ADAMAWA STATE POLYTECHNIC, YOLA

(DEPARTMENT OF CONSULTANCY SERVICES)

PUBLIC FINANCE
DPAA II

BY

MALAM U.S IBRAHIM

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INTRODUCTION

Every national economy, whether developed or underdeveloped and whether with or without
comprehensive system of economic planning, requires the intervention of government in its
development process. Even in its ideological formulation, the economics of government
intervention in modern societies is not whether or not government should intervene in national
economics conduct, but how far and with what instruments for the best socially desirable result.

Societal goals are multi-varied and often contradictory, and yet the resources and means of
meeting them are limited both in size and inn range of instruments availability within any
feasible periods. It is the task of public finance as a discipline of analysis, to determine how far a
particular policy measure contribute to some of the goals of the society and at what costs. Since
there is a multiplicity of goals in every society, there must also be some trade-offs between one
goal and another within the same period.

Public finance is thus a branch of finance that studies the effects on the economy resulting from
collection of revenue by the public authorities and its expenditure. Although the study of public
finance is the study of resources allocation, it is also pre-occupied with the problems of
economic growth, prices, income and employment. Public finance is equally concerned with the
analysis of the effect of different taxes on incentive to work, to save and to invest.

The Concept of Public Finance

There are various definitions of public finance, however, they all agree on the essence of public
finance as bordered on revenue, expenditure, debt and welfare of the society.

According to Dalton (1951), Public finance can be defined as that which “ is concerned with the
income and expenditure of the public authorities and with the adjustment of one to the other”.

Jingham (2001) defined public finance as the studies of income and expenditure of central, state,
and local governments for the collective satisfaction of wants and the principles, which govern
income and expenditure.

Carl (1926) says ‘the term public finance can be confined to a study of funds raise by
government to meet the costs of government’

Similarly Buchanan (1965) conceptualized public finance as a subject that studies government as
a unit, i.e. it studies the economic activity of government as a unit, which focus on income
(revenue) generated and how this is expended (expenditure).

For our purpose, public finance can be define as that branch of finance which studies the
activities of public authorities(government0 in generating revenue, allocating revenue (spending)
and debt management towards ensuring efficiency of the state and the general well being of the
society.
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PUBLIC SECTOR VS PRIVATE SECTOR

Public sector economics is a branch of social science that studies public finance and the activities
of the government, including their effects on the certain macro-economic variable; such as price
level, economic growth, and income distribution etc.

The scope and role of government obviously vary from country to country. in the capitalist
countries of the world, the involvement of the government in economic activities is theoretically
expected to be at the minimum level. In socialist countries, the forces of the public and private
sectors have engaged in a seemingly endless struggle for supremacy.

The main feature of the economic system of those nations (less developed) is the joint ownership
of factors of production by the government and individuals. Since the public and private sectors
operate in an integral fashion, the reactions of the private sectors to various fiscal measures such
as taxation, borrowing (public debt) and expenditure becomes important consideration.

The Differences between Public and Private Sector

This is otherwise known as the difference between public finance and private finance. This can
be seen in the table below.

Public Finance Private Sector Finance

1. Study of income, expenditure Study of income, expenditure, borrowing and

borrowing and financial administration financial administration of individuals or
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 of the government. private companies

2. It is that section of national activities Private sector includes organization owned by

that represents the government (public individuals and governed mainly by the
sector) it includes Federal, State, Local company and allied matter decree 1990. Zenith
government and Corporations Bank Pl, UBA, Adama Beverage Company
Ossimaco Electronics limited etc.
3 The main objective of public finance is
to enhance the welfare of the people Private sector finance is mainly concerned with
and provide public goods at reasonable profit making.
cost.

3. The major source of revenue to the

public sector is through the public in Private sector receives revenue through the
form of taxation sales of goods and services.

4. Public sector is primarily responsible or Private sector is accountable to their owners

accountable to the general public i.e. shareholders.
through representative institutions.

5. Under public finance the government An individual determines his expenditure on

first estimates its expenditure and then the basis of his income Individual income
finds means of raising the necessary resources are limited.
income.

6. The government has more resources of

income.

7. An individual’s expenditure is On the other hand, the government expenditure

governed by his habits, customs, depends on its economic and social policies
fashion etc.
But an individual or firm cannot force anybody
8. There is compulsion in public finance, to raise money
people have to pay taxes.
An individual is more concerned with his
9. Government is concerned with not present needs and tries to satisfy them.
only the present generation but also
with future generation

10. A government cannot go bankrupt

because it can borrow from An individual or firm can be bankrupt.
international agencies and also print
notes. It can only face a financial crises
An individual cannot raise his income by
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 11. The government has power and creating money.
authority to print notes to meets its
financial requirement during war,
emergency, etc. and for economic
development.

FUNCTIONS OF PUBLIC FINANCE

Public finance performs the following functions:

Allocation Function:

Allocation function is any activity of government, which affects the allocation of resources and
the combination of goods and services produced. Government intervention is necessitated by the
failure of market system to guarantee efficiency in the provision of certain goods referred to as
social group.

Distribution Function:

Action by government, which transfers income from one group to another group, is referred to as
distribution functions. An equitable system of public finance aims at even distribution of income
and wealth among the various sections in the community.

Stabilization Function:

The most recent development task of government is stabilization. This is to encourage a steady
rate of economic growth with full employment and stable prices. Full employment and price
stability cannot be achieved automatically without the application of some fiscal measures. The
instruments of stabilization policy include both monetary and fiscal measures and policies.

