2.

0 Public Expenditure
3.1 The Meaning of Public Expenditure
Public expenditure refers to the expenses which Government incurs in the performance of its
operations. With increasing State activities, it may be difficult to judge what portion of public
expenditure can be ascribed to the maintenance of Government itself and what portion to the
benefit of the society and the economy as a whole.

3.2 The Theory of Public Expenditure

Two notable theories of public expenditure are examined, viz:
(a) "The Law of Increasing State Activities": A German Economist- Adolph Wagner in 1890
postulated this theory. According to him, there are inherent tendencies for the activities of
Government to grow, both intensively and extensively. He added that there exists a functional
relationship between the growth of an economy and that of Government activities, and that the
Governmental sector grows faster than the economy. All categories of Governments, irrespective
of their levels, intentions and sizes, had exhibited the same kind of tendencies of increased
expenditure.
(b) "The Displacement Theory": Jack Wiseman and Allan T. Peacock put forth the theory in
1961. Their main argument was that public expenditure does not increase in a straight or
continuous manner, but in "Jack or Stepwise" fashion. At times, some social or other
disturbances occur which show the need for increase in public expenditure, which the existing
level of revenue cannot meet. Therefore, public expenditure increases will make the inadequacy
of the existing level of revenue clear to everyone. The movement from the initial and low level of
expenditure and taxation to a new and higher level is known as the "displacement effect," while
the inadequacy of the revenue as compared with the required expenditure creates the "inspection
effect." Both Government and the people would attain a new level of "tax tolerance" by
reviewing the revenue position and finding solution to the problem of inadequate finance. Since
each major disturbance always leads Government to assume a larger proportion of the national
economic activities, the net result is the 'concentration effect'. Therefore, 'concentration effect' is
the tendency for Government activities to grow faster than the economy.

3.3 Classification of Expenditure

Public expenditure may be classified on the following basis:
(i) Nature of Expenditure Incurred: Under this basis Government expenditure is broadly
divided in to two (2) main categories, namely recurrent expenditure and capital
expenditure:
(a) Recurrent/revenue expenditures: Recurrent expenditure is the type of expenditure
that happens repeatedly on daily, weekly or even monthly basis. This includes for
example payment of pensions and salaries, administrative overheads, maintenance of
official vehicles, payment of electricity and telephone bills, water rate and insurance
premiums etc.
(b) Capital or development expenditures: Capital expenditure on the other hand refers
to expenditure on capital projects. This includes construction of houses, roads, schools
and hospitals, human capital development (expenditures on education and health),
purchase of official vehicles, construction of boreholes and electrification projects, etc.
(ii) Economic Purpose for Expenditure: Under this basis we have three classes, namely:
(a) Government consumption: Government purchases of goods and services for current
use.
(b) Government Investment: Purchases of goods intended to create future benefits e.g.
infrastructure, education and research and development.
(c) Transfer payments: Transfers that do not involve purchase of any good or service, eg.
unemployment benefits, scholarships, social welfare support, interest on public debt, etc.
(iii) Unit of government involved: Under this basis we have:
 National government
 County government
 Separate Government bodies
(iv)Basis of function at which expenditure is directed:
a) justice and public order;
b) infrastructure (roads, railways, etc);
c) military;
d) Education;
e) health care;
f) support for the poor, the old, the disadvantaged;
 g) support for firms, export and production in general;
h) special policy expenditure (e.g. foreign aid, fight against
drugs, etc). –

(v) Kinds of goods and services purchased. This gives rise to three sub-classifications:
a) capital goods;
b) consumption goods;
c) personnel expenditure.
(In national accounts, public expenditure does not include transfers among social groups,
such as pensions, and interest payments of public debt).

3.4 Models of a State

The starting point is to understand that public spending nearly corresponds to three general
models of state to which a government may subscribe. In other words, how much a government
spends, overall, depends on which of these political frameworks it has chosen as the foundation
for running its affairs. These models are:
1) The minimal state: This is the model where justice, public order, foreign policy and some
basic functions should be carried out by the state; relaying on private sector for the rest. The
minimal state is currently the trend and is manifested in the drive towards less- government and
greater privatization in what advocates call public sector reforms;
2) The welfare state: This is the model where the state cares about the people’s well being
directly, also through expenditure in education, health, and support for the poor, the old, and the
disadvantaged;
3) The developmental state: This is the model where the state takes the responsibility of
promoting economic development; also through expenditure in infrastructure, support for firms,
export and production in general.

