Under the functional classification, public expenditures are grouped based on service. In other words, public expenditures are classified according to government activities and functions. Defense, social welfare, agriculture, infrastructure, and industrial growth are a few examples.
What are the benefits of public expenditures' functional classification?
Expenditures prioritized in the relevant year can be observed,
• Service costs can be seen by observing how much expenditure is made for which service,
• Savings in public expenditures can be achieved,
• Information about the country can be obtained,
• The control of public expenditures can be facilitated,
• Coordination between the plan and the program can be ensured,
• Public expenditures can be reduced without disrupting public services, and
• Benefit and cost analysis can be done easily.
What is the distinction between transfer and non-transfer expenditures as economic classification?
The distinction between transfer and non-transfer expenditures aids in describing the impacts of government spending, clarifies the allocation and utilization of resources and demonstrates how government spending may be used to influence and guide economic life. It also shows that public expenditures can be used to ensure equity in income distribution and explains the relations between central government and local governments
What is the effect of non-transfer expenditures of the government on economies?
Non-transfer expenditures are the expenditures of the government on the purchase of goods and services. Factors of production are purchased in exchange for non-transfer expenditures; therefore, new income streams are emerging in the economy, and the national income is increasing. In other words, non-transfer expenditure refers to expenses that generate income or output.
The government provides favorable conditions or an atmosphere for economic activity by incurring such expenditures. The government might be able to generate revenue through taxes and tariffs as a result of economic growth.
What are the properties of revenue (current) and capital (investment) expenditures as non-transfer expenditures?
According to revenue expenditures-capital expenditures classification, the expenditures of the government on the purchase of
consumer goods are considered as revenue expenditures while capital formation related expenditures are considered as capital expenditures. Revenue (current) expenditures are expenditures that do not contribute to the productive capacity of the country and do not add to the country’s capital stock. The benefits of these expenditures are limited to the relevant period and do not carry over to the following years.
Investment expenditures, on the other hand, are expenditures that add to the capital stock by improving the production capacity of the country, the benefits of which appear in the following years. However, they are a non-recurring type of expenditure for the budget. Capital expenditures include building durable assets like highways, multipurpose dams, irrigation projects, and buying machinery and equipment. Modern economists have adjusted non-transfer expenditures as development and non-development expenditures. Expenditures that promote economic growth and development are termed as development expenditure. Unproductive expenditures are considered as non-development expenditures.
What are the productive and unproductive expenditures?
Classical economists developed this classification based on the development of productive capacity. The economy’s productive capacity is increased, and tax revenue is generated for the government by spending on infrastructure development, public enterprises and agricultural development. They are categorized as productive expenditures as a result. Defense, interest payments, spending on law and order and other consumption-oriented expenses do not result in the creation of any productive assets that can generate revenue or yield returns for the government. These expenditures are classified as unproductive expenses.
Why do public expenditures increase according to R. Musgrave?
According to Musgrave, an increase in per capita income is correlated with a greater share of public expenditure in the national revenue. As a result, an increase in per capita disposable income over time may result in a corresponding increase in governmental spending. This is due to the fact that as per capita income rises, so does the demand for public goods. It typically rises sooner than the latter.
What is the Wagner’s law which explains rising state activity expansion and related public expenditure increases?
This theory explains the rising tendency in public expenditure by welfare state ideology. According to Wagner, a modern country is a welfare state which seeks to advance the citizens’ social, political and economic wellbeing. It works hard to raise the level of living standards for ordinary people. It must perform numerous unprecedented scale tasks and services for this aim. Even in a capitalist economy, the state has been intervening more and more through statutory and administrative measures to increase production and to enhance distribution.
According to Wagner's law, there is a persistent trend towards an increase in the costs and functions of the State, i.e., there is a functional relationship between State activities and the relative growth of public expenditure because of the “social progress” that is to be realized through State participation in economic arena. Wagner’s description of the welfare component of government activities as the demand for social improvement is accurate.
How do war and the need for national defense effect public expenditures?
Wars and threats of conflict in contemporary times may also be to blame for the enormous increase in government spending. During these periods, governments are forced to spend more funds on the creation of war commodities as a result of wars, threats of war, and the ensuing necessity for defense. The threat of foreign attack always exists because nuclear weapons were developed by many countries. The state of world politics is still unstable and unreliable. A cold war is already present among
modern states. Every country must therefore get ready for a powerful defense. That is the reason why government spending is still on the increasing path.
Peacock and Wiseman have discussed the “displacement effect” in the post-war period when greater taxes and a desire for increased revenue collection are pursued by the government because they are convenient and attractive. The government adopting additional social welfare programs on a long-term basis, may also help to support the displacement effect. In order to eliminate the devastating effects of war, war expenditures are displaced by social expenditures.