The monetary policy can be employed by the government to regulate money supply in the
economy. Monetary policy is meant to control cost allocation and pattern of distribution of
credit. Fiscal policy on the other hand, attempts to influence the aggregate demand by altering
government expenditure and revenue (tax).

Stabilization of the economy is done by increasing spending or cutting taxes to increase output
and employment, or by cutting spending and increasing taxes to curtail inflation. Stabilization
policy is mainly a responsibility of the Federal Government.

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PUBLIC REVENUE

Public revenue can be defined as ‘any income or return accruing to or derived by the government
from any sources’ as indicated below:

1. Any receipt arising from the operation of any law

2. Any receipt however described from or in respect of any property held by the government

3. Any returns by way of interest or loans and dividends in respect of shares or interest held
by the government in any statutory body.

From the above, we can thus define public revenue as that fund generated by the government to
finance its activities. It is the total fund generated by the government (Federal, State and Local
Government to meet their expenditure for the fiscal year.

Government revenue refers to the receipts or income realized from government operations used
to finance government functions. Most of this revenue accrues to the government from taxes,
which are mostly levied on private sectors of the economy. Some that attract money are import
and export duties.

Other forms of government revenue include; borrowing, fees and charges, rents, royalties, grants
and aids and profit.

Sources of Public Revenue in Nigeria

Prior to oil boom of early 1970’s, agriculture was the main stay of the economy as the sector’s
contribution to GDP was about 70%. This contribution has fallen to about 30% with the advent
of the crude oil. Since the advent of the oil, the trend has changed in favor of the latter, now it is
the oil revenue that contributes the lion share of the federal government’s revenue.

The main sources of revenue to the government of the Federation can be divided into two:

1. Oil revenue

2. Non-oil revenue

Oil Revenue Sources are as follows:

Petroleum Profit Tax: This tax was introduced in Nigeria in 1959 (PPTA 1959). It is the tax
paid by a company for its own account by drilling, mining, extraction or other like operations for
petroleum.

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Royalties: This is the revenue generated from the use of land for the exploration and exploitation
of the mineral resources under oil prospecting license or oil mining lease. Nigerian National
Petroleum earnings also form source of Nigerian revenue.

Non Oil Revenue Sources Comprises of:

Taxes: Taxation is the most important source of government revenue. This is a compulsory levy
on all-taxable persons and corporate institutions as a form of direct or indirect taxes.

Loans: The Government may source for fund from both internal and external sources.

Grants and Aids: the government may get financial assistance from foreign countries and
international institutions without any condition for repayment.

Government investment: Return on investment made by the government also form another
source of revenue and contribute immensely to the government coffers.

Licenses: The government also generates revenue from issuance of licenses to vehicles owners
for road usage and other items that requires licensing like gun etc.

Other sources of Government revenue include rents on Government properties, interest and
repayment of government loans from individuals and state or local governments and fees paid by
school and toll fees also are inclusive.

Sources of Revenue at the State Level

The following are the sources of revenue to the state governments.

Taxes: These include, Pay As You Earn (PAYE), entertainment tax, capital transfer tax,
cattle/ship and goat tax, value added tax, etc.

Fines and fees: These are revenue collected by various ministries such as pool agents,
application fees, contractor registration fees, and submission fees on certificate of occupation,
etc.

Licenses: These include special marriage licenses, licensing of churches for marriage, renewal of
licenses by contractors, etc.

Earnings: from sales of Agricultural products, and fertilizers, hiring of government houses and
equipments like tractors and rents collected on government quarters also constitute revenue for
state or local government.

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Statutory allocation and reimbursement: i.e. the share of financial allocation from the Federal
Government as well as monies pays to the state government as re-imbursement on any
expenditure that the state incurred on federal account.

Value-Added Tax: revenue also accrues to the state government through VAT i.e. tax on
consumption.

Loan, Grants and Gifts: Loan may be internal or external and grants may come from within or
outside the state e.g. rich countries.

Problems of Revenue Generation by the States and local Government

Revenue generation may be hindered by many problems at the state or local Government in
Nigeria. These may include:

1. Over- dependence on statutory allocation (i.e. Federation Account): statutory allocation

constitutes major source of revenue to both state and local governments, these account for
about 80% of state or local government total revenue.

2. Lack of Competent and Honest Manpower: Most of the revenue (tax) collectors are not
faithful and competent in services. Competence, character and technical knowledge are
sacrificed at the altar of tribalism and political ambition.

3. Inadequate mobility and infrastructural facilities: there are no good roads that lead to the
various sources of revenue. Apart from that good and serviceable vehicles at times are
not available for use. All these reduce the revenue generating capacity of the government.

4. Tax evasion and Avoidance: the self-employed people commonly practice tax evasion;
while tax avoidance is practiced by the educated elite. These arise when a tax payer seek
to reduce his tax liability through illegal method while tax avoidance is the practice on
the part of tax payer to seduce his tax liability by taking advantage of specified provision
of the law to reduce his tax assets.

5. Political interference: Political instability will discourage loans, foreign aids and grants
from developed and rich countries and international financial institutions.

6. High rate of illiteracy and low standards of living: Many illiterate people see tax payment
as a form of victimization. Low income and economic depression, which have cripple
many financially, would no doubt affect revenue generation.

7. Lack of enlightened programmes: The generality of people in the rural areas are not well
informed as to why they should pay taxes or other levies.

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TAXATION

A tax is a compulsory levy imposed by the government on individuals, goods and services and
corporate bodies for the purpose of financing government expenditures. Most of the government
revenues come in the form of tax collections. It is therefore the science of imposing tax on the
citizens.

