Lecture Notes VII Theories on Government Spending

Jai Leonard I. Carinan

Theories on Government Spending

Public Spending- is one of the instruments of modern fiscal policy employed by
government to
prevent or mitigate economic fluctuations
Sources of funding for the expenditure of the public sector
a. taxation
b. borrowings- pump priming and short and long-run compensatory spending
c. sale of government assets, goods and services privatization
Basic Premises of Public Spending Policies

a. Fiscal policy and public spending is the production depends upon the total
effective
demand for goods and services currently produced (that is, aggregate
expenditure on
consumption and investment)
Where: Y= C + I + G + X-m

b. The primary goal of government spending is to raise aggregate consumption.

Due to
the higher level of government spending, income of consumers will expand, and
consequently
consumption expenditure will rise.
c. This is so because when we view the economy as an integral whole, income and
expenditure are exactly one and same thing;
Every transfer of money is at the same time income to the individual who
receives it and
expenditure for the individual who parts with it

Individuals who are the recipients of the governments expended money naturally
find
their money income increased, and accordingly step up their rate of spending.
These rounds of
spending will, in turn, increase the incomes of the recipients who are now in a
position to
increase their expenditures.
The chain relationship of income creation and expenditure growth, of each increase
in

expenditure results indirectly in an in increase in income larger than itself, provided,

of course,
that the increase in expenditure persists.
The increase of government funds into this state of economy would assure the flow
of
disposable income sufficient to stimulate demand and production.

Deficit financing for stability and Full Employment

3 types of deficit financing

1. Deficit financing for offsetting depression

2. Deficit financing for compensatory inadequacy of private investment
3. Deficit financing for defense expenditure
The concept of pump priming
-it refers to the injection of government funds into the income stream in sufficient
quantities and
under proper circumstances in order to reverse the trend of anticipations and to
generate recovery.
- this emergency tool is a temporary device to restore the balance in the economic
system during
the cyclical downturn, after which the system is expected to operate under its own
power, this
implies that the multiplier effect will come into play and the accelerator will
reinforce the
increases in income, consumption and investment
Different stages in pump priming process

Injection of funds by the

government into the income
stream

First stage

The income stream adds the

purchasing power
of the nation, (relief, wages, grants
plus
Leads to primary and
secondary
employment

Second
stage
Third stage

The extension of government loan

to financial institution and
business
firmStimulation of net private
investment, our pump
priming
scheme shall have achieve

Compensatory spending in the short- run

- is a deficit spending scheme resorted to by government to offset the inadequacies in

private spending during periods of falling prices and rising unemployment
- Deficit spending mean incurring expenditure excess of revenue
Such an excess may result from:

a. Reduction in tax receipts at time when expenditure remains the same, it indicates an
unbalanced budget wherein the proceeds from taxation fall short of budgetary
requirement.

b. Government spending on public investment ( infrastructure, hospital or subsidies)

Compensatory spending in the long-Run
- is undertaken by the government to offset the deficiency in private spending.

- It refers to the use of government outlays as a means of counteracting the alleged longrun tendency on the part of the economy to operate at levels well below full employment

- Government outlay for capital and non capital goods and services will be directed

primarily into non competitive area where increased activity may favorably affect the
private sector of the economy.

- Government participation must be considered as the continuing activity to counter

balance the long run deficiency of private net capital formation.

- When there is anticipation of economic contraction, compensatory expenditure must be

in deficit expenditure
o1

1st= Expenditures find their way to the low income earners or unemployed

2nd=Most of them will spend this for their consumption

3rd= The increased in consumption would lead to higher production and

transmitted to investment for replacement or expansion of existing productive
capacity.

- Keynesian economics proposition is that only an expanding economy can provide full
employment and increased use of natural resources.

A continuing high level of employment must be maintained only by injectingnew purchasing

power into the economy in a steady manner. The instrument forthis would be series of fiscal
measures for deficit spending.

