Download Management Of Public Finances

Management Of Public Finances
By Julius Kipngetich,Lecturer,Department of Management Science Faculty of Commerce, university
of Nairobi.
12-09-2001
Introduction
In Kenya's economy today, total taxation is 24% of GDP and is considered on the high side by
world standards. The Government is the biggest employer either directly or indirectly through
parastatals. The Government borrows heavily from the domestic market, taking on average sh.8
billion per week. A very large proportion of our taxes go to support Government's recurrent budget
- mainly salaries and debt repayments.
Beyond the budgetary function, public policy influences the course of economic activity through
monetary, regulatory and other devices. Public enterprises play an important role, though most of
them are poorly managed and have become avenues for corruption. The modern capitalist economy
is thus a thoroughly mixed system in which public and private sector forces interact in an integral
fashion.
Need for Public Sector
In a supposedly private enterprise economy, questions are asked why a substantial part of the
economy is subject to some form of government direction rather than left to the "invisible hand" of
market forces. The prevalence of government may reflect the presence of political and social
ideologies which depart from the premise of consumer choice and decentralized decision making.
Public policy is needed to guide, correct and supplement the economy in certain respects. The
following are some of the reasons for need for governments to intervene in economies:
* The claim that the market mechanism leads to efficient resource use is based on the condition of
competitive factor and product markets. Thus there must not be any obstacles to free entry and
consumers and producers must have full market knowledge. Government regulation or other
measures may be needed to secure these conditions
* They may also be needed where competition is inefficient due to decreasing cost
* The contractual arrangements and exchanges needed for market operation cannot exist without
the protection and enforcement of a governmentally provided legal structure
* The production or consumption characteristics of certain goods are such that they cannot be
provided for through the market. Problems of 'externalities' arise which lead to market failure and
required correction by the public sector, either by way of budgetary provisions, subsidy or tax
penalty.
* Social values may require adjustments in the distribution of income and wealth which results from
the market system and from the transmission of property rights through inheritance
* The market system does not necessarily bring high employment, price level stability and the
socially desired rate of economic growth. Public policy is needed to secure these objectives.
* Public and private points of view on the rate of discount used in the valuation of future
consumption may differ
Although particular tax or expenditure measures affect the economy in may ways and may be
designed to serve a variety of purposes; several distinct policy objectives include:
* The provision of social goods or the process by which total resource use is divided between
private and social goods and by which the mix of social goods is chosen. This provision may be
termed the allocation function of budget policy. Regulatory policies are considered part of the
allocation function.
* Adjustment of the distribution of income and wealth to ensure conformance with what society
considers a 'fair' or 'just' state of distribution. This is thus the distribution function of government.
* The use of budget policy as a means of maintaining high employment, reasonable degree of price
level stability and an appropriate rate of economic growth, with allowances for effects on trade and
on the balance of payments. This is the stabilisation function.
While these policy objectives differ, any one tax or expenditure measure is likely to affect more than
one objective. The problem is how to design budget policy so that the pursuit of one goal does not
void that of another.
Government Policy Instruments to Manage the Economy
The Allocation Function
The market mechanism is well suited for the provision of private goods. The assumption is that
consumption of goods and services is based on exclusion unless you pay and is rivalrous. The
government must step in where the market cannot deal with a particular situation.
The political process must enter the picture as a substitute for the market mechanism. Voting by
ballot must be resorted to in place of voting by dollar bids. Since voters know that they will be
subject to the voting decision, they will find it in their interest to vote such that the outcome will fall
closer to their own preferences. Decision making by voting becomes a substitute for preference
revelation through the market, and the collection of cost shares thus decided upon must be
implemented via the tax system if we say that social goods are provided publicly, it means that they
are financed through the budget and made available free of charge. How they are produced does
matter. When looking at the public sector in the national accounts, the cost of such provision
through salaries of public employees, and purchases from private firms. Public production of private
goods should be severely limited.
The Distribution Function
This is the major point of controversy in any budgetary debate as it plays a key role in determining
tax and transfer policies. In the absence of policy instruments, the distribution of income and wealth
depends on the distribution of factor endowments e.g. personal earnings abilities and the ownership
of accumulated and inherited wealth. Distributional attention appears to be shifting from the
traditional concern with relative income positions, with the overall state of equality, and with
excessive income at the top scale to adequacy of income at the lower end. Thus the current
discussion emphasize on prevention of poverty, setting what is considered a tolerable cut-off line or
floor at the lower end rather than putting a ceiling at the top, as was once a major concern.
Among various fiscal devices, redistribution is implemented most directly by:
* A tax-transfer scheme, combining progressive taxation of high income with a subsidy to low
income households
* Progressive taxes used to finance public services which particularly benefits low income
households
* A combination of taxes on goods purchased largely by high income consumers with subsidies to
other goods which are used chiefly by low income consumers
The Stabilisation Function
This does not come automatically but requires policy guidance. Without it, the economy tends to be
subject to substantial fluctuations and with growing international interdependence, forces of
instability may be transmitted from one country to another, which further complicates the problem.
The overall level of employment and prices in the economy depends upon the level of aggregate
demand, relative to potential or capacity output valued at prevailing prices. The level of demand is a
function of the spending decisions of millions of consumers. These decisions in turn depend on
upon many factors, such as past and present income, wealth position, credit availability and
expectations. In any one period, the level of expenditures may be insufficient to secure full
employment of labour and other resources. Expansionary measures to raise aggregate demand are
then needed. Expenditures, also, may exceed the available output under conditions of high
employment and thus may cause inflation. In such situations, restrictive measures are needed to
reduce demand.
Policy measures available to deal with these problems involve both monetary and fiscal measures.