Tax is a transfer payment to government from individuals and private sector, which constitute
the principal source of revenue to finance government expenditure and also act as an instrument
of fiscal policy.

It involves compulsion, the tax payers are required to pay certain amount regardless of their
feelings and willingness. Once taxes have been levied no individual has a choice of paying
except defaulters.

The Purpose of Taxation

1. To generate revenue: Government imposes taxes to generate revenue to finance its

activities like provision of social services, administration of government and financing
capital projects.

2. To achieve income equality: Taxes can be used to redistribute income by adopting the
progressive system of taxation. To redistribute income in favour of the poor, a
progressive form of taxation is employed such that a higher rate of tax is imposed on
high-income earners.

3. To encourage Local Production: Foreign made goods are heavily taxed in order to
discourage their importation. This in turn, enhances the consumption of locally made
goods as well provide employment. Taxes may be imposed on commodities especially to
discourage importation and encourage production.

4. To achieve Balance of Payment Equilibrium: Taxes can be used to correct a balance of

payment deficit through the manipulation of import duties and export duties.

5. To achieve price stability in the economy: The government may introduce tax holiday
to indigenous companies. Low company income tax may induce further investment and
economic growth. During a depression, a reduction of tax rates will have an inflationary
effect and stimulate consumer’s demand, thus encouraging production.

6. To discourage the consumption of harmful goods: indirect taxes are imposed to

discourage the importation and consumption of certain goods, which are considered
harmful.

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Forms of Taxation

Taxes may be classified into two: Direct and Indirect taxes.

Direct Taxes:

These are taxes levied directly on the incomes of individual and business firms. They are taxes
levied by the government on the income and properties of tax payers.

Direct taxes constitute the most important source of government revenue in Nigeria prior to the
oil boom and are still significant in the present days of the economy. The most important forms
of taxes include; Poll tax, Personal income tax, company tax, etc.

Poll tax: This is tax operated on flat rate basis usually imposed on the income of some
individuals.

Personal income tax: This is a compulsory levy imposed on the personal income of individuals,
usually during a period of one year.

Company Income Tax: This is a tax imposed on the net profit of a company. The tax is charged
on the profit after deducting other allowances. This form of direct tax is easier to collect
especially in Nigeria because of government’s directives on the submission of tax certification in
respect of any official obligation.

Petroleum Profit tax: The petroleum profit tax act of 1959 as amended provide for the taxation
of companies engaged in petroleum operation.

Capital Gain Tax: Capital gain tax is the type of tax levied on the gains or profit derived from
the sale of land and capital assets.

Advantages of Direct Taxes.

1. It is economical to administer

2. It is equitable if progressive

3. Its yield is predictable

4. It creates awareness among the citizens (taxpayers) in terms of their contribution

5. It is convenient for tax payers

6. Direct taxes are difficult to evade

7. They are used as weapons to curve inflation: whenever there is inflation direct taxes are
raised in order to reduce disposable income and velocity of money.

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Disadvantages

1. It may discourage savings

2. It reduces the purchasing power of the tax payer

3. It can cause disincentive to investment

4. Evasion is sometime possible

Indirect Taxes

These are taxes levied on goods and services of the taxable units. It is mostly levied or imposed
on locally made, imported and exported goods and services. The tax payers do not bear the entire
burden of the tax, but it is partly passed to the consumers depending on the elasticity of demand
for the commodity being taxed.

Indirect taxes consist of the following:

1. Value added Tax: these are taxes incorporated in the price of goods or service being
purchased. It is mainly borne by the consumers of goods or services.

2. Excise Duties: it refers to a tax imposed on locally manufactured goods within a country.
The level of industrialization in a country determines the amount of tax revenue that will
be generated through excise duties.

3. Export Duties: these taxes are imposed on locally produced goods exported out of the
country.

4. Import Duties: These are imposed on imported goods brought into the country by
external manufacturers. E.g. tariffs.

Advantages of Indirect Tax

1. It is difficult to evade, this is so because it is mainly paid as part of the prices of goods
and services.

2. It is simple to collect, since manufacturers pay tax immediately they produce their goods
before such goods are even sold to the consumer. On the part of the Government it yields
quick revenue.

3. Indirect taxes does not lead to agitation by workers, because they are mostly unaware of
the payment of such taxes
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 4. Indirect taxes are used to protect infant industries. This is done by raising import duties
on foreign made goods; while subsidizing the production of home made goods thus
making them relatively cheaper.

5. It is useful to regulate consumer expenditure.

6. It is flexible and can be modified easily.

Disadvantages

1. It tends to create inflationary pressure

2. Its incidence is uncertain

3. It tends to be regressive

4. It negates the principles of ability to pay

5. It restricts free trade

Forms of Income Tax

1. Proportional Tax: is a tax that takes a constant percentage of income as income rises.

2. Progressive Tax: is a tax that takes a greater percentage of income as income rises.

3. Regressive Tax: Is a tax that takes a smaller percentage of income as income rises. This
encourages individuals to be hard working to earn more income.

INCIDENCE OF TAXATION

When a tax is imposed on a commodity, it can be passed on to consumers in the form of higher
prices. It should be noted that the incidence may be upon the buyer, or the seller or divided
between them, depending on the elasticity of demand for the commodity. Incidence of taxation
therefore refers to the point at which the tax burden finally rests. The burden here refers to the
amount paid as tax.

Tax shifting

This is the process whereby the economic agent that bears the initial impact of the tax is able to
pass the whole or part of the tax burden to another economic agent through changes in prices.

