Notes on Public Expenditure: Meaning & Nature, Canons /Principles of Public Expenditure

Public Expenditure: Meaning & Nature, Canons of public expenditure/Principles of Public Expenditure

 

Meaning

Public expenditure is spending made by the government of a country on collective needs and wants such as pension, provision, infrastructure, etc. Throughout the 19th Century, most governments followed laissez faire economic policies & their functions were only restricted to defending aggression & maintaining law & order. The size of pubic expenditure was very small.But now the expenditure of governments all over has significantly increased. In developing countries, public expenditure policy not only accelerates economic growth & promotes employment opportunities but also plays a useful role in reducing poverty and inequalities in income distribution.

Definition

“Public expenditure refers to the expenditure incurred by the central,state  or local government of a country for its own administration,social welfare,economic development and for providing help to other countries.”

Nature of Public Expenditure

The nature of public expenditure differs from country to country as per the needs and requirements of the country.In developing country,like India,government has a unique role to play with a vision of socio-economic makeover and attainment of higher rate of growth with social justice. Public spending in developed countries is basically undertaken to check the fluctuation in effective demand.In developing countries  public expenditure has the objective of socio-economic transformation and positioning a leading big emerging economy in the global setting in a developed country status.Public expenditure has multiplier effect on level of output and employment.As the public expenditure is made by the government for public goods,it also raises the real income and quality of life.But on one hand it has potential to raise the standard of living at the same time it also has the tendency to push up the price by injecting the purchasing power.So cost of living also increases.

Canons of public expenditure/Principles of Public Expenditure

There are several principles suggesting maximization of gains of public expenditure.These principles are called canons of public expenditure.

1.Canon of Benefit

Findly Shirras states “ Other things being equal,public expenditure should be made in such a way that society gets major benefits which, in turn,may increase production,protect against external aggressions maintain the internal order,and may possibly reduce the economic inequalities. “

Acheivement of these objectives can be possible only when public expenditure is made  not for an individual or a class,but for the whole society.By studying the effect of public expenditure on the distribution of income and wealth productioneconomic development etc. assessment can be made regarding their benefits.A major canon of public expenditure is the canon of maximum social benefit.

2. Canon of Economy

It implies that public expenditure should be incurred carefully and economically. Economy here means avoidance of extravagance and wastages in public spending. Public expenditure must be productive and efficient.

Hence, it must be incurred only on very essential items of common benefit, without duplication, in a way that involves minimum cost. An efficient system of financial administration is, therefore, very essential in any country.

3.Canon of Sanction 

Another important principle of public expenditure is that before it is actually incurred, it should be sanctioned by a competent authority.  Unauthorised spending is bound to lead to extravagance and over-spending.  It also means that the amount must be spent on the purpose for which it was sanctioned. As a rule, therefore, money must be spent on the purpose for which it is sanctioned by the highest authority and accounts be properly audited.

4. Canon of Surplus

Findly Shirras states “ Other things being equal,public expenditure should be made in such a way that society gets major benefits which, in turn,may increase production,protect against external aggressions maintain the internal order,and may possibly reduce the economic inequalities.”

This canon suggests that saving is a virtue even for the government, so an ideal budget is one which contains an element of surplus by keeping public expenditure below public revenue. In other words, it means that the government should avoid deficit budgeting in the interest of its own creditworthiness.

5. Canon of elasticity

Another same principle of public expenditure is that it should be fairly elastic.  It should be possible for public authorities to vary the expenditure according to the needs.  A rigid level of expenditure may prove a source of trouble and embarrassment in bad times.  Alteration in the upward direction is not difficult.  But elasticity is needed most in the downward direction.  It is not so easy to cut down expenditure.  When the economy axe is applied, it is a very painful process.  Retrenchment of a widespread character creates serious social discontent.  Perfect elasticity is out of question.  But a fair degree of elasticity is essential if financial breakdown is to be avoided at the time of shrinking revenue.

6.Canon of Productivity

Public expenditure should stimulate productivity.Public expenditure should be made in such a way that it fosters capital formation and generated employment opportunities alongwith increases levels of productivity and employment opportunities.

7. Canon of Equitable Distribution

Public  expenditure should help equitable distribution of wealth.The government should make expenditure  so as to provide more benefit to the backward section of the society.

8. Canon of Certainty

The areas in which public expenditure is to be made should be certain so that the development works may be carried out properly.The government should determine with certainty the allocation of public expenditure to various uses.

9. Canon of Co-ordination

The items and amounts on which public expenditure is to be made by central,state and local self governments should be clearly demarcated.Their should be proper co-ordination among different governments so that dual expenditure on same item can be avoided.

