3 2010 Asiyah Kassim

PUBLIC FINANCE ADM652

BudgetPublic Expenditure Reasons P. Expd Classification & CanonCost and Benefit Analysis

To explain the components of budgetTo discuss the various reasons for the brisk expansion of public expenditureTo identify the mechanism to control public expenditureTo understand the application of CBA

Derived from the French word bongette= a small bag symbolizes a bank containing the financial planThe term budget used for the financial plan by the governments in Europe back in 1733What is Budget?BUDGETDefinition: Formal estimate of the resources required for a given period of timeResource man, money, materialPeriod short & long term

B.J. Reed & John W. Swain Plan acquisition and used of resources by public entities similar to what individuals and household do when spending money.Otto Eckstein A detail statement of government expected expenditures and revenues.William Gladstone Budgets are not really a fares of arithmetic but in a thousand ways go to the route of prosperity of individuals, the relations of classes and strength of kingdomsOther Definitions of Budget?BUDGET

1. Money is limited resource -Allocating the money according to the needs of the society-There is a competing demand the allocations are based on priority2. Equitable Distribution Fund-To distribute the resource equally or reasonable (needs and situations-Taxes the rich and distribute to the poor through the Fiscal PolicyFunctions / Purpose / AimBUDGET

3. Stabilization Function-Stabilization role via the tax policy and expenditure policy-e.g. During the period of recession, the government used more resource to the extent of borrowing-e.g. During inflation govt. will tax more, encourage people to save (the govt take out the money from people to reduce the purchasing power / no demand for certain goodsFunctions / Purpose / AimBUDGET

1. Policy Tool has important impacts not only through the flows of fund but also to various fiscal policies and financial measures, as a tool to formulate policies and set priorities for the development planRolesBUDGET2. Management Tool can be used to allocate resources, distribute costs & benefits and stabilize economies as well as to present choices under the condition of scarcity

3. Control Tool as budget represents constrains (restrictions) thus, govt. officials are required to strictly adhere to the restriction terms provided in the budgetRolesBUDGET4. Political Tool political parties, administrators, interest groups and interested citizens vie one another to have their preferences to be listed in the budget (budget outcome of political compromises and bargains, victories & defeats)

5. Statement of Government Expenditures must provide clear, systematic and detailed description of its revenue and expenditures for a financial year for public reference. Hence, public aware of the activities undertaken by government. guide for government officials to perform dutiesRolesBUDGET6. Performance Measurement Tools To assist in the performance measurement of government programs in terms of efficiencies and effectiveness.

BUDGETIntroIt is an annual financial plan of the governmentInvolved 2 elements = (revenue & expenditure)Plan = it is a proposed projected revenue and proposed expenditureConsist of revenue & expenditure prepared for a period of 1 year ( short-term plan)There are two types of Budget:- Operating Budget & Development BudgetAlso involved Charged Expenditure

Types of BudgetOperating BudgetDevelopment BudgetAlso called Supply BudgetE.g. Salary / Emoluments, utility bills, repairsIt also refers to the expenditure that recur monthly or annually that could not be avoided (recurrent expenditure)Involved the acquisition of landE.g. equipment cost, construction cost, compensation on landAlso refers to projects which involved acquisition of land, equipment, consultancy & contract serviceAll 5-year development plan are put under Development BudgetE.g. Smart School, Agriculture Development

Types of BudgetDifferencesOperating expenditure on annual basisDevelopment- period between 1 5 yearsSimilaritiesBoth must become Supply BillCould not be held without parliamentary approvalCharged ExpenditureCharged = no need to get approval from ParliamentParliament has enacted legislation for this particular expenditureStraight away withdraw from Consolidated Fund

Components of Budget?BUDGETPublic ExpendituresPublic Revenues

What?Public ExpendituresRefers to expenses (federal or state) incurred by the government-provision of various public spending & services to the people e.g. education, health, security-promoting the welfare and well-being of the people-maintenance of the government defenses forces, police, civil servants, etc-maintaining the economic stability-reducing inequality of income & for reallocations of resources

What are the macro economic objectives of public expenditure?Public ExpenditureRefers to expenses (federal or state) incurred by the government-provision of various public spending & services to the people e.g. education, health, security-promoting the welfare and well-being of the people-maintenance of the government defenses forces, police, civil servants, etc-maintaining the economic stability-reducing inequality of income & for reallocations of resources