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Tax evasion

Tax evasion arises when a taxpayer seeks to reduce his tax burden or liability through illegal
methods. In income taxation, for example, the taxpayer may deliberately reduce his turnover or
increase his expenses in order reduce his taxable income. He may also fail to report a source of
income altogether. It is therefore implied that tax evasion is a crime that will render fiscal policy
ineffective.

Tax Avoidance

Tax avoidance is the practice on the part of the taxpayer to reduce his tax liability by taking
advantage of specific provisions of the law to reduce his tax liability.

Causes of Tax Avoidance

The following will represent the possible causes of tax avoidance and evasion in Nigeria.

1. Inability of Nigerian tax system to satisfy the principle of economic justice, that is, in a
situation where government cannot live up to expectation, there is bound to be problems
of tax evasion and avoidance.

2. Inadequate information:- in an economy like Nigeria where activities have not been fully
monetized, there will be room for tax avoidance and tax evasion

3. The nature of manufacturing sector in Nigeria. Most companies in Nigeria have their
parents companies abroad and in addition; they depend on foreign input, which is an
opportunity for them to evade tax by over invoicing.

4. Unpatriotic attitude of tax collectors and taxpayers:- for their own personal benefit/gain
tax collectors will always like to collude with tax payers to evade tax

5. The problem of porous economy borders: that is, borders are not effectively policed are
situations that allow smuggling activities to take place.

Solutions to Tax Avoidance and Evasion

1. It is necessary for government to live up to expectation so that the tax system will satisfy
the principle of economic justice.

2. It is advisable for government to place emphasis on indirect tax, which cannot be easily
avoided or evaded.

3. The use of monitoring agents to check the unpatriotic attitudes of tax collectors.

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 4. Penalty for tax evaders and disciplinary action against unpatriotic tax collectors. The tax
payer should be made to pay the evaded tax in arrears plus market rate of interest. The
unpatriotic collector should be dismiss from service.

5. Effective use of tax clearance certificate

6. Effecting policing of border to check smuggling

7. Public enlightenment campaign should be embarked upon to sensitize and educate the
people of the damage that will be done to the economy anytime tax is evaded or avoided.

Effects of Taxation

Effect on the prices and outputs of goods and services: Taxes on profits of firms are often part
of the cost of production. Thus, indirect taxes will raise the cost of production and the price of
the commodity under consideration since part of the tax burden could be shifted to consumers in
terms of a higher price.

Effect in the form of Inflation: The level of taxation in relation to income has been on the
increase since 1930s, thus, contributing to pushing up of income through increasing wage rate,
increasing cost of production.

Disincentive effects on labour and enterprise: Heavy taxes on incomes serves as a disincentive
for those who would have worked for more hours than they now do, particularly over-time
workers. Also, taxes on profits of entrepreneurs make them less willing to take risk since they
consider profit taxes as ‘penalty for successes’.

Effect on saving: Income taxes reduce the proportion of income at the disposal of the earner,
thus making saving more difficult.

Effect on the structure of production and allocation of resources: If profits are taxed, the
profits of capital-intensive industries will be more affected than those of the labour-intensive and
resources may be allocated from the former to the latter.

PRINCIPLE OF TAXATION

Adams Smith in 1776 stated four attributes of a good tax system known as Canon of Taxation.
These canons comprise of equity, certainty, convenience and economy. Generally, a modern tax
system must possess these attributes:

Equity: Equity is a measure of fairness. The principle states that people should be taxed in
proportion to their ability to pay. The burden of tax should be according to one’s ability. When
we speak of equity, we often distinguish between horizontal equity and vertical equity.

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Horizontal equity is achieved when all taxpayers in a certain economic category pay the same tax
and vertical equity is a situation that is achieved when taxpayer of different categories are treated
differently.

Certainty: the amount of tax, which a taxpayer is required to pay should be as certain as
possible. When and how to pay tax should be made known to the taxpayer.

Convenience: The place, time and manner of payment of tax should be made as convenient as
possible for the taxpayer e.g. salary earners- PAYE.

Economy: The administrative cost and cost of collecting tax should be low as much as possible
compared with the tax proceeds.

Simplicity: The tax system and the law relating to taxes should be as simple as possible and
clear to the tax payer.

Visibility: This refers to the taxpayer’s awareness of the taxes they are paying.

Hard to evade: it should be difficult to evade tax i.e. Difficult to escape payment.

Efficiency: an ideal tax is one that is neutral. A neutral tax would cause no distortion in
economic activities.

Political acceptability: The government should be able to collect the tax without generating
political discontentment.

Elasticity: Taxes must respond closely to changing economic conditions without changing the
tax rate.

PUBLIC EXPENDITURE

Introduction

According to Bhatia (1976), Public expenditure refers to the expenses, which the government
incurs for its own maintenance and also for the society and the economy as a whole. In other
words, government expenditure is the expenses incurred by the government for the maintenance
of itself, the economy and the society.

Public expenditure is an important mechanism which the government can use to have significant
effects on people’s lives in terms of standard of living and better opportunities.

Components of public Expenditure

In Nigeria, public expenditure may be classified into two:

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 1. Capital expenditure

2. Recurrent expenditure

Capital Expenditure: These are expenses on goods and services whose services are rendered
over a long period of time. These are expenditures on projects like land, building, road
construction, housing etc. The benefits of capital of capital expenditure are more durable and
long lasting for years than those of the recurrent expenditures. They are financed mainly from
borrowing, budget surplus and from grants and aids.

