2010 Asiyah Kassim

PUBLIC FINANCE ADM652

Budget
Public Expenditure Reasons
P. Expd Classification & Canon
Cost and Benefit Analysis

To explain the components of budget

To discuss the various reasons for the brisk
expansion of public expenditure
To identify the mechanism to control public
expenditure
To understand the application of CBA

BUDGET

What is
is
What
Budget?
Budget?

Derived
Derived from
from the
the French
French
word
word bongette=
bongette= aa small
small bag
bag
symbolizes
symbolizes aa bank
bank
containing
containing the
the financial
financial plan
plan

The
The term
term budget
budget used
used for
for
the
the financial
financial plan
plan by
by the
the
governments
governments in
in Europe
Europe back
back
Definition:
Definition:
in
in 1733
1733
Formal
Formal estimate
estimate of
of the
the
resources
resources required
required for
for aa
given
given period
period of
of time
time
Resource
Resource man,
man, money,
money,
material
material

BUDGET

Other
Other
Definitions
Definitions
of Budget?
Budget?
of

B.J.
B.J. Reed
Reed &
& John
John W.
W. Swain
Swain
Plan
Plan acquisition
acquisition and
and used
used of
of
resources
resources by
by public
public entities
entities
similar
similar to
to what
what individuals
individuals
and
and household
household do
do when
when
spending
spending money.
money.

Otto
Otto Eckstein
Eckstein A
A detail
detail
statement
statement of
of government
government
expected
expected expenditures
expenditures and
and
revenues.
revenues.

William
William Gladstone
Gladstone Budgets
Budgets
are
are not
not really
really aa fares
fares of
of
arithmetic
arithmetic but
but in
in aa thousand
thousand
ways
ways go
go to
to the
the route
route of
of
prosperity of individuals, the

BUDGET

1.
1. Money
Money is
is limited
limited resource
resource
-Allocating
-Allocating the
the money
money
according
according to
to the
the needs
needs of
of the
the
society
society
-There
-There is
is aa competing
competing
demand
demand the
the allocations
allocations are
are
based
based on
on priority
priority
2.
2. Equitable
Equitable Distribution
Distribution
Fund
Fund
-To
-To distribute
distribute the
the resource
resource
equally
equally or
or reasonable
reasonable (needs
(needs
and
and situations
situations

BUDGET

3.
3. Stabilization
Stabilization Function
Function
-Stabilization
-Stabilization role
role via
via the
the tax
tax
policy
policy and
and expenditure
expenditure policy
policy
Functions //
Functions
Purpose //
Purpose
Aim
Aim

-e.g.
-e.g. During
During the
the period
period of
of
recession,
recession, the
the government
government
used
used more
more resource
resource to
to the
the
extent
extent of
of borrowing
borrowing
-e.g.
-e.g. During
During inflation
inflation govt.
govt.
will
will tax
tax more,
more, encourage
encourage
people
people to
to save
save (the
(the govt
govt take
take
out
out the
the money
money from
from people
people to
to
reduce
reduce the
the purchasing
purchasing
power
power // no
no demand
demand for
for

BUDGET

Roles
Roles

1.
1. Policy
Policy Tool
Tool has
has important
important
impacts
impacts not
not only
only through
through the
the
flows
flows of
of fund
fund but
but also
also to
to
various
various fiscal
fiscal policies
policies and
and
financial
financial measures,
measures, as
as aa tool
tool
to
to formulate
formulate policies
policies and
and set
set
priorities
priorities for
for the
the
development
plan
development
plan can be
2.
2. Management
Management Tool
Tool can be
used
used to
to allocate
allocate resources,
resources,
distribute
distribute costs
costs &
& benefits
benefits
and
and stabilize
stabilize economies
economies as
as
well
well as
as to
to present
present choices
choices
under
under the
the condition
condition of
of
scarcity
scarcity

BUDGET

Roles
Roles

3.
3. Control
Control Tool
Tool as
as budget
budget
represents
represents constrains
constrains
(restrictions)
(restrictions) thus,
thus, govt.
govt.
officials
officials are
are required
required to
to
strictly
strictly adhere
adhere to
to the
the
restriction
restriction terms
terms provided
provided in
in
the
budget
the
budgetTool
4.
4. Political
Political
Tool political
political
parties,
parties, administrators,
administrators,
interest
interest groups
groups and
and
interested
interested citizens
citizens vie
vie one
one
another
another to
to have
have their
their
preferences
preferences to
to be
be listed
listed in
in
the
the budget
budget (budget
(budget
outcome
outcome of
of political
political
compromises and bargains,

BUDGET

Roles
Roles

5.
5. Statement
Statement of
of Government
Government
Expenditures
Expenditures must
must provide
provide
clear,
clear, systematic
systematic and
and detailed
detailed
description
description of
of its
its revenue
revenue and
and
expenditures
expenditures for
for aa financial
financial
year
year for
for public
public reference.
reference.
Hence,
Hence, public
public aware
aware of
of the
the
activities
activities undertaken
undertaken by
by
government.
government. guide
guide for
for
government
government officials
officials to
to
6.
Performance
Measurement
perform
6.
Performance
duties
perform
duties Measurement
Tools
Tools To
To assist
assist in
in the
the
performance
performance measurement
measurement of
of
government
government programs
programs in
in
terms
terms of
of efficiencies
efficiencies and
and
effectiveness.

