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Similarities Between Public Finance and Private Finance
Similarities Between Public Finance and Private Finance
1.
There are some basic differences between private and public finance. Some of the important
differences are:
The objectives are different by the very nature of public and private finance. The government has
to set an objective standard of utility from given public expenditure while an individual fixes a
subjective standard of utility from his given personal expenditure.
Private individuals or firms are mainly concerned with private consumption or profits, while the
government aims at promoting the society’s welfare. Again, an individual or a firm is mainly
concerned with present profits and prospects, not with that of the distant future. But the
government has to serve society generation after generation.
In other words, government is not guided by the profit motive; it is mainly concerned with the
general interest of the society. An individual is myopic in the long run, and that is why he attaches
more importance to the present period than to the future. On the other hand, since government
regards itself as a trustee for the future, it makes provisions not only for present period but also for
posterity.
Thus, expenditure is the crucial determinant of public budget. In view of this difference, it is said
that in private finance the coat is cut according to the cloth available, while in public finance the
opposite happens—the size of the coat is determined first and then the authorities set out to gather
the necessary cloth (through taxation, borrowing and deficit financing).
However, there may arise some situations in which an individual may also adjust his expenditure
to income—like the government. In case of unforeseen emergencies, an individual may have to
spend more than what he receives from current income.
Under the circumstances, he will have to work harder and sacrifice leisure or to borrow money
from different sources to supplement his present income. Likewise, when government expenditure
exceeds government revenue, government borrows money. Or it may cut expenditure when its
expected revenue falls short of the target.
An individual tries to maintain a balanced budget and maintenance of a surplus budget is a virtue.
Instead of a balanced or a surplus budget it is desirable to have a deficit budget of a government
so as to increase the country’s productive power. In other words, a surplus budget may not
stimulate economic activities. On the contrary, a deficit budget is often made to finance economic
development.
One of the important areas of differences between public and private finance lies in the method
of raising income. First, resources of the state are large compared to individuals. Secondly, a
government has the power to raise revenues from nationals as taxes are defined as the
compulsory contributions to the government. An individual cannot force others to pay him
money. In order to raise money, a government can print money.
An individual does not have this right. Further, the government can raise money both from its own
citizens and from external sources like the IMF, the World Bank, foreign countries, etc. No such
prerogative is enjoyed by individuals. Government may force people to buy its own bonds to
enable it to raise resources, particularly during emergencies like war.
Private finance relating to sources of revenue and spending is a secret affair. An individual tries to
maintain secrecy of his accounts. Usually, an individual does not disclose his financial standing.
Nor such disclosure has any significance to other people.
No such secrecy is maintained in the case of public finance. Government places its budget (i.e.,
estimated accounts of income, expenditure, methods of financing deficit) in the parliament. All
these information are available in the news media so that transparency in public budget is
maintained.
Thus, dissimilarities between public and private finance are more important than similarities. That
is why we have separate theories and tools, principles and practices relating to public finance.
Public finance is not merely the study of revenue-expenditure process of the government; it also
studies how revenue-expenditure process affects macro- economic variables of an economy like
consumption, interest rate, etc.
Thus, public finance is a part of the economic system as a whole. The domain of private finance
is microeconomics while that of public finance is macroeconomics—although governmental and
private activities are more complementary in nature.
Furthermore, according to Findlay Shiraz ( ) Public finance is different from private finance in
various perspectives. Findlay Shiraz in his famous book 'Principles of Public Finance' has listed
the following points of difference between government finance and private finance.
(1) Adjustment of Income and expenditure. An individual usually adjusts his expenditure to his
income. But the public authority generally adjusts its income to its expenditure. In other words,
we can say that an individual cuts his coat according to his cloth. While the public authority first
decides the size of the coat and then tries to procure cloth according to the size of its coat. The
public authority prepares an estimate of the total expenditure to be incurred during a fiscal year
and then devises ways and means to raise the required amount. The individual, on the other hand,
tries to live within his own means. His expenditure is generally determined by his income.