Recurrent Expenditure: These are expenses carried out by the government on the day to day
activities i.e. general spending on services to maintain the existing facilities in the economy.
They include spending on wages and salaries, maintenance of social services, rent and rates, etc.
Recurrent expenditures are generally consumable year by year.

Classification of Government Expenditure

Government expenditures are classified into

1. Administration

2. Economic services

3. Social and community services and

4. Transfers

This classification is based on both capital and recurrent expenditure

Administration expenditure: This type of expenditure is undertaken in order to ensure effective

organization of the whole society. Expenditures on administration comprises of general
administration (e.g. wages and salaries), defense (armed forces) and internal security
(maintenance of law and order)

Economic services expenditure: Government incurs expenses on economic service like

agriculture, construction, transportation, communication, mining, manufacturing and others.

Social and community services: These are government spending on the provision of social
amenities which comprises expenditures on education, health, housing, recreation facilities and
other social amenities like electricity and water etc.

Transfers: These are expenditure made on debt repayment, both the principal and the interest.
While the transfers under recurrent expenditure consist of public debt charges (local and
foreign), pensions and gratuities, contingencies and extra budgetary expenditure, the transfers
under capital expenditure includes financial obligations, capital repayment, and loan to
parastatals, outstanding liabilities and others.
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PURPOSE OF GOVERNMENT EXPENDITURE

To defend the territorial integrity of the country: The government of every country spends
huge amount of money in defense of its territorial integrity.

Economic growth and development: Government spends on economic activities like

industries, trades transport and communication in order to accelerate economic growth and
development.

Maintenance of internal peace and security: To maintain internal peace and security
government must fully equip the police, courts and prisons.

Servicing of Loan: To repay loan borrowed internally and externally, a huge sum of money is
spent from government purse.

Provision of social amenities: To provide social amenities for people and industries,
government always allocates a huge sum of money.

General Administration: In Nigeria, salaries and wages have undergone many changes and
these are paid from the government’s purse.

Grants and aids: At times, the federal government does assist the state and local governments
by giving grants and aids and equally helps maintain order and peace in neighboring countries
e.g. ECOMOG

Miscellaneous expenditure: These include payments of pension and gratuities, training

manpower, etc.

THE EFFECT OF PUBLIC EXPENDITURE

Public expenditure has effects on economic stabilization, production, distribution and economic
growth as indicated below:

Economic stabilization: Economist advocated a continuous injection of additional purchasing

power in the market through stimulation of investment and consumption activities and through
direct public investment. This direct investment is part of the public expenditure. The public
authority can increase its spending; this in turn stimulate investment

On the other hand, during boom, the government may reduce public spending in order to curb
extra-demand.

Production: Low investment is one of the features of less-developed countries. This feature can
be eradicated through increase in government spending on productive projects.

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Government can enhance productivity or investment through direct public saving and
investment, education and training of human resources, provision of social amenities etc. the
monetarist believe that increased government expenditure will gear up private investment
entirely.

Distribution of wealth: In developing countries, there is a wide gap between the poor and the
rich in terms of income and wealth. A shift towards equality may be achieved through various
expenditure measures especially such measures that tend to help the poorer sector of the
economy. A number of welfare measures like free education, health, water and other facilities
can be given a top priority, which the poor and low income groups could not have afforded with
their meager income

Economic growth: Every developing country desires to achieve economic growth and
development. Public expenditure has a role to play in achieving this objective through creation of
infrastructure for economic growth. Expenditures in manpower development that increase skills
and efficiency of labour tend to increase the level of economic growth.

Employment: Government expenditure in the establishment of industries and public enterprises

has created a lot of employment opportunities.

CANONS OF PUBLIC EXPENDITURE

Canons of public expenditure are the general principles, which should govern the public
expenditure decision, in order to make an impact in the life of the people.

Economy: Economic resources are scarce relative to the needs of the society. In recognition of
this fact, public funds must be utilized judiciously without wastage. Decision-makers should
exercise due care in planning and executing public project in order to reduce wastage.

Authorization: This canon asserts that no public funds should be used without proper
authorization and funds must be used only for the purpose for which they have been approved.
The community is represented by a democratically elected legislatures, their task includes the
preventing of the executive from incurring unnecessary expenditure.

Benefit: The magnitude of every expenditure must be related to the benefit it can generate to the
society. Government should embark on the projects that are beneficial to the general public. The
canon makes it mandatory for the government to undertake cost-benefit analysis of public project
before committing fund to them.

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BUDGETARY SYSTEM

Introduction

The word budget has been derived from the French word ‘bougette’ which means a small bag. It
symbolizes a bag containing the financial proposals. Historically, the budget was an essential
part of the British parliamentary system over two centuries ago and has been in operation in
France for over a century. The budget was inaugurated and introduced into the American system
in the third decade of the Twentieth century.

In Nigeria, the idea of budgeting was part of our national inheritance from Britain, our colonial
master. Usually, about six months to the close of each financial or fiscal year, the government
starts to budget for its capital and recurrent expenditures and revenues for the year ahead.

Public budget provides the most comprehensive picture of the government’s total expenditures
and receipts as well as its policy thrust for the period. Thus it offers some indications of the
aggregate fiscal impact of government programmes. The budget offers the government a vehicle
for implementing its policies through expenditures of the various Ministries and departments.

What is Budget?

The word budget originally meant the moneybag or the public purse, which served as a
receptacle for the revenue and expenditure of the state. Eventually, the term came to mean the
documents, which are contained in the bag i.e. the plan for government finances submitted for
the approval of the legislature.

