency fund and public account
Consolidated fund: all the revenues of the government go to the
consolidated fund
Spending from the consolidated fund requires the permission of the
legislative
Government Accounts…ctd

Contingency fund: is another type of fund which is used to meet

unforeseen expenses and urgencies
This fund is kept in the form of imprested money and it is at the
disposal of to the President or the Prime Minister (the HoS or HoS).
Contingency fund can be withdrawn without approval of the
parliament and latter it will be replenished that an equivalent amount
will be withdrawn from the consolidated fund with the approval of
the parliament and deposited with the contingency fund.
Government Accounts…ctd
Public account: in this case the government acts like a banker as this
account is established from small savings and collections from the
public such as provident fund and pensions

Such funds are retained by the government, but it is to be repaid to

the public latter

The government can cover some of its expenditures from public

account and latter reserve it back from its revenue. Parliamentary
authorization is not necessary for expenditures from public accounts.
Budget Structures
o Budget structures are the formats that organize budget data.
o The structure of the government budget can be discussed in terms of
two ways of classification.
• The first classification is b/n revenue budget & expenditure budget,
and
• The other way is in terms of the classification b/n recurrent & capital
budget.
• These classifications are discussed below.
 Revenue Budget Vs Expenditure Budget
Revenue Budget
Revenue budget represents the annual forecast of revenues to be raised by
gov’t through taxation & other discretionary measures
Ordinary revenues include both tax & not-tax revenues
The tax revenues being
 Direct taxes (personal income tax, rental income tax, business income tax,
agricultural income tax, tax on dividend &chance wining, land use fee & lease)
 Indirect taxes (excise tax, sales tax, service sales tax, stamps & duty); & taxes on
foreign trade (customs duty on imported goods, duty & tax on coffee export)
Non-tax revenues include charges and fees; investment revenue; miscellaneous
revenue (e.g. gins); and pension contribution.
Revenue Budget…ctd
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 & bilateral creditors mostly for capital projects, & grants.
Expenditures Budget
Government expenditures for administration and developmental
activities are handled through the expenditures budget.
Expenditure budget can be categorized in two ways.
The first way categorizes expenditure in to plan & non-plan
expenditure
The second way categorizes expenditure into recurrent and capital
expenditures
Expenditures Budget…ctd
Plan Vs Non Plan
Plan expenditure shows provision of fixed amount of expenditure for
various ministries & regional gov’ts for their plans & schemes
It includes both recurrent expenditure & capital expenditure

Non-plan expenditure is expenditures which are not included in the

plans
It includes both developmental and non-developmental expenditures
Non-plan expenditure includes interest payment, pension payments,
defense expenditure, internal security, etc
Recurrent Vs Capital expenditures

The categorization of expenditure into recurrent & capital

expenditures 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 in the economy is financed through external borrowing and
grants
Recurrent Vs Capital Budget
• The definition of recurrent & capital budgets has been a common problem in most
countries. The problem relates to delineating, w/c specific expenditures need to be
included in the recurrent budget & w/c ones in the capital budget.
• In practice three criteria have been in use to define budget into capital & recurrent.
These are sources of finance, object of expenditure, & nature of activity.
• Capital budgets were originally defined by western gov’ts 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), & objective
specific.
Recurrent Vs Capital Budget…ctd
a) Recurrent Budget
• Recurrent budget consists of recurrent receipts and recurrent
expenditure.
• Recurrent receipts include tax revenues and non-tax revenues.
• Recurrent expenditure, on the other hand, can be plan or non-plan
expenditure.
• Recurrent expenditure is supposed to be met from recurrent receipts.

• Recurrent expenditure is used for the normal running of government

departments and it does not lead the creation of any kind of asset.
Recurrent Vs Capital Budget…ctd
b) Capital Budget
• Capital budget consists of capital receipts and capital expenditure.

• Capital receipts can take d/t forms like borrowing from the central
bank, loans raised by the gov’t from the public w/c is called market
loan, & loans received from abroad including external assistance.

• Capital expenditure includes government expenditure on items like

land, buildings, machineries, equipments, etc. This is why capital
expenditure is sometimes called development expenditure.
Recurrent Vs Capital Budget…ctd

In relation with the above budget components, there are two
important types of deficits called recurrent deficit and budget deficit

These types of deficits can be given by the formula below.

• Recurrent Deficit = Recurrent Receipts – Recurrent Expenditure

• Budget Deficit = Total Receipts – Total Expenditure (on both

revenue and capital accounts)
Recurrent Vs Capital Budget…ctd
In most of the third world countries there is always deficit in the
recurrent account & the gov’ts have to borrow to cover such deficits.

In principle, there should always be surplus in the recurrent budget &
this surplus has to be used to finance the capital expenditure. But this
is an ideal situation.