Public Expenditure Trend

YearOperating(RM)Development(RM)TOTAL(RM)1997199819992000200120022003200420052006200742,713,554,700 45,633,123,200 47,042,200,000 53,350,999,600 62,210,442,950 66,982,014,490 72,838,816,760 80,530,000,000 89,141,090,000101,246,477,910 112,985,928,000 17,268,654,900 18,491,268,800 18,053,000,000 24,674,292,000 28,836,348,460 33,536,491,630 36,962,737,700 31,960,000,000 28,303,894,600 35,502,044,600 46,510,219,00059,982,209,600 64,124,392,000 65,095,200,000 78,025,291,600 91,046,791,410 100,518,506,120 109,801,554,460 112,490,000,000 117,444,984,600 136,748,522,510 159,496,147,000

Reasons for the Growth ofPublic Expenditure in MalaysiaExpansion in the Activities of the GovernmentThe Growth of Social Security / Social Assistance SchemeDevelopment of AgricultureMeeting Defense NeedsRising Trends of PricesIncrease in administrative costUrbanization economic stMaintainingability through fiscal policyEconomic DevelopmentIndustrial DevelopmentRural DevelopmentTourism Development

Reasons for the Growth ofPublic Expenditure in MalaysiaIntroduction of New TechnologyIncreasing PopulationInternational RelationsImplementation of 5-Year PlanGlobalizationMismanagement of Fund / MaladministrationImplementation of Mega / Prestige ProjectsPolitical Activities

1. Classification by CategoriesClassification ofPublic ExpendituresOperating Expenditure; (Supply)-denoted by the letter B=bekalanCharged Expenditureshown by the letter T=tanggunganDevelopment Expenditure; (project which involved acquisition of land, equipment, construction and compensation)-denoted by the letter P=pembangunan

2. Classification by SectorClassification ofPublic ExpendituresDivided into:-(i) Economy services (agricultural, mineral resources, transportation, communication utilities, trade & industry, public utilities)(ii)Social Services (education, healthcare, information, housing, culture, youth & sports, welfare services)(iii) Security (Ministry of Defense)(Internal Security, External Security)

2. Classification by SectorClassification ofPublic ExpendituresGeneral Admin(Services of all agencies, ministries, departments, universities e.g UiTM 300,000 mil annually)(v)Transfer Payment(All the grants and loans to the states)(vi)Specific Obligation(Charged expenditures, pension & gratuities, debt, service charges, interest)

3. Classification by General ObjectClassification ofPublic ExpendituresOn items of expenditureDivided into:-Emoluments - Code 10,000 (Salary & Remuneration)Supplies & Services Code 20,000 (buy / maintain/ repair e.g aircondAssets Code 30,000 (Purchase of equipment / government assetsGrants & Transfer Code 40,000 (transfer of money to state universities, PEs, Statutory Bodies

General Object10000 Emoluments20000 Services and Supplies30000 Assets40000 Grants and Fixed Charges50000 Others ExpenditureTOTALYear200623,586,575,71520,553,979,9151,608,062,94054,993,809,530504,049,810101,246,477,910200522,241,481,99618,790,128,2641,414,421,59046,263,928,540431,129,61089,141,090,000200420,933,872,96017,215,514,155768,494,10339,426,938,0092,185,180,77380,530,000,000200319,727,373,93714,253,002,5991,612,982,44934,514,289,8752,731,167,90072,838,816,760200217,581,347,01712,065,207,1871,532,739,43133,328,009,9752,474,710,88066,982,014,490200116,921,053,41010,078,049,9031,149,547,59532,135,234,4921,926,557,55062,210,442,950200014,607,733,0107,564,036,760610,145,96028,370,827,9802,198,255,89053,350,999,600

4. Classification by Program / ActivityClassification ofPublic Expenditures-Codes (6 digits) are assigned for programmes: 010000 to 380000 for Ministry of Education-Examples: 010000 Corporate Mgmt & Audit (P) 010100 Corporate Mgmt (A) 010200 Policy & Quality (A) 010300 Schools Audit (A)-Parliament give allocation based on programmes-The idea is to capture how much to spend / to capture accounting information or data-e.g Ministry of Health Hospital Service Program