Items of the minimal state are found in both welfare and developmental states. However, military
and special spending is common to all three models, even though in different proportions.
Government expenditure virtually depends on the model of state chosen.
3.5 Determinants of Public Expenditure
Determinants-Public expenditure is determined, generally, by:
(a) The political will of those at the helm of affairs of the government;
(b) their priorities,
(c) chosen state-model
(d) interpretation of current economic and political trend.
(e) other factors: Urbanization; Population; Economic growth; Depreciation; Technological
change; and Reduction in inequality.

3.6 Reasons for Increase in Government Expenditure

A number of factors have been identified as causing increasing in public expenditure in various
countries over time. Some of these are general, having relevance to all countries, while others are
specific to certain countries. These factors include the following:

(i) Increase in Costs of Providing Security: The traditional functions of government

such as defense, maintenance of law and order, etc. are becoming extensive and
cumbersome. Defense is becoming expensive more than ever. Within the country
administrative set up is increasing both in coverage and intensity, that is, government
machinery has to be manned by experts in their respective fields. In addition, various
complexities of economic and social measures develop which make an efficient
administration complex and expensive as well.

(ii) Increase in Public Awareness: Besides the traditional functions of the state, there is
growing awareness of additional responsibilities. The government is expanding its
activities in the area of various welfare measures which include measures to enrich
the cultural life of the society and those designed to provide social securities to the
people such as pensions, old peoples’ home etc.

(iii) Growing Population: Increasing population may also be a determinant of public

expenditure growth. The share scale of various public goods and services has to rise
in conformity with the growth of population. The need for more schools, hospitals
and such likes cannot be over-emphasized is the light of increasing population.
 (iv) Urbanization: It has been suggested that urbanization and the resulting congestion
has increased the need for more infrastructure and public goods and services. Also
quite a number of incidental services like those connected with traffic, roads,
pedestrian bridge etc. has to be provided.

(v) Increase in prices: The tendency for prices to go up has equally contributed to the
growth of public expenditure. The increase in prices of input and other goods
purchased by public sector has resulted in an increase in public expenditure. It is the
responsibility of the government to protect the citizenry against the evils of price
mechanism. Consequently, anti-cyclical and other regulatory measures are put in
place. Efforts are made to reduce income and wealth inequalities and bring about
social and economic justice.

(vi) Increasing Cost of Debt Servicing: Increasing public expenditure can also he
explained in terms of increasing cost of debt servicing. Since states are related to one
another through various economic transactions, there are tendencies to run into debts,
which must be settled.

3.7 Purposes/Functions of Public Expenditure

The effects of public expenditure include the following:

1. Economic Stabilization: The philosophy of laisser faire leaves much to be desired in terms
of economic results. The more advanced and free the market mechanism, the more prone the
economy is to the vagaries of income, employment and price fluctuations. Public expenditure
as an anti-cyclical tool can be devised in such a manner as to create effective demand thereby
stimulating investment activities. It may be emphasized that the total demand need he
regulated so that the demand flows match the supply flows otherwise the stimulating effect
would result in inflationary pressure.

2. Production: Public expenditure can help the economy to attain a higher level of production.
Through stimulation of investment, it can create conditions favourable for market forces to
push up production. It can be used to create human skills through education and training and
maintenance of social overheads. Public sector investment can be specifically directed
 towards creation of particular supplies and facilities, which may form an important and
necessary input for other industries. Through research and development, new and effective
methods of production can be found whereby County resources are used.

3. Economic Growth: Economic growth can be defined as an increase in a country’s physical

output over a long period of time. A country is said to have experiment economic growth,
when the real output of goods and services is increasing at a faster rate than the rate of
growth of its population. Countries pursue economic growth in order to enjoy the benefit of a
greater output, hence improve their standard of living. In a developed economy, through
economic stabilization, stimulation of investment activities and so on, public expenditure
helps to maintain a smooth growth rate. In an under-developed economy. Public expenditure
has important role to play in reducing regional disparities, developing social overheads,
creation of infrastructure for economic growth in terms of communication and transportation
facilities, education and training, growth of capita] goods industries, research and
development etc. When expenditure is incurred, it may be directed towards a particular
investment or it may be used to bring about re-allocation of investible resources in the private
sector of the economy. An important way in which expenditure can accelerate the rate of
economic activities is by reducing the divergence between the social and marginal
productivity of certain investment.

4. Economic Development: Economic development cat be defined as the elimination or

reduction in poverty, inequality and unemployment within the context of a growing
economy, there may be growth without economic development.