(2) Unit of time. The public authority balances its budget during a given period which is generally
a year. For an individual, there is no period of time in the course of which the budget must be
balanced. The individual generally continues earning and spending without keeping any record-of
his budget by a particular date. The public authority, however, has to keep full records of its income
and expenditure and the accounts are to be in balance during the financial year.
(3) An Individual cannot borrow from himself. If at any time an individual is in need of money,
he cannot borrow from himself. He can raise me loan from other individuals or can utilize his past
savings, but he cannot borrow internally. The public authority, on the other hand, can borrow
internally from its own people and externally from other nations.
(4) Issue of currency? Government has full control over the issue of currency in the country. No
other person except the stale can print notes. If an individual floes so be will be put behind the
bars.
(5) Provision for the future. The government has to make a solid provision for the future. It
spends large amounts of money on those projects which the future generation is only to benefit.
The individuals, on the other hand, are not generally liberal and far sighted. They discount the
future at a higher rate and so usually make inadequate provision for the future.
(5) Big and deliberate changes in public finance. It, is easier for the government to make big
and deliberate changes in its income, and expenditure but for an individual it is a very difficult
affair. A few individuals may succeed in increasing their incomes but all the persons cannot do so.
The public authority can also make deliberate decrease in its income without feeling any difficulty.
But for individuals, reduction in income is very painful as they are used to certain standard of
living.
(6) Surplus budgeting. For an individual, excess of income over expenditure or surplus budgeting
is considered to be a virtue but for the public authority it is not as such, it is expected from the
government that it should raise only as much revenue as it needs during a calendar year. After all
what is the fun of showing persistently surplus budgets? It is not better to give relief to the tax-
payer; than to show surplus budgets.
(viii) Mystery shrouds Individual Finance. Individual's finance is usually shrouded in mystery.
Everybody likes that his financial position should 1 remain a closely guarded secret but this is not
the case with public authorities. The government publishes its budget and gives due publicity to it.
Budget Formats
Current perspectives on what constitutes prudent fiscal policy differ considerably from those of
the past. The appropriate role of government in providing public facilities and services as a
"driving engine" for societal change has come under considerable scrutiny. These shifts in
perspective have both emerged from and resulted in changing attitudes toward budgeting in the
public sector. It is possible to identify three successive stages of budget reform. In the first stage,
dating roughly from 1920 to 1935, the emphasis was on developing adequate mechanisms for the
control of public expenditures. The second stage began with the New Deal of the Roosevelt
administration and reached its peak in the fifties with the introduction of performance budgeting
and provided a focus on fiscal management considerations. The third stage began in the sixities
and is manifest in current efforts to link strategic planning and budgeting in a multipurpose
budget system. As Charles Beard once observed, "Budget reform bears the imprint of the age in
which it originated."
A budget can serve as a fiscal control mechanism, a management tool, and an important
component of financial planning. As a control mechanism, a budget seeks to assure financial
integrity, accountability, and legal compliance--this is the traditional role of the budget. As a
management tool, a budget can be used to achieve operating economies and performance
efficiencies. As a component of financial planning, a budget must reflect public goals and
objectives and the overall effectiveness of government programs in meeting public service needs.
For trivia fans, the word budget is derived from the French word "bouge," meaning leather bag.
The Lord of the Exchequer would bring to Parliament a document which the government
proposed be adopted as its fiscal commitments for the coming year. This document would be
carried in a small leather bag or bougette, and thus the document eventually took on the name of
the container used to transport it.
Historically, the fiscal control aspects of budgeting have received the greatest emphasis both in
practice and in the literature of public budgeting. The budget has been viewed primarily as an
extension of the accounting and management control system, in which expenditure estimates for
various programs are reviewed in monetary terms. Under this approach, budget requests are
supported by detailed objects of expenditures--tabulations of the myriad items required to operate
each program, including salaries and wages, rent, office supplies, travel, equipment, and other
inputs. The validity of budget requests is judged primarily through comparisons with previous
levels of expenditures.