Why do a high rate of population expansion increase public spendings?
A high rate of population expansion inevitably results in higher costs because all governmental functions must be carried out more thoroughly. In developing nations, the growing population also causes several issues. The State will also be in charge of handling issues like housing, sanitation, unemployment, and food. In doing so, overpopulated nations like China and India will need to restrain population growth. As a result, the State must spend more money on family planning initiatives every year in such countries.
How do the growth of transportion and communication and the planned economy effect public spendig increases?
The State must establish and maintain a prompt and effective transportation infrastructure considering the increase of trade and commerce. Since transportation is a public good, the government must make it affordable as well. Railways and passenger transportation are thus nationalized for instance. Therefore, the government must operate transportation services even at a loss. This necessitates substantial maintenance and growth costs. A poor country’s government must also make significant investments in building new roads, national highways, bridges, and even canals to connect the various regions with a reliable
transportation infrastructure, which is a must for growth. Economic planning is used by the government to advance national development in economies that are less developed. Therefore, in a planned economy, public spending inevitably exhibits an upward tendency as the public sector expands its role.
How can you explain the Musgrave’s theory of public expenditure as increasing role of government in an economy?
Musgrave and Rostow are the economists that better explain this theory of increasing public expenditures. Public sector investment as a percentage of the economy’s overall investment is found to be high in the earliest stages of economic growth and development. Therefore, it is believed that the public sector is responsible for funding social infrastructure expenses like public transportation, sewage systems, law and order, health and education, and other expenditures in human capital. It is suggested that this public sector investment is required to prepare the economy for growth into the middle phases of economic and social development (Musgrave and Musgrave, 1989). During the middle stages of growth, the government still provides products for investment, but this time, public investment is a complement to the growth in private investment. Market imperfections exist at all phases of growth and can hinder efforts to reach maturity. As a result, the government is becoming more involved in addressing these imperfections in the market.
Why there is continuous increase in public spending acorrding to Wagner’s Law?
According to Wagner’s Law, the activities and duties of the government increase as the economy improves through time. This approach argues that as economic growth increases, the share of the public sector in the economy increases. Accordingly, the public sector inevitably grows faster than the economy as a whole. Wagner's claim is that the income elasticity of demand for utilities in the narrow sense is greater than one, so that the demand for utilities grows faster than national income. This will naturally lead to a continuous increase in the share of public expenditures in national income. Therefore, Wagner’s law is also called the law of continuous increase in public expenditure or the law of continuous expansion of government activities. Causality relationship between public expenditures and national income is from national income to public expenditures. According to this approach, the share of public expenditures in the economy increases as the national income increases due to industrialization.
What are some critics about Wagner’s law in the literature?
According to these critics the Wagner hypothesis offers numerous benefits but also several drawbacks. Allan T. Feacock and Jack Wiseman criticized Wagner’s law of growing state activity for the following reasons:
• The premise of Wagner’s research is an interdisciplinary phenomenon; But its analytical framework does not use an integrative approach.
• Analyses are not comprehensive enough and it is not all-inclusive; Any theory of public expenditure should include elements of political science, economics, and sociology, among other fields. All these traits are disregarded by Wagner’s hypothesis.
• It is founded on an organic self-determining conception of the state, which differs from the idea that now dominates in the majority of western nations.
• The hypothesis disregards how conflict affects public expenditure.
• It places a strong emphasis on the long-term trend of public economic activity while largely ignoring the key “temporal pattern” or process of public expenditure growth.
What are the historical periods for public expenditure in the Odle’s Hypothesis of Public Expenditures?
Odle’s Hypothesis of Public Expenditures approach argues that the changing role of the state is the most important factor determining the development of public expenditures. According to odle’s approach, there are three historical periods for public expenditure.
Traditional period (Before 1960): This period is the colonial period in which public expenditures were designed in line with the interests of foreign companies. Public resources are reserved for port and road construction so that foreigners can reach natural resources easily. On the other hand, the share of educationand health expenditures remained low in this period.
Transition period: In this period, governments showed an effort to industrialize with liberal tax incentives. Share of social expenditures and infrastructure investments to support private capital in public expenditures increased during this period.
Post-independence period: Public expenditure increased sharply during this period. Defense expenditures, education expenditures and health expenditures have increased significantly. In this period, taxes on imports began to be replaced by income taxes. In addition, state enterprises and national banks were established during this period.
How can be shortly expained Peacock and Wiseman’s hypothesis aboutpublic spending increases?
In order to raise more money to cover the rise in defense spending, the government raises tax rates even further and broadens the tax code during times of war. The new tax structures and rates maynot change much after the war as people become used to them. As a result, rising government spending is a direct effect of rising revenue. In doing so, increasing levels of public sector allocation are supported permanently by the higher tax receipts.