A budget is a financial plan expressed or prepared in quantitative and monetary terms and
approved prior to the defined period of time, usually a year. In other words budget is a financial
estimate of revenue receipts and proposed expenditures, covering a specific period of time.

Characteristics of a good Budget

A good budget must possess the following attributes:

1. The budget proposals should be accompanied by an analytical description of the current

economic situation of the country.

2. It must be accompanied by the fiscal and monetary control measure to be introduced by

the government.

3. The present position of the treasury must be known

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 4. It must be comprehensive and clear, so that a correct judgment can be formed as to the
way in which the budget is expected to function in the coming year

5. It must reflect the overall policy and purpose of the government

6. A good budget should reflect the estimates, both revenue and expenditure, arranged under
recurrent and capital grouping.

7. A good budget should always cover a period. In Nigeria, however, the life of government
budget is usually one fiscal year.

BUDGETING

Budgeting is basically planning and controlling. In budgeting, there is the need for wise selection
of essential activities or programmes to be undertaken and for coordinated plan of financing such
activities or programmes. In business, the fundamental purpose of budgeting is to find the most
profitable course through which the efforts of the business may be directed and to aid
management in holding to that course.

Benefits of budgeting by the government are:

1. Action is based on study: Due to the fact that executive and operating heads make the
plan, which they are bound to execute when approved, careful study will become a habit
before any action is taken.

2. Policies are established: policies are declared in the budget where emphasis is laid on
the essential of projects to be undertaken. A system of priorities is often established
especially where there are limited resources.

3. Programme or activities are related to expected or available resources and economic

conditions.

4. Balanced programmes are developed: Again, the priority and essentiality of projects
are studied for determining how money should be spent and what is to be expected in
prosecution of chosen projects or actions

5. Coordinated efforts are attained: In budgeting, coordination of all ministries,

departments or divisions is necessary, without it concerted actions cannot be achieved.

6. Operations are controlled: Control of expenditures and operations is provided in

systematic budgeting.

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 7. Weaknesses in the Ministries/Departments are revealed: Where plans are developed
and responsibilities for the accomplishment are delegated, weakness, if any in the
department will be revealed.

8. Wastage is prevented: Because budgeting analyses the reasons for proposed

expenditures in advance, waste is prevented.

Types of Budgets prepared in the public Sector

Generally, there are two main types of budgets being prepared in the public sector. These are:

1. Revenue budget and

2. Expenditure budget

Revenue Budget

This comprises the estimated revenue of government both tax-revenue and non-tax-revenue in
the subsequent fiscal year. The non-tax-revenue receipts include revenue from rent on the
government properties, reimbursement, interest, dividends, revenue from social and community
services etc. tax-revenue receipts include revenue from personal income taxes, company income
tax, and petroleum profit tax etc.

Expenditure Budget

This comprises the estimated expenditure melted out of revenue receipt by the government. This
can be further classified into three main categories, which are:

Personal Emolument Budget: This is the estimated salaries, wages, allocations and leave bonus
of members of staff of different cadres within the ministries, Departments and Agencies of
Government for the subsequent fiscal year.

Overhead budget: This is the estimated recurrent expenditure in the next financial or fiscal year
such as transport and travelling, stationary, repairs and maintenance, entertainment, as well as
staff development and training.

Capital expenditure Budget: This is the estimated capital expenditure in respect of the
execution of capital projects of the government in the following fiscal year e.g. construction of
roads and bridges, acquisition of mass transits buses, etc.

Budgets can further be classified according to their nature and basis; these include Annual,
supplementary, deficiency and special budgets.

Annual Budget: is a budget which covers a period of one year. It is the basis of an annual
appropriation.

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Supplementary Budget: is the kind of budget which is expected to supplement or adjust a
previous budget, deemed inadequate for the purpose to which it is intended. It is the basis of
supplementary appropriation.

Deficit budget: this is a budget prepared in order to cover any deficit, or overdraft incurred over
and above those originally budgeted. It is a basis of deficiency appropriations passed by the
legislative body.

Special Budget: Special Budgets are budgets generally submitted in special forms on account of
the fact that they are not adequately provided in the appropriation act or the amounts are not at
all included in the appropriation act. These types of budget are used generally for special funds
not ordinarily subject to formal budgetary control like other trust funds.

OBJECTIVES OF GOVERNMENT BUDGET

The objectives of a typical budget include the following:

1. To allocate resources: Government expenditure and taxation have a great influence on the
allocation of resources. If applied efficiently and wisely, it can lead to efficient allocation
of resources in the economy.

2. To check inflation: If the government spend less than it realizes, the purchasing power of
the people will consequently be reduced and this may eventually curb an inflationary
trend.

3. To reduce cost of living: A budgetary surplus could be used to reduce the cost of living
since a reduction of the rate of inflation means reducing the cost of living.

4. To redistribute income and wealth: Budgetary policy may be used to bridge the gap
between the rich and the poor.

5. To achieve balance of payment equilibrium: Government budget can be used to achieve

balance of payment equilibrium by encouraging export promotion.

6. To protect infant industries: a budget, through its provision may be used to protect local
industries.

7. To increase output in the economy: a budget deficit could directly lead to an increase in
the level of production, provided the extra spending of the government is on productive
investments.

8. To achieve full level of employment: a budget deficit can assist to achieve full level of
employment.

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Budget Deficit

A budget deficit is the situation in which the government estimated expenditure exceeds its
estimated revenue for the period and this type of financing is called deficit financing. This may
be adopted to stimulate economic growth during economic depression.