Def: Rules / Principles that has to be followed by the government when incurring expenditures-This principles have been suggested by economistWhy?1. They believed public expenditure has to be made according to priority2. To avoid waste3. To avoid extravagance & unnecessary spending want government to be thrifty4. Made to produce wealth, goods that we can earn some income for the country, to enhance national productivity5. To maximize benefits6. Want to have equitable distribution of wealth ( tax the rich, social assistance, programme of eradicating poverty)Canon ofPublic Expenditures

Types of CanonCanon ofPublic Expenditures1.Canon of Benefit-When public expenditure is incurred, they must be the social advantage (maximum social benefits to the citizen)-Must benefit all members of society / nation regardless of race, religion & background-Must benefit all section of society-Concept: Greatest happiness of the greatest number = everyone in the society must be able to have the benefit from the expenditures-Why acceptable? it benefits all, critical especially in multiracial country

Types of CanonCanon ofPublic ExpendituresProblems / Weaknesses:--how do we measure national unity benefits?-e.g. how do we measure enjoyment?-certain things are not quantifiable / some activities are intangible cannot be measured

Accepted or Not?-useful to developing countries

Types of CanonCanon ofPublic Expenditures2.Canon of Economy-most developed and developing countries use this rule-to avoid corruption-to protect the interest of tax payers-avoiding lavish spending (extravagance) / thrifty-must not implement programme that does not benefit the society-the spending must be able to generate income/revenueUseful Principle-advises government throughout the world future-help the businesses to meet the consumer demand-multiplayer effect for productive purpose

Types of CanonCanon ofPublic Expenditures3.Canon of Sanction-means approval= public expenditure must be incurred only after approval and it is made according to the authority-Art 99 & 100 budget must be submitted to the Parliament every year-Parliament is considered as the sanctioning authority-Only those who has the authority can approved itReasons:-The approved fund will only be used for that particular purpose-To take it as mandatory that fund must first be approved

Types of CanonCanon ofPublic ExpendituresWhy accept?-to control expenditure-to make the expenditure legal or authorized-to avoid corruption, especially in developing countries

Types of CanonCanon ofPublic Expenditures4.Canon of Surplus-means: access (balance, deficit, surplus)-surplus: revenue is more than expenditure-government must avoid deficit budget-they must spent less from what they have earned and keep it for the future-surplus fund has to be spent to face the emergency needs e.g. flood, earthquake, war-unnecessary borrowing has to be avoided

Types of CanonCanon ofPublic ExpendituresProblems / Weaknesses:--not applicable during recession-certain condition (economic) are unpredictablePractical or not? Pragmatic or not? Accepted?Government could not administer the country w/o fund-according to the eco. Principles, government need to spend more during inflation & recession-not so pragmatic expenditures depends on the current situation esp, during economic crisis-it is only practical when there is a boom in economy-Only countries like Japan and US ever used this rule

Types of CanonCanon ofPublic Expenditures5.Canon of Elasticity-means: flexible = can be changed according to the needs / circumstances-the expenditures must be flexible-the policy must be adaptable according to the situation-recession spend more / inflation spend less-e.g. danger / threat from enemy government has to spend more money on defense systemGood or not ?-a very pragmatic principle-acceptable to all countries globally

Types of CanonCanon ofPublic Expenditures6.Canon of Productivity-means: performance-guidance for developing countries-focus more on agriculture and industrial sectors-development of roads, schools-industrial goods (export and import)-the government should encourage productive activities to offer more benefits to the society offer more job opportunities (employment opportunity is the main obj)-must be maximum output-greater income element to enhance national output-production will not depends heavily from other countries import

Types of CanonCanon ofPublic ExpendituresAcceptable or not?-industrial & agricultural goods emphasized national production that can generate income-useful to developing countries to focus more on industrial and technological means-can be considered as the perfect canon of expenditures for developing countries to achieve higher economic growth

Types of CanonCanon ofPublic Expenditures7.Canon of Equitable Distribution-to reduce the inequitable distribution of wealth or national income-public expenditure should reduce the gap / disparities between the have and have not-more money should be allocated to the poor rather than the rich e.g. social assistance sheme, subsidies-to help increase the income of lower income group-assistance: loans, better health, housing, welfare, education

Types of CanonCanon ofPublic ExpendituresUseful or not?-useful to the country glaring inequitable income eg. India, China and Pakistan and most countries in Africa

Weaknesses-burden the rich people-poor people will fully depends on the government