By the early 1920s, the object-of-expenditure approach was wide-spread in its public application.
This budget format, with its detailed recording of spending requirements and subsequent
commitments, provides a most effective basis for fiscal control. The expenditure of budget
allocations can be controlled within relatively narrow, predetermined limits. Financial
accounting systems--developed in parallel with the object-of-expenditure budget--admirably
support the objectives of fiscal control. This period in public financial management was marked
by a pre-occupation with forms and detailed procedures for budgeting and accounting.
As more reliable systems of accounting were installed, the budget was gradually freed from its
primary role as fiscal watchdog. If the main function of budgeting is to keep spending in check,
then program outputs are seen primarily in terms of limited and fixed values. However, if
program accomplishments are examined in terms of benefits, the task of budgeting must be
redefined to include a more effective marshaling of fiscal and other organizational resources to
achieve those benefits.
In the late 1930s, the budget began to be recognized as an important tool of management--
providing a focus on operating economies and performance efficiencies. These efforts
culminated in the concept of performance budgeting which had its heyday in the late forties and
early fifties. In 1949, the Hoover Commission called for a budget approach that would:
focus attention upon the general character and relative importance of the work to be done,
or upon the service to be rendered, rather than upon the things to be acquired, such as
personal services, supplies, equipment, and so on. These latter objects are, after all, only
the means to an end. The all important thing in budgeting is the work or the service to be
accomplished, and what that work or service will cost. [13]
Performance budget format seldom is discussed in any detail in contemporary texts on public
budgeting, being relegated for the most part to a historical footnote. Nevertheless, many of the
attributes of performance budgeting have survived to become important, integral parts of modern
budgeting systems.
The principal objective of a performance budget is to help administrators assess the work
efficiency of operating units, by (1) casting budget categories in functional terms and (2)
providing work-cost measurements to encourage more efficient and economical performance of
prescribed activities. Performance budgeting derives much of its conceptual and technical basis
from cost accounting and the precepts of scientific management.
The innovation in the budget process that received the greatest attention in recent years is the
Planning-Programming-Budgeting system (PPBS). PPBS was brought to full public attention in
August, 1965, when President Lyndon B. Johnson announced that all federal departments would
adopt the budgeting system that had been used for some years in the Department of Defense.
PPBS represents a "top-down" budget format, wherein decisions and directives flow from the
policy levels to the operating levels of the organization.
PPBS was an outgrowth of program-based budgeting techniques that had been developed earlier
in business and industry. [14] The basic objective of PPBS is to present budget requests in terms
of program "packages" rather than the usual object-of-expenditure format. A conscious effort is
made under PPBS (1) to state end objectives, (2) to seek a wide range of program alternatives,
and (3) to link program and financial plans. In short, PPBS recognizes that planning and
budgeting are complementary processes.
The need for planning, programming, budgeting, and scheduling arises from the
indissoluble connection between the allocation of resources and the formulation and
conduct of govern-mental policy. When undertaken in the proper "mix," these processes
constitute the means by which objectives and resources--and the interrelations among
them--are taken into account to achieve a more coherent and comprehensive program of
action. . . . [15]
For over seventy years, budget reformers have criticized the lack of coordination and the neglect
of important values in traditional budget-building procedures, suggesting that they produce only
small, incremental changes in the status quo. Such procedures, they argue, are arbitrary and
irrational in that short-term results from previous allocation decisions are accepted as the primary
criteria for future decisions. Existing programs are continued into the future, often without
intensive re-examination. A comprehensive analysis of previously allocated resources--the
budget base--seldom is undertaken under the incremental approach.