5. Distribution: An important evil of the market mechanism is the inequalities of income and
wealth, which arise on account of it and get widened through the institution of private
property and inheritance Furthermore, such income and wealth disparities not only result in
social and economic injustice but also distort production and employment patterns. Suffice to
say that lesser income and wealth inequalities contribute towards economic stability. Welfare
consideration favours an equitable distribution of income and wealth since the purpose of
economic policy is to attain the maximum level of social benefits possible. A shift towards
equality may be achieved through various forms of public expenditure especially those that
 are meant to help the poorer sector of the society. Items of common consumption may be
subsidized and production of those, which are in short supply, can be taken up by Public
Sector. Left for the market mechanism the supply of merit goods tiny in be possible. Public
Expenditure through direct purchase production or subsidies can ensure that their supply is
augmented to the desired level and can reduce unemployment and improve income and
wealth distribution.

6. Price Stability: Price stability refers to a situation where the general level of prices of goods
and services changes very little or no changes at all. Price level stability exists when the
annual rate of increases in prices measured by appropriate indexes is less than 2%. Common
measures of price stability are: (i) Consumer price index (measure of level of prices of all
new domestically produced goods and service); (ii) Wholesale price index; and (iii) National
product deflator (an economic metric that accounts for the effect of inflation in the current
year’s GNP by converting its output to a level relative to a base period).

7. Full Employment: Full employment is a concept that cannot be precisely defined. Full
employment does not mean that everyone has a job. This is because there shall always be
people, such as babies, under-aged kids, very old people who cannot work even if they are
willing to do so. This situation makes every government to define its full employment level
e.g. in US full employment level is 97%. In Canada it is 96%, then the balance being the
unemployment rate.

In Kenya, however, full employment policy has not been given a place of prominence and
specific target has not been mentioned, Unemployment is a welfare loss to the society in
terms of total output that is being forgone. It is equally a welfare burden borne by
individuals.

8. Balance of Payment (BOP) Equilibrium: Balance of Payment (BOP) equilibrium is a

record of a country’s transaction with the rest of the world over a period of time in respect of
visible and invisible items. The balance of payment provides an indicator of a country’s
international economic position. Because of the importance of the above, balance of payment
equilibrium becomes an important objective of economic stabilization policy.
9. Equitable Distribution of Incomes: This has to do with how income is being distributed in
the economy in a fair and equitable manner. Unfortunately in less developed countries, the
income distribution pattern is an asymmetrical one, i.e. it is not evenly distributed. This
accounted for the widespread poverty in these countries. The policy investment usually used
to achieve the above macro-economic objective are: (i) Monetary Policies (cost, allocation
and distribution of credit to change the level of money supply); (ii) Fiscal Policies
(government spending and levying taxes to achieve macroeconomic objectives); (iii) Incomes
Policy (regulation of reward to factors of production, minimum and maximum prices,
minimum wages, rent and interest). The monetary policy is a measure designed to influence
cost, allocation and is tribulation of credit in order to change the level of money supply in the
economy. This fiscal policy refers to the deliberate action, which the government of a
country takes in areas spending money and/or levying taxes with the objective of achieving
macro-economic variable. The income policy on the other hand relates to the regulation of
the rewards that go to the factors of production such as labour (minimum wage legislation). It
equally includes the registration of product prices (minimum and maximum price
legislation).

3.8 Standards of Public Expenditure Decisions

Expenditure decisions should be guided by the following standards, among others:
a) Economy: The nation's resources are scarce, compared with the needs of the society. It is
therefore important that no wastage is allowed in public expenditure. The process of public
spending should not involve the use of more resources than are actually necessary wasteful usage
of public fund must be avoided. Scientific approach towards assessment of required expenditure
must be adopted. Budgeting techniques such as Planning and Programming Budgeting System
and Zero-Base Budgeting System could be adopted.
(b) Benefit: Every public expenditure should be viewed against the benefits that will accrue there
from. It should be incurred only if it is beneficial to the society.
(c) Surplus: Government should avoid persistent deficit budgeting. It should be consistently
prudent and aim at meeting its current expenditure needs out of current revenue. Government
should not over- spend and eventually run into debt. Moderate surpluses over some years will
take care of any unavoidable deficit during any other year.
(d) Sanction: All public expenditure should be subjected to legal appropriations and
authorisations. Any contravention of expenditure procedure and due process should be
sanctioned. As required by law all unspent appropriations should be returned to the Treasury at
the financial year end.