Advantages of deficit budget

1. It is a device to solve the problem of unemployment

2. It can be used to stimulate economic growth and development

3. It can be used to improve the standard of living especially if the deficit is for
infrastructural development.

Disadvantages of deficit budget

1. It may generate price instability (inflation)

2. It will encourage reckless spending on the part of government

3. It will encourage borrowing, which can complicate the problem of debt-burden

4. It discourages multi-national agencies like IMF, to provide financial assistance

5. It may complicate the problem of exchange rate and balance of payment.

MONETARY AND FISCAL POLICY

Monetary policy is dominated by monetary and fiscal policy. Other policies include income,
price, employment, trade and industries. Money supply and government expenditure are two
cardinal tools of monetary and fiscal policy.

Monetary policy

Monetary policy is the actions taken by the monetary authorities to influence the national
economic objectives of a country by controlling or influencing the quantity and direction of
money supply.

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Ubogu (1985), defines monetary policy as an attempt by the monetary authorities to influence
the level of aggregate economic activities by controlling the quantity and direction of money and
credit availability.

According to Johnson (1962) monetary policy is the policy employed by the Central Bank to
control the money supply as an instrument for achieving the objectives of economic policy.

In general, monetary policy refers to the combination of measures designed to regulate the value,
supply and cost of money in an economy, example an excessive supply of money would result in
an excess demand for goods and services, which would cause rising prices or a deterioration of
the balance of payment position. On the other hand, inadequate supply of money will induce
stagnation in the economy thereby retarding growth and development. Therefore monetary
authorities must keep the money supply growing at an appropriate rate to ensure sustainable
economic growth and maintain internal and external stability.

In a simpler term, monetary policy refers to the various methods which government adopts to
expand or contracts money supply working through the Central Bank.

Monetary policy can either be expansionary, where the Central Bank tries to increase money
supply in an economy or contractionary where the money supply is reduced. In a nut shell, the
aims of monetary policy are basically:

1. To reduce price stability

2. To maintain a healthy balance of payment position

3. To redistribute income

4. To sustain the level of economic growth and development

5. To increase employment opportunities

6. To increase a broad and continuous market for government security.

In a typical developing country like Nigeria, where the financial and capital market are
underdeveloped, monetary policy is adapted to accommodate Government financial problems of
economic growth and development.

TECHNIQUES AND INSTRUMENT OF MONETARY POLICY

The techniques by which the monetary authorities try to achieve the objectives of monetary
policy can be classified into two categories.

1. Direct control or Quantitative instrument

2. Indirect/Market-based control or Quantitative instrument.

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Direct Control (Qualitative instruments)

These are monetary instruments that place restrictions on a particular group of institutions
(especially deposits banks) by limiting their freedom to acquire assets and liabilities. This
method is employ mainly in developing economies in which the financial infrastructure
necessary for operating indirect monetary control is absent or underdeveloped. These instruments
include:

a) Sectorial Credit allocation: It gives directives to bank in terms of the proportion of

aggregate credit that should go to a specific sector of the economy. Central Bank
classifies borrowing into preferred and less preferred sectors of the economy.
Commercial Bank will now be directed to give more loans to the preferred sector of
economy.

b) Aggregate credit ceiling: Central Bank influences and controls the level of aggregate
credit expansion by imposing a limit or ceiling on the credit rate of bank, usually as a
proportion of their deposit.

c) Interest rates ceiling: It is a form of maintaining a minimum or maximum on interest rate

chargeable on loans or payable on deposits by banks, as a means of inducing an increase
in productive capacity.

Indirect/Market-based control or Quantitative Instrument

These are indirect instruments of monetary policy mainly because they are to be channeled
towards the real sector of economy through the money market. It is used mainly in developed
financial systems, relies on the power of the monetary authority to influence the availability and
the rate of return on financial assets. These instruments include:

Open Market Operations (OMO): When the Central bank feels that the money in circulation is
rather small and wants to increase it, she buys treasury bills from the commercial banks and
gives the commercial bank money in return. This increase the money in possession of
commercial banks and they are thus in a position to give out more loans. But if the central Bank
feels that the money in circulation is rather too much and it wants to reduce same, what it does is
to sell treasury bills. When the central bank sells treasury bills it collects money from the
commercial banks. This decreases the amount of money held by commercial banks as a result of
which their loan is decreased.

Bank Rate: The bank rate is very important because all interest rate charged by commercial
banks, insurance companies, and hire purchase companies depends on the bank rate. If the bank
rate is high the interest rate charged by these financial houses will be high. Conversely if the
bank rate is low the interest rate charged by all these financial houses will also be low. When the
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bank rate is reduced, all other interest charges made by financial institutions will be reduced. The
public will be able to obtain more loans, advances and overdrafts. It is profitable to lend when
the interest rate is increased, and unprofitable for people to borrow. The people will not borrow
when the bank rate is high. They will wait until the bank rate is low or reduced.

Cash Ratio: All commercial banks are expected to keep certain percentage of their total
deposits with the Central Bank. For example, the percentage kept with the bank may be 10% of
the total deposit which represents the cash-deposit ratio. The Central Bank can expand or
contract credits by manipulating the cash.

Liquidity Ratio: It is a reserve held in form of cash in the bank in order to meet depositors
demand, when the Central Bank wants to reduce bank lending (or Money Supply), it increase
this ratio. But if the Central Bank wants to increase bank lending it will reduce this ratio. The
reduction in this ratio enhances the ability of the commercial banks to grant loans and advances.
This in turn increases money supply.