Therefore, such incremental budgeting is suspect as to its ability to limit the growth of
governmental appropriations or to allocate scarce fiscal resources in the most economical,
efficient, and effective manner. As E. Hilton Young observed in 1924:
Zero-base procedures were first adopted at the federal level in 1962 as part of an experiment in
the preparation of the budget request of the U.S. Department of Agriculture for FY 1964. The
instructions issued by the Office of Budget and Finance of USDA stated:
All programs will be reviewed from the ground up, and not merely in terms of the
changes proposed for the budget year. . . . Consideration must be given to the basic need
for the work contemplated, the level at which work should be carried out, the benefits to
be received and the costs to be incurred. The fact that certain activities have been carried
out for a number of years will not, per se, adequately justify their continuation nor will
the fact that programs are prescribed by statutory law necessarily be a controlling
consideration. [17]
The results of the USDA experiment with zero-base budgeting revealed certain disadvantages or
problems with the process. A major factor limiting the application of zero-base budgeting is the
increased workload, often resulting in the diversion of effort from regular programs. The USDA
found that analyzing budget requests from the "zero base" did not significantly improve program
efficiency or effectiveness, but did produce overwhelming amounts of paperwork. The
experiment was abandoned after one year.
As Governor of Georgia, Jimmy Carter became interested in ZBB through an article authored by
Peter Phyrr that appeared in the November-December, 1970 issue of the Harvard Business
Review. Phyrr spent a year in Georgia helping to design and implement the first year of zero-base
budgeting for the entire state government in conjunction with the reorganization of the executive
branch. Upon his election as President, Carter sought to install ZBB techniques at the federal
level, and in April of 1977, the Office of Management and Budget published the official federal
instructions on zero-base budgeting.
Although zero-base-analysis techniques have received the greatest publicity at the federal and
state levels, they may have even more significant potential in application at the local level. The
basic objective remains the same--to circumvent the shortcomings of incremental budgeting.
However, current applications of ZBB have taken a somewhat more modest and more realistic
approach as compared to earlier efforts in the mid-1960s. The detailed analysis of programs "to
the zero base" has been replaced by the concept of levels of effort. ZBB requires agencies "to
examine their budgets below the base; the base being their current level of expenditures. . . .
Zero-base budgeting requires each agency to specify--on paper--as part of its regular policy
submission--possibilities for spending less money than the current year." [18]
The past twenty years have been a period of experimentation in the processes of public
budgeting. At the federal level, PPBS--the major budgetary reform of the mid-sixties--gave way
to zero-base budgeting under the Carter administration, only be replaced by mission budgeting
and supply-side economics in the 1980s. Each of the approaches represent an attempt to provide
a more comprehensive and longer-range perspective to the budget process--to incorporate a
planning perspective.
An evident shortcoming of these new budgetary approaches has been the failure to fully integrate
these more systematic procedures with the other basic components of financial management. In
particular, more recently developed budgeting techniques--such as program budgeting and zero-
base budgeting--have not been well aligned with appropriate accounting procedures. These new
budgetary formats tend to emphasize the planning function. Far less attention is given to the
equally important techniques and procedures for financial control. As a result, these new
approaches, in many cases, have failed to produce the desired improvements in terms of more
efficient, economical, and effective governmental operations.
Introduction of these budgetary techniques in the private sector has usually been accompanied by
parallel improvements in accounting procedures--in particular, the fuller application of
managerial and cost accounting techniques. Applications of managerial accounting in
government are still in the formative stages.
Each of these budget formats arose from the financial management needs at a particular point in
time; each reflects varying decision-making capacities; and each has varying management
information needs and output capacities (see Exhibit 1).
Adapted from: Allan Schick, "The Road to PPB: The Stages of Budget Reform," in Planning
Programming Budgeting: A Systems Approach to Management, ed. Fremont J. Lyden and Ernest
G. Miller (Chicago, Ill.: Markham Publishers, 1968), p. 50.
Under the line-item/objects of expenditure approach, budget requests are supported by detailed
listings of the categories of expense required to operate each program (see Exhibit 2). Projected
expenditures may be backed up by a personnel schedule which identifies the specific positions
(i.e., by job titles) to be authorized and the anticipated salary commitments of each position (see
Exhibit 3).