Whar are the two institutional components that support the Colin Clark’s Critical Limit Hypothesis?
The two institutional components that support the hypothesis are as follows:
1. The income earners suffer significantly from decreased incentives and a decline in their output when tax collection by the government crosses the key threshold of 25% of the GDP. Compared to their potential, they produce less. The result is a decrease in supplies. In other words, taxes going beyond a certain point have a negative impact on the incentive to produce and invest.
2. However, even if the budget is balanced, a rise in government spending would represent increased demand. Inflation thus results from a misalignment of supply and demand.
How do organic state model explain public expenditure increases?
In organic state model, the state is assumed to grow as an organism that reflects changes in the economy and society and makes decisions for the benefit of its citizens. As income per capita increases, so does society’s demand for services such as education and health, where demand is more income elastic. Such services, on the other hand, cannot be produced optimally by the private sector due to their externalities and virtues. This would lead us to market failures. In order for these services to be produced at an adequate level and efficiency, the intervention of the public in the form of subsidies or direct delivery is required.
As the economy and society become increasingly complex, so does the degree of market failure. In addition, for reasons such as price stability and employment (which are also examples of market failure), public interventions for stabilization increase. Thus, as a result of such interventions of the state, public expenditures increase in the long run
What are the results of distributive policies and the welfare state that restricts individual freedoms according to Libertarians?
Libertarians oppose redistributive policies because they violate private property rights. According to them, the welfare state restricts individual freedoms and can lead to despotism. In doing so,
• Private property rights are violated by redistributive taxation.
• Public services are limited in variety.
• The state is paternalistic and makes central choices.• Individuals are subject to bureaucratic obstacles.
• A social welfare understanding that eliminates incentives and self-employment creates a culture of dependency.
What are the factors leading to fiscal illusion?
Factors leading to fiscal illusion can be classified as follows;
• Shift of the tax system towards less observable taxes (VAT etc.) embedded in the price.
• The increasing complexity of the tax system. Thus, very few people are aware of how much total tax they pay on their income and savings, investments and expenditures.
• Widespread application of withholding tax at source.
• Automatic increases in taxes and other fiscal liabilities (the increase in the rate of revaluation every year is not felt by the citizens as it takes place quietly).
• Increasing budget deficits through borrowing.
• Fiscal drag
What are the factors leading to fiscal illusion?
Factors leading to fiscal illusion can be classified as follows:
• Shift of the tax system towards less observable taxes (VAT etc.) embedded in the price.
• The increasing complexity of the tax system. Thus, very few people are aware of how much total tax
they pay on their income and savings, investments and expenditures.
• Widespread application of withholding tax at source.
• Automatic increases in taxes and other fiscal liabilities (the increase in the rate of revaluation every
year is not felt by the citizens as it takes place quietly).
• Increasing budget deficits through borrowing.
• Fiscal drag
How can be explained the Leviathan model?
Leviathan Model assumes that political constraints have a limiting effect on the growth of public spending. According to the model, what really increases public expenditures is the tendency of the politicians to grow and expand. Because these segments tend to spend more. They always determine the level of service delivery and professional standards with the aim of maximizing their own interests. This effect increases as public employment increases and the votes of public servants become more pronounced. These, in turn, generally prefer to increase public expenditures. Thus, the public sector is likened to a mythological sea monster (Leviathan) serving itself, constantly growing and crushing under its own weight
What is fiscal drag?
According to the theory of fiscal drag, rising incomes and inflation may cause more taxpayers to fall into higher tax brackets. As a result, fiscal drag has the effect of increasing tax revenue without directly increasing tax rates. Fiscal drag serves as an illustration of a somewhat deflationary fiscal policy by lowering (or limiting increase) in aggregate demand. Because higher earnings growth will result in higher taxes, which will reduce inflationary pressure in the economy, it can also be seen as an automatic fiscal stabilizer.
What is the fiscal drag?:
The definition of the fiscal drag is as the economy approaches the full employment balance, the increasing tax revenues due to the flexible tax system (progressive taxation) drag the economy to extreme stability and prevent it from reaching the full employment balance. According to the theory of fiscal drag, rising incomes and inflation may cause more taxpayers to fall into higher tax brackets. As a result, fiscal drag has the effect of increasing tax revenue without directly increasing tax rates. Fiscal drag serves as an illustration of a somewhat deflationary fiscal policy by lowering (or limiting increase) in aggregate demand. Because higher earnings growth will result in higher taxes, which will reduce inflationary pressure in the economy, it can also be seen as an automatic fiscal stabilizer.
What are the reasons that the median voter’s demand for public goods increases?