Special directives: The Central Bank can issue directives or specific instructions to the
commercial banks and other financial institutions to restrict their lending or credit policy or on
the direction to which loaning should follow. They will be told to direct their funds to sectors,
which are in need of investment.

Special deposit: Special deposit is also an instrument of monetary policy, which is used to
restrict lending. The central bank can order the commercial banks to have special deposits,
usually a percentage of the banks’ deposits to be made with it. This is intended to control credit
and is often used with banks. The Central Bank will mandate the commercial banks to keep
special deposit over the statutory requirement.

Moral suasion: The Central Bank can make an appeal to the commercial banks to restrict or
expand the level of credit to the public. Moral suasion is not based on the use of force but an
appeal to restrict or expand the lending policy.

Limitations of Monetary policy

The features of developing countries will make monetary policy ineffective due to undeveloped
nature of money and capital markets. The limitations of monetary policy include:

1. Inadequate information: it is difficult for monetary authorities to have the right

information on economic indicators.

2. Conflicting objectives: A policy designed to reduce inflation in an economy while

achieving this objective, may create more unemployment within the economy.

3. Time lag: There is always a long time lag between the time the need for action is realized
and the time the action is taken such that a bad situation might have grown worse.
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 4. Nature of economy: It will be difficult for monetary policy to work in highly
monocultural economy. Nigeria is characterized with rural sector, therefore it is unlikely
for monetary policy to work in such sector.

5. Poor Banking habit: Many Nigerians do not keep their money with the financial
institutions and few that do withdraw all their salaries form the banks. This reduces the
effectiveness of monetary policy since their money has nothing to do with the banking
system; monetary policy has no effect on the amount of money available to them.

6. Political instability: This is another limitation to the effectiveness of monetary policy.

Change of government (leadership) may result to change of policy. Political instability
may aid budget indiscipline and this reduces the effectiveness of monetary policy.

7. Unrealistic foreign exchange rate: this unrealistic exchange rate problem has often
discourage foreign investment in the economy and even discourage domestic savings,
increasing rate of speculation, smuggling and a discouragement of exports also often
follow the exchange rate problem.

8. The low rate of monetization: This has reduced the success of monetary policy in
Nigeria. Low monetization rate has always meant that most of the funds available in
circulation circulate outside the banking system. This means that the ratio of demand
deposits to currency outside banks is very low. It becomes difficult to use monetary
instruments to reduce the amount of money in circulation.

9. The Problem of lack of Collateral Security: in this case, if the price of borrowing is
almost nothing, since majority cannot take loans, credit expansion becomes difficult. In
Nigeria, the level of income is very low.

FISCAL POLICY

Fiscal policy is one of the tools of government intervention in an economy. Keynesians (1976)
defined fiscal policy as the use of government spending and tax policies to stimulate or control
economic activities.

Fiscal policy can also be defined as the use of government expenditures, taxes, borrowing and
financial administration to further national economic objectives. Government uses its
expenditure and revenue activities to effect desired changes in income, production, prices and
employment.

In a nutshell, fiscal policy is the use of revenue and expenditure instruments or policies to control
or regulate the economic activities in a country. It is a plan of action pertaining to the raising of
revenue through taxation and other means and the pattern of expenditure to be applied.
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The objectives of fiscal policy include:

(i) To achieve domestic price stability

(ii) To attain full employment

(iii) To achieve balance of payment equilibrium

(iv)To accelerate the rate of economic growth

(v) To redistribute income

Fiscal Policy can be expansionary or contractionary, for instance, during periods of

unemployment, expansionary fiscal policy is usually employed. During periods of inflation,
government often resorts to contractionary fiscal policy.

Instruments of Fiscal Policy

There are four components of fiscal policy, which government tries to manipulate to achieve the
desired goals. These are:

1. Taxation

2. Government expenditure

3. Public debt

4. Subsidy

Taxation: Taxes are compulsory payment often imposed on individuals, companies or corporate
bodies either directly (e.g. personal income and company taxes) or indirectly (excises, import
duties etc.). Taxes are often imposed for a number of reasons, for instance to increase the supply
of public goods, enhance the welfare of the society, regulate the economy through reduction in
prices etc.

Government Expenditure: This is the spending on goods and services by the public authorities of
the federal, state and local governments. Government expenditure refers to the total expenses
incurred by the public authorities at all levels of administration.

Public debt: in recent times, public debt management and servicing have become an important
aspect of fiscal policy. This is so because borrowing has become an annual source of revenue for
various levels of government.

Subsidy: At times, the government may decide to pay part of the cost of producing an item either
to stimulate its supply or to reduce the price paid by the final consumers. This is known as
subsidy.

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PUBLIC DEBT

Public debt is the total borrowing by the government or public authority at home and overseas. In
other words, public debt is the total amount of the county’s contractual obligations or liabilities
to individuals, institutions, countries and other creditors. Put simply, Public Debt refers to the
debt a country owes its citizens or other countries or organization like the IMF and the World
Bank.

Division of Public Debt

Public debt may be grouped into two:

1. Internal or domestic public debt

2. External public debt.

Internal public debt: When debt is owned or held by the subject of the indebted government, it
may be called an internally held debt i.e. the country owes this debt to some of its own citizens.

External public debt: External debt refers to unpaid portion of external resources acquired for
developmental purposes and balance of payments support, which could not be repaid when they
fell due. In other words external debt is the debts owed by a country to institutions or countries
abroad.

Assignment

Discuss the various sources of public debt, why is the need for it and how does public debt
differs from that of private debt?

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