Budgets based on objects of expenditure are readily understood by legislators and other public
elected officials, which is one important reason why this approach has survived so long. It is
relatively easy to grasp the fiscal significance of a proposed increase of 10 percent in printing or
data processing, or a salary reclassification for a specific position or salary class. Therefore,
governing bodies can review the budget and alter the minutiae of proposed expenditures. Larger
issues of efficiency and effectiveness that should be examined through the budget process,
however, often remain buried in the detail of object classifications. Such classifications cannot
provide a basis for measuring the performance of an agency or program or the progress made in
the implementation of a particular set of objectives or activities.
The object-of-expenditure budget has two distinct advantages over other budget formats:
(1) Management control--Personnel requirements are closely linked with other budgetary
requirements. The control of authorized positions can be used as leverage to control the whole
budget.
Exhibit 2. Line Item Budget for Investigation Division of the City of Rurbana
Police Department
BUDGET COMMENTS
As a result of the reorganization of the Police Department, it is requested that the staff
of the Division be increased by three persons. The budget request shows an increase
of 18.35% or $225,205 over the current budget period. Personnel Services shown an
increase of $142,165 (17.7%). This increase is the result of four new employees and a
five percent salary increase for all city employees. Increased emphasis is placed on
the purchase of drug information. This increase is shown under object code 1250.
Additional data process and laboratory equipment has been requested.
The personnel schedule (Exhibit 3) for the Investigations Division of the Rurbana Police
Department clearly shows that the proposed staffing increase would add a sergeant, an inspector,
and a detective to the ranks of the Division. Each of these new positions presumably would be
funded at the entrance level of the salary range. Therefore, of the $117,085 budget increase
requested for salaries, $78,000 can be attributed to the three new positions and the balance to the
proposed 5% across-the-board increase for all city employees. The possible linkages between the
proposed staff increase and the 12 percent increase ($6,955) in the operating costs (exclusive of
equipment) shown in Exhibit 2, however, is not evident from the object of expenditure budget.
A budget built on objects of expenditure frequently is called a line-item budget, since the
proposed expenditures are detailed with great specificity, resulting an array of lines within the
budget document Technically, "line item" refers to the manner in which appropriations are made
to agencies within the budget structure. Appropriations may be made on a lump-sum basis,
leaving considerable discretion to the agency regarding the specific categories of expenditure
permitted. Or the funds may be allocated according to specific line items, whereby the agency
must receive legislative approval for any deviations from the initially authorized appropriations
(usually beyond some predetermined range, for example plus or minus 10 percent).
Line items can be specified at several levels of detail. Funds might be appropriated, for example,
for personal services (salaries, wages and staff benefits) and nonpersonal services (all other
operating expendi-tures). Under this approach, agencies might be permitted to shift dollars from
other operating categories to salaries and wages but might not be authorized to shifted funds
from salaries and wages to operations. In effect, appropriations for salaries and wages are
encumbered, and any unexpended funds in this line item revert to central appropriations. This
approach is used to prevent agencies from holding positions vacant to generate more operating
dollars (for example, for "windfall" equipment purchases). Such line itemization can also specify
appropriations for various personnel categories (for example, professional staff versus technical-
support personnel) or for specific object codes (for example, equipment or travel).
23-01-105-1245-45301
might be used to record a travel expenditure for meals and lodging (1245) of a staff member
from the Police Department (105) under the public safety function (23) in conjunction with an
out-of-town investigation on a specific case (45301). The code 01 might be used to designate the
funding source (general funds) to which this expenditure is to be charged. The five-digit project
code might also be used to designate the program or subprogram (45xxx) and the activity
classification (xx30x). The activity classification in this instance might represent a felony
involving bodily harm to the victim. Using such multi-digit codes, accounting entries can be
retrieved and sorted to meet a variety of fiscal management and reporting purposes. The capacity
to monitor and to "crosswalk" expenditure data for various financial planning and control
purposes will be discussed in further detail in a subsequent section.