In practice, most countries have recurrent deficit as a result of

problems in recurrent receipts, especially tax revenue because of
corruption and inappropriate tax collection practices that allow tax-
evasion and tax-avoidance.
Section Four: Systems of
Budgeting
Types of Budgeting Systems
Incrementalism
As one way of budget determination, incrementalism suggests that an
agency’s budget in one year will tend to be its last year's budget plus some
additional increment
The gov’t budget is complex & with so many agencies demanding &
receiving appropriations, it is difficult to fully review each agency's
requests
This is especially true when the agencies produce nothing relating to
profits and losses by w/c spending can be evaluated
As a result, incrementalism suggests that the budgets of gov’t agencies
will tend to be incrementally larger than they were the previous year
Incrementalism…ctd
The influences of special interests, including the agencies themselves,
are an important element in the budgetary process.
Each program has constituents that benefit from the program and,
therefore, will be very knowledgeable about it.
To eliminate, or even reduce, the program will harm these special
interests while perhaps benefiting the general public, but recall that the
general public tends to be rationally ignorant of most of what the
government does.
This means that individuals probably will be unaware of the benefits of
reducing the expenditure.
As a result, political pressure ends to work toward expansion rather
than reduction of existing programs.
Incrementalism…ctd
Incrementalism can easily be understood from two different
perspectives.
• It makes sense within the framework of the special interest theory of
gov’t.
• Whereas special interests want to see appropriations to the programs
that benefit them increased, the general public has little incentive to
lobby for a cut in a program b/c the benefits from a cut will be dispersed
throughout the nation & would not benefit anyone very much.
• Thus, concentrated interests have more influence than the diluted
interest of the general public.
• For political reasons, the way to maximize political support is to spread
the budget increases around so that everyone gets something.
Incrementalism…ctd
• Incrementalism also makes sense when the complexity of gov’t
spending is considered, keeping in mind that there is no profit & loss
indicator to suggest where federal expenditures are being best spent.
• In the absence of a clear-cut indicator of the success of a gov’t
program, a legislature may be able to do no better than to increase
program budgets by about the same amount.
• Programs that appear to be more successful might be increased a
little more, while those that appear unsuccessful might be increased a
little less, but on programs for which there is no clear consensus,
increases might take place at roughly the same rate.
Incrementalism…ctd
• Programs that are popular or that show increasing demands will be
increased by larger increments, while those that are less in demand
will receive smaller budgetary increments.
Program Budgeting Vs Line-item Budgeting
A program budget groups expenditures by the program goals they
are intended to achieve
A line item budget groups expenditures by the types of items that are
purchased

For example, a university’s budget might be organized according to

line item, including expenditures for faculty salaries, utilities, office
supplies, building maintenance, and so on

Alternatively, the budget could be composed of expenditures on

business education, arts & sciences, engineering - a program budget
Program Budgeting Vs Line-item
Budgeting…ctd
Each of these budgets could be broken down further, of course

In the line item budget, office supplies would include paper, pencils,
and photocopier toner

In the program budget, business education could be broken down

into economics, accounting, finance, and so on

The principle is that line item budgets enumerate the items

purchased, whereas program budgets enumerate the objectives
sought
Program Budgeting Vs Line-item
Budgeting…ctd

Line item budgets can be useful at times, but they do not give much
insight into whether the budgeted expenditures are being effectively
spent

To evaluate the effectiveness of government expenditures, they

should be grouped by program wherever possible, so that the costs of
attaining certain objectives can be compared with the benefits
The Planning-Programming-Budgeting System
Has its origin in the American government

When President Kennedy took office in 1961, he instituted a reform

in the procedure by which the Bureau of the Budget evaluated
projects

He instituted a system called Planning- Programming-Budgeting

System (PPBS), in w/c gov’t expenditures were grouped by objective
to facilitate the undertaking of cost-benefit analyses of the programs
The Planning-Programming-Budgeting System

Under PPBS, the government

 First defined the objectives sought by the government activity,
 Then considered alternatives for achieving the objectives, and
 Finally undertook cost-benefit analyses that would compare the
costs and benefits of each alternative
President Johnson was so impressed with the system that in 1965 he
required all executive agencies in the federal government to
participate in PPBS
The requirement was dropped under President Nixon in 1971, but,
by then, cost-benefit became a standard part analysis was firmly
established as a tool for evaluating the merits of federal programs
The Planning-Programming-Budgeting System
If a program requires major overhaul, a cost-benefit analysis would
be likely to give some indication, but the analysis itself does not give
an indication of how the program should be changed
Typically, a cost-benefit analysis of a current program will show that it
is cost-effective as it is
This type of analysis is likely to be most useful when considering
whether a new program should be implemented
The PPBS system originally implemented by President Kennedy has
not been maintained into the present, but one concept that has
survived is the use of program budgets to help evaluate the cost-
effectiveness of government spending
Cost-Benefit Analysis
 The principle of cost-benefit analysis is fairly straightforward - one
simply compares the costs and benefits of a program to see that it
generates net benefits
 Typically carried out when a program is in its planning stages to see
whether the program should be enacted
 This requires that both the costs and the benefits of a project be
weighed, which means that they first must be estimated
Cost-Benefit Analysis…ctd
Steps
Step one: Enumerating the options
• The first step is to enumerate the options available

• Sometimes the only option will be to undertake or not to undertake

the project, but often other options will present themselves

• For example, if a bridge is being considered, a number of potential

sites may exist, several types of bridges might be built, and even the
number of lanes can vary; perhaps a ferry would be better than a
bridge in some locations
Cost-Benefit Analysis…ctd
Step two: Enumerating the costs and benefits
o The next step is to enumerate the costs and benefits of each option,
thus allowing the analyst to see what costs have to be compared with
what benefits
o Enumeration of the costs and benefits is not always easy
o Not only might some benefits or costs be over-looked, but some
might also be counted twice if the analyst is not careful

o In addition, there may be secondary effects that should be included in

the analysis
Cost-Benefit Analysis…ctd
Step three: Converting the costs and benefits to monetary terms
• Once the costs and benefits are enumerated, they must be converted
to monetary terms so that they can be compared
• The costs are usually easier to estimate than are the benefits because
they tend to be expressed in the form of money
• By contrast, the benefits of government programs usually do not
accrue as money
• A successful cost-benefit analysis must attempt not only to enumerate
but also to attach monetary figures to the costs and benefits of a
project so that they can be compared on the same terms
End of Unit Two!