The median voter’s demand for public goods will increase for three reasons.
• There may be an increase in the (after tax) net income of the median voter
• An increase in the relative price of the substitute good can increase the demand for the public good.
• A decrease in the relative price of a complementary good can increase demand for public goods.
Why do public expenditures increase according to Baumal effect?
Baumol's this hypothesis , aims to explain one of the reasons for the increase in public expenditures (especially current expenditures). Baumol divides the economy into progressive and non-progressive. In the former, productivity increases, while in the other it remains constant. The reason for the productivity difference is due to the labor force. In some cases, labor is a tool in the production of the final product, while in others it is itself a final product. Baumol attributes the increase in public expenditures to inefficiency in the public sector. According to Baumol, there are two sectors in the economy: dynamic and static. While the dynamic sector is a manufacturing industry; the static sector is the services sector. Besides, while wage structures in the two sectors are close to each other, labor productivity is lower in the static sector. According to Baumol, costs are high in the public sector despite low labor productivity, as the public sector tends more towards service production. This leads to an increase in public expenditures. According to Baumol, the power of the unions and the status quo behavior of the bureaucrats cause wage increases without an increase in labor productivity.
What kind of effects do public expenditures create on production side?
Examining how public spending affects ability and willingness to work, save and invest, and resource allocation can help us understand how public spending affects productivity. The productive potential of the community is increased by socially desirable governmental spending. Spending on communication, education, and health improves people’s productivity at work and, consequently, their income. Income growth is accompanied by an increase in savings, which benefits capital formation and investment.
Sometimes, public spending has a negative impact on people’s willingness to work and save. Spending by the government on social security institutions could have such negative outcomes. For instance, the government allocates a substantial proportion of its revenue to the provision of social security benefits like unemployment benefits, old age pensions, insurance benefits, sickness benefits, and medical benefits. Benefits like these lower individual’s desire to work. In other words, they discourage individuals from work.
Government spending frequently proves to be a successful tool for promoting investment in a particular sector. For instance, if the government intends to encourage exports, it offers incentives like subsidies and tax benefits to attract investment towards such a sector. In a similar manner, the government might encourage investment in a particular area by offering a variety of incentives.
What kind of effects do public expenditures create on income/welfare distribution?
The government’s main goal is to maximize social benefit through public spending. The goal of maximizing social welfare can only be met when inequality is eliminated or reduced. Government spending is highly practical in achieving this objective. Through income tax and sales tax on luxury, the government reimburses the surplus income of the wealthy. The money raised in this way is used to support programs that increase the standard of living for the weaker and poorer sections of society. Thus, government
spending aids in achieving the goal of an equitable distribution of income. The goal of spending on social security and providing poor people with subsidies is to increase their actual income and purchasing power. Public spending on communication, health, and education boosts the productivity of the most vulnerable members of society, boosting their ability to produce an income
What kind of effects do public expenditures create on economic growth?
In order to achieve substantial growth, the government assigns funds for the expansion of numerous sectors, including agriculture, industry, transport, communications, education, energy, health, exports, and imports. The maintenance of balanced economic growth has been greatly assisted by government spending. The government is very interested in providing more funding for the development of underdeveloped areas. These initiatives help to lessen regional disparity and encourage balanced economic growth. Thus, government spending has increased dramatically in all contemporary economies. Therefore, in order to achieve the desired impacts on income, employment and growth, governments must develop sensible public expenditure programs.
What is peak load pricing?
Demand for some public utility services varies during the day, week, and season. There is a higher demand for transportation at morning and evening rush hours than others. Power is needed more during the day than at night since businesses need it then. There are times of the year when long distance call rates are higher. Demand for restaurants varies between weekdays and weekends. The demand for hotels varies depending on whether it is peak or off-peak season. Periods in each of these situations can be divided into peak and non-peak periods. When services cannot be easily stored, a distribution over time can be handled by charging two separate fees for two different periods, making the load of the service more consistent. Peak times higher price, non-peak time low price can be charged. Situations like these can be treated with a congestion cost. This suggests that services like metros do not alternate between periods of empty and congested service; rather, a balance between peak period demand and non-peak period demand can be achieved with the introduction of a price disparity as an incentive. The flexibility for certain consumers is a saving grace.
With this strategy, a portion of the demand can be changed by making a large price gap between two items. A person heading to work would not change his travel plans, while a person going on a social call might. A leisure call can be made at a different time of the day, but a business call cannot be changed. It means that different consumer groups have different levels of price elasticity, which would help to balance the demand for the service’s use. The approach also works better than imposing physical limitations to reduce congestion. Since then, with good success, this approach has been extensively applied for services like parking, public transportation, water supply, power supply and telephone.