10. Miscellaneous

Some other canons are:

i. While making expenditure various works should be given priority according to their relative importance.

ii. Mode of expenditure should alos be kept in mind

iii. Both short term and long term effects of public expenditure should be kept in mind

iv. While making public expenditure,population of the country,its area,its physical resources etc. should be kept in mind.

Revenue Expenditure and Capital Expenditure of India!

An expenditure that neither creates assets nor reduces a liability is categorised as revenue expenditure. If it creates an asset or reduces a liability, it is categorised as capital expenditure.

This is the basis of classification between revenue expenditure and capital expenditure.

(a) Revenue Expenditure:

Simply put, an expenditure which neither creates assets nor reduces liability is called Revenue Expenditure, e.g., salaries of employees, interest payment on past debt, subsidies, pension, etc. These are financed out of revenue receipts. Broadly, any expenditure which does not lead to any creation of assets or reduction in liability is treated as revenue expenditure.

Generally, expenditure incurred on normal running of the government departments and maintenance of services is treated as revenue expenditure. Examples of revenue expenditure are salaries of government employees, interest payment on loans taken by the government, pensions, subsidies, grants, rural development, education and health services, etc.

It is a short period expenditure and recurring in nature which is incurred every year (as against capital expenditure which is long period expenditure and non­recurring in nature). The purpose of such expenditure is not to build up any capital asset, but to ensure normal functioning of government machinery. Traditionally, all grants given to state governments are treated as revenue expenditure even though some of the grants may before creation of assets.

(b) Capital Expenditure:

An expenditure which either creates an asset (e.g., school building) or reduces liability (e.g., repayment of loan) is called capital expenditure.

 (A) Capital expenditure which leads to creation of assets are (a) expenditure on purchase of land, buildings, machinery, (b) investment in shares, loans by Central government to state government, foreign governments and government companies, cash in hand and (c) acquisition of valuables. Such expenditures are incurred on long period development programmes, real capital assets and financial assets. This type of expenditure adds to the capital stock of the economy and raises its capacity to produce more in future.

(B) Repayment of loan is also capital expenditure because it reduces liability. These expenditures are met out of capital receipts of the government including capital transfers from rest of the world.

Comparison between Revenue Expenditure and Capital Expenditure

Revenue Expenditure	Capital Expenditure
1. It is incurred for normal running of government departments and maintenance.	1. It is incurred for acquisition of capital assets.
2. It does not result in creation of assets.	2. It results in creation of assets.
3. It is recurring in nature and incurred regularly.	2. It is non-recurring in nature.
4. It is short period expenditure.	4. It is generally a long period expenditure.
5. For example, expenditure on medicines and salaries of doctors for rendering services is	5. For example, construction of a hospital building is capital expenditure.

(i) Developmental Expenditure

Developmental expenditure refers to the expenditure of the government which helps in economic development by increasing production and real income of the country. Some people call it productive expenditure because it helps in increasing production and productivity of the economy.

Developmental expenditure on revenue is divided into developmental expenditure on revenue account and developmental expenditure on capital account.

(ii) Non Developmental Expenditure

it refers, to those expenditure of the government which does not directly help in economic development of the country. Cost of tax collection, cost of audit, printing of notes, internal law and order, expenditure on defence etc. are treated as non-developmental expenditure. Pension to retired govt. employees, non-developmental assistance to states are also included in this category. Non-Developmental expenditure may be non-developmental revenue, expenditure and non developmental capital expenditure.

Development and Non-Development Expenditure

 

Developmental Expenditure	Non-Developmental Expenditure
It helps in economic development of the country directly. Social and community services, economic services and developmental assistance to states are included in it. Developmental expenditure has a definite objective to achieve during the plan period. The share of developmental expenditure is gradually decreasing.	It does not directly help in the economic development of the country. Defence expenditure, police, pension, loan repayments, cost of tax collection, non-development assistance to states etc. are included in it. It is not possible to fix the targets and achieve it under non-developmental expenditure. The share of Non-Developmental expenditure is           gradually increasing

Effects of Public Expenditure on production, distribution and economic stability

 

Public expenditure has a great bearing on economic development and social welfare of a country. Following observations may be noted in this regard.

Effect on Production

 

According to Dr.Dalton,public expenditure tends to affect the level of production in the following manner:

1.Capacity to work and save

As a result of public expenditure,capacity to work and save tends to rise.Government expenditure provides various kinds of social and economic facilities stimulating the capacity to work of the people.Increased capacity implies increased efficiency and greater employment. Level of income and saving tends to rise facilitating greater investment and adding to the pace of growth.