3.9 Public Expenditure Management and Control: The management and control of public
expenditure is a responsibility that falls on government institutions and individual public
servants. As an institutional duty, both executive and parliamentary arms of government have
constitutional roles aimed at ensuring the proper disbursement of public fluids. Individually, all
civil servants who handle government funds and properties are required to observe certain rules
and guidelines in ensuring appropriate custody and spending of public monies. For clarity,
expenditure management and control are discussed separately, although they are inter-related.

3.9.1 Principles of Public Expenditure Management (PEM): Due to the scarcity of resources
in the face of unlimited demands, the need for an economic utilization of these resources by the
management of organizations becomes imperative. For this reason, certain guidelines, in the
form of basic truths or principles, ‘have been evolved to assist in the effective and efficient
management of public expenditure. Before embarking on spending any of public funds, officials
should examine the Ten Principles of Public Expenditure Management contained in Table below.

Table 4: Guidelines for dealing with Public Finances

Principles to be
observed by Public
S/No. Officials Action Required from Public Officials
Budgets must encompass all financial operations of
1 Comprehensiveness government; off-budget expenditure and revenue are prohibited.
Decision-making must be restrained by resource realities over
the medium term; the budget should absorb only those
resources necessary to implement government policies, and
2 Discipline budget allocations should be adhered to.

3 Legitimacy
Policymakers who are in a position to change policies during

4 Flexibility
5 Predictability
6 Contestability
7 Honesty
8 Information
9 Transparency
10 Accountability
implementation must take part in the formulation of the original
policy and agree with it.
Decisions should be defend until all relevant information has
become available.
There must be stability in general and long-term policy and in
the funding of existing policy.
All sectors must compete on an equal footing for funding during
budget planning and formulation.
The budget must be derived from unbiased projections of
revenue and expenditure.
There should be medium-term aggregate expenditure baseline
against which the budgetary impact of policy changes can be
measured; accurate information on costs, outputs and outcomes
should be available.
Decision-makers should have all relevant information before
them and be aware of all relevant issues when they make
decisions; these decisions and their bases should be
communicated to the public.
Decision-makers are responsible and accountable for the
exercise of the authority provided to them.

In addition to the ten principles outlined, civil servants are required to be cost-conscious. The
following ways could check extravagance:
a) Every officer or employee should justify his employment by giving efficient services in return
for his earning,
b) Every official expenditure should be duly authorized by an appropriate authority, as required
by regulation,
c) The expenditure should be in accordance with the Financial Regulations
(Instructions/Memorandum),
d) Staff recruitment should be dictated by real needs so that underemployment and over-
establishment are avoided,
e) Economy should be exercised in buying office furniture, equipment and stationery,
f) Made-in-Kenya goods should be preferred to imported goods,
g) No officer should condone wasteful spending of public funds by other civil servants.

3.10 Financing Government Expenditures

How a government chooses to finance its activities can have important effects on the distribution
of income and wealth (income redistribution) and on the efficiency of markets (effect of taxes on
market prices and efficiency). The issue of how taxes affect income distribution is closely related
to tax incidence, which examines the distribution of tax burdens after market adjustments are
taken into account. Public finance research also analyzes effects of the various types of taxes and
types of borrowing as well as administrative concerns, such as tax enforcement.

(i) Taxation: Taxation is the central part of modern public finance. Its significance arises not
only from the fact that it is by far the most important of all revenues but also because of
the gravity of the problems created by the present day tax burden. The main objective of
taxation is raising revenue. A high level of taxation is necessary in a welfare State to fulfil
its obligations. Taxation is used as an instrument of attaining certain social objectives i.e.
as a means of redistribution of wealth and thereby reducing inequalities. Taxation in a
modern Government is thus needed not merely to raise the revenue required to meet its
ever-growing expenditure on administration and social services but also to reduce the
inequalities of income and wealth. Taxation is also needed to draw away money that
would otherwise go into consumption and cause inflation to rise.
(ii) Public finance through state enterprise: Public finance in centrally planned economies
has differed in fundamental ways from that in market economies. Some state-owned
enterprises generated profits that helped finance government activities. The government
entities that operate for profit are usually manufacturing and financial institutions, services
such as nationalized healthcare do not operate for a profit to keep costs low for consumers.
(iii) Non-Tax Revenue: This is made up of all revenues, other than taxes, that are generated
by government to finance its expenditures. These include fines, fees and rates, licenses,
earnings from sales, rent from government properties, interest payment and repayment of
loans, re-imbursement, and miscellaneous revenue.
(iv) Donations: Donations received from foreign governments and donors agencies.
(v) Public debt: Public borrowing from the capital market by way of bonds or from County
and international financial institutions.