BUDGET

Intro
Intro

It
It is
is an
an annual
annual financial
financial plan
plan of
of the
the
government
government
Involved
Involved 22 elements
elements =
= (revenue
(revenue &
&
expenditure)
expenditure)
Plan
Plan =
= it
it is
is aa proposed
proposed projected
projected revenue
revenue
and
and proposed
proposed expenditure
expenditure
Consist
Consist of
of revenue
revenue &
& expenditure
expenditure prepared
prepared
for
for aa period
period of
of 11 year
year (( short-term
short-term plan)
plan)
There
There are
are two
two types
types of
of Budget:Budget:- Operating
Operating
Budget
Budget &
& Development
Development Budget
Budget

Types of Budget
Also
Also called
called Supply
Supply Budget
Budget

Operatin
Operatin
Budget
gg Budget

Developme
Developme
nt Budget
Budget
nt

E.g.
E.g. Salary
Salary // Emoluments,
Emoluments, utility
utility bills,
bills,
repairs
repairs
It
It also
also refers
refers to
to the
the expenditure
expenditure that
that
recur
recur monthly
monthly or
or annually
annually that
that could
could
not
not be
be avoided
avoided (recurrent
(recurrent

Involved
expenditure)

Involved the
the acquisition
acquisition of
of land
land
expenditure)
E.g.
E.g. equipment
equipment cost,
cost, construction
construction
cost,
cost, compensation
compensation on
on land
land
Also
Also refers
refers to
to projects
projects which
which
involved
involved acquisition
acquisition of
of land,
land,
equipment,
equipment, consultancy
consultancy &
& contract
contract
service
service
All
All 5-year
5-year development
development plan
plan are
are put
put
under
under Development
Development Budget
Budget
E.g. Smart School, Agriculture

Types of Budget

Differences
Differences

Similarities
Similarities

Operating
Operating expenditure
expenditure on
on annual
annual
basis
basis
DevelopmentDevelopment- period
period between
between 11 55
years
years
Both
Both must
must become
become Supply
Supply Bill
Bill
Could
Could not
not be
be held
held without
without
parliamentary
parliamentary approval
approval
Charged
Charged =
= no
no need
need to
to get
get approval
approval
from
from Parliament
Parliament

Charged
Charged
Expenditur
Expenditur
ee

Parliament
Parliament has
has enacted
enacted legislation
legislation
for
for this
this particular
particular expenditure
expenditure
Straight
Straight away
away withdraw
withdraw from
from
Consolidated
Consolidated Fund
Fund

BUDGET

Public
Expenditures
Component
Component
of
ss of
Budget?
Budget?
Public Revenues

Public Expenditures

What?
What?

Refers 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

What are
are the
the
What
macro economic
economic
macro
objectives of
of
objectives
public
public
expenditure?
expenditure?

Refers 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

Year

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007

Operating
(RM)

42,713,554,700
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
89,141,090,000
101,246,477,910
112,985,928,000

Development
(RM)

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
46,510,219,000

TOTAL
(RM)

59,982,209,600
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 of

Public Expenditure in Malaysia
Expansion in the
Activities of the
Government

The Growth of Social

Security / Social
Assistance Scheme

Development of
Agriculture

Meeting Defense
Needs

Rising Trends of
Prices

Increase in
administrative cost

Urbanization

economic
stMaintainingability
through fiscal policy

Economic
Development

Rural Development

Tourism
Development

Industrial
Development

Reasons for the Growth of

Public Expenditure in Malaysia
Introduction of New
Technology

International
Relations
Increasing
Population

Implementation of 5Year Plan

Globalization

Political Activities
Implementation of
Mega / Prestige
Projects

Mismanagement of
Fund /
Maladministration

Classification of
Public Expenditures

1. Classification
Classification
1.
by Categories
Categories
by

a) Operating Expenditure; (Supply)

-denoted by the letter B=bekalan
a) Charged Expenditure
shown by the letter T=tanggungan
a) Development Expenditure; (project
which involved acquisition of land,
equipment, construction and
compensation)
-denoted by the letter
P=pembangunan

Classification of
Public Expenditures

2. Classification
Classification
2.
by Sector
Sector
by

Divided 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)

Classification of
Public Expenditures

2. Classification
Classification
2.
by Sector
Sector
by

(i) General 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)