* Monetary instruments - if left to its own devices, the banking system will not generate precisely
that money supply which is compatible with economic stability but will accentuate prevailing
tendencies to fluctuation. The money supply must be controlled by the central banking system and
be adjusted to the needs of the economy in terms of both shortturn stability and long-range growth.
* Monetary policy - cash ratio, treasury bills, discount rates, interest rates, exchange rates etc - is thus
an indispensable component of stabilization policy. Expanding money supply will tend to increase
liquidity, reduce interest rates, and thereby increase the level of demand, with monetary restriction
working on the opposite direction.
* Fiscal Instruments - raising public expenditures will be expansionary as demand is increased,
initially in the public sector and transmitted to the private market. Tax reduction, similarly, may be
expansionary as taxpayers are left with a higher level of income and may be expected to spend more.
Expansionary effects of deficit finance, if matched by a tight monetary policy will call for an increase
in the rate of interest.
Fiscal Institutions
Whereas a unitary government need not have its taxing and spending powers specified in the
Constitution, a federation by necessity must have them so specified. Fiscal arrangements of taxing
and spending powers are all at the very core of the contract between the constituent governments
which combine to form the federation. Even though the Central Government necessarily must have
fiscal powers, the composing units retain a sovereign right to conduct fiscal transactions of their
own.
The USA Experience on Public Finance
The fiscal powers of the Federal Government were laid down in a series of specific constitutional
provisions which came to be further defined by judicial interpretations given to certain other
provisions not exclusively aimed at fiscal matters. The major provisions are:
* Taxing powers and expenditure functions - the general enabling statute for federal taxing powers is
contained in Article 1 Section 8 of the Constitution which provides that the "Congress shall have
power to levy and collect taxes, duties, customs and excise, to pay the debts and provide for the
common defense and general welfare of the United States".
* Uniformity Rule - also covered in Article 1, Section 8, it states that all taxes shall be uniform
throughout the U.S. This means that there is equal treatment of tax payers in equal position
independent of their place of residence.
* Apportionment Rule - this is covered under the 16th Amendment which states 'Congress shall
have power to levy and collect taxes on incomes, from whatever source derived, without
apportionment among the several States and without regard to census or enumeration. This cleared
the way for uniform and nationwide income tax.
* Export taxes - Article 1, Section 9 of the Constitution also prohibits the levying of export taxes. It
is interesting to note in connection with the potential use of tax policy to affect the balance of
payments that there is no corresponding prohibition of export subsidies. Whereas the Federal
Government had to be granted basic taxing powers by the constitution, the states did not need this
provision. Taxing powers of the states is vested in their sovereign rights as constituent members of
the federation and retained by them under the residual power doctrine. The constitution however,
imposes certain restrictions on the taxing power of the states, partly through specific provisions and
partly again through judicial application of other clauses of the constitution to tax matters. The
following four limitations are important:
o In Article 1, Section 10 of the Constitution, the states are prohibited specifically from imposing
taxes not only on exports but on imports as well. This was to place the regulation of foreign
commerce exclusively under the authority of the federal government.
o The immunity doctrine forbids federal taxation of state and local instrumentalities and also applies
in reverse. States may not tax the instrumentalities of the federal government. Salaries paid by the
federal government are subject to state income tax though.
o The 14th Amendment holds that a state must not deny to any person within its jurisdiction the
equal protection of the laws. This clause has been interpreted as a prohibition against arbitrary
classification and sets some limits on the extent to which states may discriminate among various
categories of taxpayers.
o The 14th Amendment has also been interpreted as granting the taxpayer the right of appeal against
arbitrary acts of state or local tax administration, similar to its application at the federal level.
Right to Education and School Finance
The bulk of the funds for public elementary and secondary education come from the local property
tax. Since the property tax base varies among school districts, children in low base districts may be
disadvantaged. The California Supreme Court in Serrano v. Priest held that the right to an education
in public schools is a fundamental interest which cannot be conditioned on wealth.
Budgetary Process
The central instrument of expenditure policy is the budget. The four steps involved in the budget
cycle are
* Formulation of the President's budget by the executive branch
* Appraisal of the President's budget by Congress and budget legislation
* Execution of this legislation by the executive branch
* Auditing by the General Accounting Office - the independent audit office reporting directly to
congress
Proposals Regarding Public Taxation and Expenditure
* Sharing of Revenue
* National Taxes
o Income tax, VAT, customs and excise, court fees and levies –
* Provincial Taxes
o Rates on property, land taxes o Special consumption taxes
* District/Municipal Taxes
o Cess, tolls, fees, licenses
o Special consumption taxes
* Creation in the constitution a Monetary and Fiscal Commission to oversee the Central Bank and
Ministry of Finance policies
* Education
* Provincial and District government matter
* National government grants to subsidize education
* Commitment to universal primary education up to Standard 8
* Establishment of national secondary schools funded by the national
* government
* Universities will be national matter
* Commitment to affirmative action
* Research to be funded by the National Government
* All schools and colleges to be run by Community Management Boards
* Health
* Provincial matter for District and Provincial hospitals
* Referral hospitals to be run by the national government
* directly to Congress.
* Disease control a national government matter
* Commitment to universal basic health care
* Labour
* Constitution to protect the interest of minorities, children and disabled
* Constitution to clearly delineate employee/employer relationship
* Provinces to establish appropriate labour contracts e.g. working hours
* Prohibition of double taxation
* Infrastructure
* Aviation, railways, postal, telecommunications, highways, radio,
* television to fall under the control of the national government
* Water and energy to be shared between the national, provincial and local
* governments
* Science and Technology
* National government to protect intellectual property rights
* Research to be a national issue in collaboration with university research institutes and international
institutions.