2. Desire to Work and save

Expenditure incurred by the government promotes the will to work and save.As a result,their income and standard of living tent to rise.

3. Productive Utilization of Resources

Public expenditure restores a balance in the economy by focusing on those areas of production which generate maximum linkages effect.Public expenditure acts as a pump-priming,attracting idle resources to their productive utilization.Accordingly,production level tends to raise the resources from unproductive activities to productive ones.This results in increase in production.

 Effect on Distribution

Public expenditure affects distribution in the following possible ways:

1. Regional Inequality

This is how public expenditure can promote equality across different regions of a country :

i. The government expenditure should focus on development of backward areas,increasing the level of production and income of the people of those areas.Their standard of living will increase to catch up with the living standards in developed regions of the country.

ii. Public expenditure should include financial help to the small-scale and cottage industries.These industries have the merit of easy-diversification across different parts of the country.Accordingly regional inequality is expected to improve.

2. Distribution of the Dividends of Industrial Development

As a result of public expenditure,public sector industries in the country.The workers employed in these industries are paid higher wages.They get some facilities also,better than others.Following the public sector industries,private sector industries also provide higher wages and other facilities to the workers.Increase in the workers wages will lead to the reduction in economic inequality.

3. Benefit to the Weaker Section

If the government makes public expenditure on social services like education,medical care,unemployment allowance,labour welfare etc. after collecting resources by way of taxes from the rich class,it will result in the increase in real income of the poor people,thus tilting the distribution further in their favour.

4. Increase in the Ability to work of the Poor

Distribution of income can also be influences by increasing the ability to work of the poor with the help of public expenditure.This objective can be achieved in two ways:

i. Direct Help : The government can provide direct help to the poor people in the form of cash,commodities and service.

ii. Indirect Help: The government can provide loans to the poor at a low rate of interest.It can provide them food at fair price.It can provide more social services to them.As a result of it,their efficiency will be increased.With rise in their income level their standard of living will improve.

Public Expenditure and Economic Stability

Cyclical changes are an inherent character of a market economy.These changes are called Trade Cycles,and are manifested as the state of recession,depression,recovery and boom.The states of recession and depression are particularly dangerous for restricting the pace of growth.Inflation is equally bad when it tends to be galloping or hyper.Note the following observations to understand how public expenditure facilities economic stability:

1. Public Expenditure and depression

During depression,the prices of commodities tend to fall. Accordingly there is a fall in production and employment.Unemployment increases.Both the producers and the consumers become pessimistic.Producers reduce output because of the lack of demand.Consumers,hoping for a further fall in prices,suspend their existing consumption needs.Accordingly,reduction in demand is compounded.As a consequence,the vicious circle of reduced demand,reduced production,and reduced employment sets in.Here comes the significance of public expenditure.According to Keynes, in the state depression,the government should plan for a comprehensive increase in public expenditure.It can be of twp types:

i. Compensatory Expenditure

It includes those spending which the government makes on public works so as to increase employment and aggregate demand.Such spending generate multiplier effect on income.Income rises in consonance with increased employment,acting as an anti-dote the situation of depression.

ii. Pump Priming Expenditure

During the depression periods,investment is low.If investment is made in public sector,it will prompt private investment as well.Public expenditure thus made is called pump priming.Initial expenditure by the government particularly on infra-structural facilities,tends to be conductive for an all round growth of private investment.

Taylor categories public expenditure during depression as

(a)Home Relief

(b) Unemployment Compensation Plans, and

(c) Work Projects.

a) Home relief is provided to the poor so as to increase their consumption,without getting their services.This is a kind of transfer payments expected to raise consumption expenditure.

b) Unemployment Compensation Fund is set with the help of the employers,employees and the government.Help is provided to the workers during the period of unemployment out of this fund.

c) Work projects include public works like construction of roads,bridges and dams, etc. Expenditure on such projects will projects will generate income to combat deflation through increased demand.

2.  Public Expenditure and Inflation

Public expenditure can be used as a policy instrument to curb inflation.It should focus on the following areas:

i. Increase in Production

Public expenditure should be utilized for increasing production. Increase in production during inflation implies increased flow of goods and services in the economy.In the backdrop of rising prices,increased flow of goods and services will help strike a balance between demand and supply.

ii. Reduction in Consumption

In a state of price-rise,the government should reduce its consumption expenditure.This will reduce the pressure of demand on the goods and services.Accordingly prices are expected to fall,or at least their pace of rise will be arrested.

 

November 27, 2018

CPD-II (Paper-1)