Cost-Benefit AnalysisCost-benefit analysis is a valuable tool for evaluating the net benefits of proposed government projects. It represents a practical technique for determining the relative merits of alternative government projects over time. Use of cost-benefit analysis can contribute to efficiency by making sure that new projects for which marginal social cost exceeds marginal social benefit are not considered for approval.It can be used to organize information in a way that aids citizens, politicians, and bureaucrats in making choices among alternative government projects.CBA is not a new tool. It has been used in US since 1900.Essentially, there are 3 steps involved in CBA:-Enumerate all costs and benefits of the proposed projectEvaluate all costs and benefits in Ringgit / dollar termsDiscount future net benefits.Introduction

1) Enumerating Benefits and CostsFirstly is to define both the project under consideration and its output. Once this is done, the analyst can proceed to enumerate the costs incurred and the benefits generated over the life of the project.Benefit can be divided into two categories: direct and indirect.Direct Benefits = those increases in output or productivity attributable to the purpose of the project. Eg. Irrigation project: The purpose is to increase the fertility of a particular track of land. The direct benefits in this case will be the net increase over time in agricultural output on the land being irrigated. Indirect, or spillover, benefits = those accruing to individuals not directly associated with the purpose of the project. In an irrigation project, spillover benefits might include the improved fertility of adjoining land that is not actually irrigated by the scheme.In enumerating benefits, only real increases in output and welfare are considered. Care must be exercised not to double-count benefits.

1) Enumerating Benefits and CostsDouble Counting still occur on various occasion.Problem with definition of indirect or spillovers, effects of a project. In some cases, analysts include as a benefit the extra profits of third parties not directly affected by a project.For some projects, enumeration of benefits is difficult. How are the benefits of an education program or a health program defined? Again the answer must yield a quantifiable result that avoids double counting.In enumerating costs of a project, listing direct resource costs gives only a partial account of real cost when external costs also will occur.Any costs not reflected in the prices of inputs must be included. E.g. a new project in a given area will have the effect of reducing water resources available to nearby agricultural land. The corresponding reduction in agricultural output must be included as a cost of the project.Problems

2) Evaluating Benefits and CostAfter all costs and benefits have been satisfactorily enumerated, the nest step is to evaluate these costs and benefits in dollar terms.Valuing output requires and estimate of the demand for increased production and calculation of consumer surplus. When the outputs of particular programs are not sold in markets, the problem of valuation is difficult. Surrogate (substitute) measures of the willingness of beneficiaries to pay for outputs that are not sold must be obtained. E.g. although the benefits of many public health programs are consumed collectively, the value of these benefits might be reflected in increased earnings of those whose health is improved by the project.An additional problem occurs with outputs and inputs that are marketable but have prices that do not reflect their true social value. This results when any output attributable to a project is sold in monopolistic markets, when external effects are generated by production of the output.

Here the step involved is, the choice of an appropriate discount rate is of crucial importance. The need to discount stems from the existence of positive interest rates in the economy.Positive interest rates imply that a dollar of benefits in the future will be worth less than an equivalent dollar of present benefits, because it takes less than a dollar of resources invested today to produce a dollar of resources tomorrow, when interest rates are positive.In general, the present value of X ringgit to be received n years from now at simple interest rate r is obtained by solving the equation: X=PV (1+r)n or PV=X/(1+r)n 3) Discounting Future Net Benefits

It is no more important than the proper enumeration and evaluation of costs and benefits. an analysis that uses the correct discount rate but seriously miscalculates costs and benefits will produce results as misleading as a study that uses a zero discount rate.The higher discount rates result in fewer government projects that can be approved. Insofar, as the discount rate reflects the return to private consumption and investment, a higher rate implies that the opportunity is greater. This in turn, implies that efficiency requires a relatively smaller amount of government expenditure as a percentage of GDP.Economic efficiency must always become the main priority in weighting or aggregating the projects.How Discount Rate Affects the PV of Projects?

Avoid Double Counting avoid miscalculates costs and analysis consider externalities both positive and negativeChoose the right social rate of discountAvoid from modifying techniques to build in equity as well as efficiency criteria in ranking projects to be doneTreatment of inflation both benefits and costs could be measured through time in nominal values by estimating the rate of inflation over time and inflating both future benefits and costs accordinglyRanking projects according to the present value of their discounted net benefitsAvoid any biasness, discrimination in doing the analysisPREVENTING ERRORS IN CBA?