Classification of
Public Expenditures
On items of expenditure

3. Classification
Classification
3.
by General
General
by
Object
Object

Divided into:(i) Emoluments - Code 10,000 (Salary &

Remuneration)
(ii)Supplies & Services Code 20,000 (buy /
maintain/ repair e.g aircond
(iii)Assets Code 30,000 (Purchase of
equipment / government assets
(iv)Grants & Transfer Code 40,000
(transfer of money to state universities,
PEs, Statutory Bodies

Gener
al
Objec
t

10000
Emolument
s

20000
Services
and
Supplies

30000
Assets

40000
Grants and
Fixed
Charges

50000
Others
Expenditur
e

TOTAL

Year

2006

23,586,575,71
5

20,553,979,9
15

1,608,062,9
40

54,993,809,53
0

504,049,810

101,246,477,910

2005

22,241,481,99
6

18,790,128,2
64

1,414,421,5
90

46,263,928,54
0

431,129,610

89,141,090,000

2004

20,933,872,96
0

17,215,514,1
55

768,494,10
3

39,426,938,00
9

2,185,180,77
3

80,530,000,000

2003

19,727,373,93
7

14,253,002,5
99

1,612,982,4
49

34,514,289,87
5

2,731,167,90
0

72,838,816,760

2002

17,581,347,01
7

12,065,207,1
87

1,532,739,4
31

33,328,009,97
5

2,474,710,88
0

66,982,014,490

2001

16,921,053,41
0

10,078,049,9
03

1,149,547,5
95

32,135,234,49
2

1,926,557,55
0

62,210,442,950

14,607,733,01

7,564,036,76

610,145,96

28,370,827,98

2,198,255,89

Classification of
Public Expenditures

4. Classification
Classification
4.
by Program
Program //
by
Activity
Activity

-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

Canon of
Public Expenditures
Def: Rules
Rules // Principles
Principles that
that has
has to
to be
be followed
followed by
by the
the
Def:
government when
when incurring
incurring expenditures
expenditures
government
-This principles
principles have
have been
been suggested
suggested by
by economist
economist
-This
Why?
Why?
1. They
They believed
believed public
public expenditure
expenditure has
has to
to be
be made
made
1.
according to
to priority
priority
according
2. To
To avoid
avoid waste
waste
2.
3. To
To avoid
avoid extravagance
extravagance &
& unnecessary
unnecessary spending
spending want
want
3.
government to
to be
be thrifty
thrifty
government
4. Made
Made to
to produce
produce wealth,
wealth, goods
goods that
that we
we can
can earn
earn some
some
4.
income for
for the
the country,
country, to
to enhance
enhance national
national productivity
productivity
income
5. To
To maximize
maximize benefits
benefits
5.
6. Want
Want to
to have
have equitable
equitable distribution
distribution of
of wealth
wealth (( tax
tax the
the
6.
rich, social
social assistance,
assistance, programme
programme of
of eradicating
eradicating poverty)
poverty)
rich,

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

1.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

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

Problems / 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

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

2.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/revenue
Useful Principle
-advises government throughout the world future
-help the businesses to meet the consumer demand
-multiplayer effect for productive purpose

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

3.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 it
Reasons:
-The approved fund will only be used for that particular
purpose
-To take it as mandatory that fund must first be approved

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

Why accept?
-to control expenditure
-to make the expenditure legal or authorized
-to avoid corruption, especially in developing countries

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

4.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

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

Problems / Weaknesses:-not applicable during recession

-certain condition (economic) are unpredictable
Practical 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

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

5.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 system
Good or not ?
-a very pragmatic principle
-acceptable to all countries globally

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

6.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

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

Acceptable 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

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

7.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

Canon of
Public Expenditures

Types of
of Canon
Canon
Types

Useful 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 Analysis

Introduction
Introduction

Cost-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:-

1) Enumerate all costs and benefits of the proposed project

2) Evaluate all costs and benefits in Ringgit / dollar terms
3) Discount future net benefits.

1) Enumerating
Enumerating Benefits
Benefits and
and
1)
Costs
Costs

Firstly 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
Enumerating Benefits
Benefits and
and
1)
Costs
Costs

Problems
Problems

Double 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.

2) Evaluating
Evaluating Benefits
Benefits and
and
2)
Cost
Cost

After 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.

3) Discounting
Discounting Future
Future Net
Net
3)
Benefits
Benefits
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

How Discount
Discount Rate
Rate Affects
Affects the
the PV
PV of
of
How
Projects?
Projects?
1) 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.
2) 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.
3) Economic efficiency must always become the main

PREVENTING ERRORS
ERRORS IN
IN CBA?
CBA?
PREVENTING
1) Avoid Double Counting avoid miscalculates costs and
analysis consider externalities both positive and
negative
2) Choose the right social rate of discount
3) Avoid from modifying techniques to build in equity as
well as efficiency criteria in ranking projects to be
done
4) Treatment 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 accordingly
5) Ranking projects according to the present value of
their discounted net benefits