Recent developments in the field of budgeting have emphasized the planning aspects of the
resource allocation process. Unfortunately, some of these applications of budget reforms have
abandoned or have signifi-cantly altered the management control features of more traditional
budget approaches. In part, this counter swing is a reaction to perceived short-comings of the
line-item/objective-of-expenditure budget. It also is a consequence of a more centralized, "top-
down" approach to budgeting which seeks to improve the rationality of public decision-making
through both structural and procedural changes. Techniques and procedures to increase the
efficiency and effectiveness of resource allocation decisions must be incorporated in any
financial planning and control system that is responsive to these demands. By the same token,
the mechanisms of accountability and control must be retained in a balanced approach to
budgeting.
Performance Budgeting
The budget objective of efficiency and economy derives much of its conceptual and technical
basis from cost accounting and the precepts of scientific management. Three components
distinguish performance budgeting from other budgetary approaches:
(1) Identification of work programs that are meaningful for management purposes,
(2) Delineation of performance units within each work program, either in terms of activities or
by specific end-products, and
To illustrate the performance budget format, the data for the Investigations Division of the
Rurbana Police Department, presented in Exhibit 2, have been translated into a work program
and related effort and cost distributions in Exhibit 4.
Performance costs are those costs directly associated with carrying out these activities. The
aggregate costs associated with each activity classification are shown in Exhibit 4 for the
previous fiscal year, the current fiscal year, and the level of support requested for next fiscal
year. A significant increase (18.7%) is projected in the number of felony cases to be investigated,
and a slightly lesser increase (16.9%) in the number of misdemeanors. The staff hours to be
devoted to the investigation of felonies are projected to increase by only 8%, whereas the staff
hours devoted to the investigation of misdemeanors are projected to increase by 19.3%.
Misdemeanors are investigated initially by uniform patrol officers, and therefore, cases that are
referred to the Investigations Division tend to be more time consuming. A modest increase in the
case load is likely to result in a proportionately greater increase in the staff hours required for
these investigations.
Unit cost measures aggregate all relevant costs associated with the delivery of a particular
service and divide these costs by the total units of service provided. Workload measure relate to
the volume of work performed during some time period. When workload or output measures are
related to unit costs or input measures, the resulting index often is called a performance measure.
Workload and unit cost measures for the Investigations Division of the Rurbana Police
Department are shown in Exhibit 5. As these data suggest, the unit costs for felony cases are
anticipated to decrease as the number of units increases, whereas the unit costs for cases
involving misdemeanors are projected to increase in the coming fiscal year.
Performance measures often are used as indicators of operating efficiency--for example, the cost
per patient-day of hospital service; the number of cases successfully prosecuted per law
enforcement officer; or the response time involved in providing paramedical services. As may be
seen from these examples, not all performance measures are expressed in cost terms.
Performance measures provide basic information on program economics, that is, such measures
can reveal important relationships between initial resource allocations (inputs) and the delivery
of services (outputs).
An overemphasis on performance measures in administrative decision-making, however, may
result in pseudo-efficiency. Performance measures can be overstated. Or units may resort to
"creaming"--doing the easy assignments first and deferring or neglecting the more difficult ones-
-in order to meet such measures of efficiency. If, for example, the forensic laboratory is
evaluated in terms of the number of tests performed, priority might be given to the relatively
simple tests, leaving the more involved ones until the "volume" tests have been completed. Thus,
there is need for careful review of performance data by disinterested third parties--often the
responsibility of internal auditors.
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Richard W. Tresch. (1981) Public Finance: A Normative Theory (Third Edition). Chestnut
Hill, Massachusetts.
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Hugh Dalton. 1926. Introduction to the financial science. Springer-Verlag Berlin Heidelberg
John Maynard Keynes - Wikipedia (1936). The General Theory of Employment, Interest and
Money (1936) Cambridge University Publisher. England: Cambridge.
Findlay Shiraz