Budget Program for Stability and Full employment

a. Annually Balanced Budget
- this principle calls for a budget that maintains an exact balance between expenditures and
revenue each year.

b. Swedish Budget or the Cyclically- Balanced Budget Policy

- This advocated by the Committee for Economic development an organization of
outstanding business leaders
- budget should recognize the need for counter cyclical fiscal policy, namely surpluses
during prosperous period and deficits in times of recession.
the stabilizing budget program, calls for a fixed tax rates is so devised as to create a
budget balance when 93% of the labor force is employed. At full employment the fixed tax rates
structure should yield a surplus in the cash budget.
- The basic rule is that tax revenue will rise during boom and fall during a depression
- Budget should become an automatic stabilizing instrument, with tax rates kept stable, the
governments revenue from taxes will rise when the national income rises and fall latter falls
- Booming economic conditions mean high personal incomes, high corporate profits and
high sales volumes (large tax base)
- When economic activity continues to decline, the surplus diminishes, the budget would
balance and then justifiable deficit would appear.
c. Formula Flexibility
- is a system of counter-cyclical variations in tax rates, on the one hand and in government
expenditures, on the other hand, with these variations automatically going into effect when
certain designated indices rise or fall.
-the so called peril points, these changes in selected indices example rise or fall in the
level of employment. CPI etc
d. The managed Compensatory Budget Program
- This policy attempts to fit the budget to the changes in the business cycles, when the
national income and employment are expected to fall, the program calls for a combination of
expenditure increase and tax reduction in the amount necessarily to minimize instability.
- If economic activity is on upswing tax rates would be increased and expenditures pruned
to siphon off excess purchasing power, the surplus generated can be utilized for debt reduction.
The Growth of Public Spending
a. Wagners Law- The law of Ever- increasing State Activity
- It was formulated by Adolph Wagner a German economist 1883
- It states that demand for social goods and services tends to Increase elative to the demand
for private goods as real per capita incomes rise.
- In a low income economy, people utilized their real income on consumption of basic
private good (food, clothing, shelter). As the economy advances, as the societys wealth
increases, and the basic wants have been largely satisfied, new need arise, most of it are public
gods ( police, fire protection, highways, education)
b. Parkinsons Law

- it was formulated by C. Northcote Parkinson

- This law of organizational growth, which is especially pronounced among administrative
staff, is based on two premises: (1) the psychological desire f individual officials to have more
and more subordinates(but not rivals) and (2) the phenomenon that the personnel of
an
organization perform work for one another
- The law provides a realistic explanation to the rising cost of government, specifically the
pyramiding organization of several government agencies.
c. Somers Principles of Government expenditures
-These are suggestion of Professor Harold Somer in arriving at appropriate expenditure
policies.
1. Principle of Minimum expenditure
The government should spend the least it possibly can, consistent with the
protection of its citizens.
The criterion may be set up in terms of the maintenance of law and order.
2. Principle of Minimum Interference with Private Enterprise
Government spending should have a little interference with private enterprises.
It should not provide public works that would compete with established private
firms
The government should not set up retail stores and factories.
3. Principle of Maximum Employment
The aim of the government expenditures is sometimes to raise the level of
employment as high as possible.
4. Principle of Maximum advantage
Maximum advantage should be achieved at all times. The implication is that each
should spent where the marginal social utility is the greatest
Harold D. Smith presented his Budgetary Commandments in 1944. The Budget as an
instrument of legislative Control and Executive Management. Public Administration Review
IV (Summer 1944) 181-188
These historical budget principles are substantially as follows:
1. Publicity The main stages of the budget process, which include executive
recommendation, legislative considerations and action, budget execution, should be made public.
2. Clarity The budget should be understandable to every citizen. As was said by a
British writer in 1764: The Administration has condescended to explain the budget to the
meanest capacity
3. Comprehensiveness The budget should contain expenditures and revenues on a
gross basis, reflecting all governmental activities without exception, and should show the surplus
available for debt retirement or the deficit to be met by new revenue legislation or borrowing
4. Budget Unity All receipt should be recovered into one general fund for financing all
expenditures. This principle condemns ear marking of revenue for specific purposes of
expenditures, except incases of trust accounts, or in cases where a special and direct relationship
exists between receipts and expenditures.
5. Detailed Specification Receipts and appropriations should be expressed in detailed
specifications. Transfer of items should be permitted only in exceptional cases.
6. Prior Authorization The budget should be submitted, considered, and acted upon in
advance of the period during which the expenditures are to made, it should include estimates for
all foreseeable needs, thus reducing as far as possible request for supplemental and deficiency

appropriations. Budget execution should stay strictly within the legislative authorization and
should be checked by an auditing agency reporting to the legislature.
7. Periodicity Appropriations should be authorized for a definite period of time. An
appropriation not used at the end of the period should generally lapse or be re-appropriated with
the specific amount and purpose detailed.
8. Accuracy Budget estimates should be as accurate as possible and there should be no
padding of expenditures estimates or providing for hidden reserves by underestimating
revenue.
Reference:
Romualdez, Eduardo Sr. E., Yoingco, Angel Q. and Cosem, Antonio O. Philippine Public
Finance, Manila, Philippines, G10 Enterprise, 1994
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