Chapter-8

Government finance
• Government budget
• A government budget is a document prepared by the government
and/or other political entity presenting its anticipated tax revenues
and proposed spending/expenditure for the coming financial year. In
most parliamentary systems, the budget is presented to the
legislature and often requires approval of the legislature.
• government budget, forecast by a government of its expenditures
and revenues for a specific period of time. In national finance, the
period covered by a budget is usually a year, known as a financial or
fiscal year, which may or may not correspond with the calendar year
 1.Revenue budget
• The revenue budget consists of revenue receipts of the government (revenues from tax and other
sources), and its expenditure.Following are the revenue and expenditure related to the revenue
budget.
• A. Revenue receipts. Revenue receipts can be defined as those receipts which neither create
any liability nor cause any reduction in the assets of the government. ... For example, taxes
received by the government, unlike borrowings, do not create any liabilities for it.It is divided into
(source of government revenue)
• A. tax revenue
• B. non - tax revenue
• Tax revenue. Tax revenue is defined as the revenues collected from taxes on income and
profits, social security contributions, taxes levied on goods and services, payroll taxes, taxes on the
ownership and transfer of property, and other taxes.tax revenue is the major source of public
revenue.It It consists of the following:
• 1.taxes on property, profit and income: It includes income tax from the public corporations ,private ,
corporate bodies. Individuals, urban houses and land tax, vehicle tax and tax on interest.these are direct in
nature.
• 2. Domestic taxes on goods and services:They are based on production. It includes excise duty, sales tax,
value added tax entertainment tax, road tax etc . They are indirect nature.
• 3. Land revenue and registration taxes: It includes land tax, land registration tax and house registration tax.
• 4. custom duty: Customs Duty is a tax imposed on imports and exports of goods. Description:
The rates of customs duties are either specific or on ad valorem basis, that is, it is based on the
• B. non- tax revenue: Non-Tax Revenue is the recurring income earned
by the government from sources other than taxes
• Sources;
• 1.Fees: A fee is a fixed price charged for a specific service.
Fees are applied in a variety of ways such as costs, charges,
commissions, and penalties. Fees are most commonly found in
heavily transactional services and are paid in lieu of a wage or
salary.It include,birth , death registration fees passport
education, health, license of vehicle and gun.
• 2. Escheat: Escheat refers to the right of a government to take
ownership of estate assets or unclaimed property. It most
commonly occurs when an individual dies with no will and no
heirs. Escheat rights can also be granted when assets are
unclaimed for a prolonged period of time.
• 3. Special assessment: A special assessment tax is a surtax
levied on property owners to pay for specific local
infrastructure projects such as the construction or
maintenance of roads or sewer lines. ... Special assessments
may be levied for a pre-set number of years, and they are often
not tax-deductible.
• 4.fines and penalty: An infringement notice, or fine, is a penalty for
breaking the law. In Victoria offences for which fines can be issued are
covered by more than 60 acts and are administered by a range of state
and local government agencies, including universities and hospitals.
• Traffic, parking and transport-related offences are the most common.
• 5.Gift and grants:
• B. Revenue expenditure.
• Revenue expenditure is expenditure for the normal
running of government departments and various services,
interest charges on debt incurred by government, subsidies and
so on. Broadly speaking, expenditure which does not result in
the creation of assets is treated as revenue expenditure.
• 2. Capital budget
• Capital Budget consists of capital receipts and payments. It also
incorporates transactions in the Public Account.It consists of capital
receipt and capital expenditure
• A.capital receipts: Capital receipts are loans raised by the government
from the public (which are called market loans), borrowings by the
government from the Reserve Bank and other parties through sale of
treasury bills, loans received from foreign bodies and governments,
and recoveries of loans granted by the Central government to state and
Union Territory governments and other parties.
• B. capital expenditure: Capital payments consist of capital expenditure
on acquisition of assets like land, buildings, machinery, and
equipment, as also investments in shares, loans and advances granted
by the Central government to state and Union Territory governments,
government companies, corporations and other parties.
•
Methods of deficit financing
• 1 Internal borrowing
• 2. external borrowing
• 1.Internal borrowing.
• Internal borrowing refers to a country's borrowing from own national
resources. This borrowing has no effect on increasing or decreasing
national income.
When the debt is raised within the country it is called internal debt.
• Sources
• Individuals and Private Organizations - Individuals and private
organizations provide loans to government with the purchase of
securities like bonds and treasury bills. They provide loans reducing
consumption, diverting savings accounts and corporate securities, and
out of the funds that would remain idle. This source of debt normally
does not exert inflationary pressure, except that from the idle funds,
as there will be just a transfer of purchasing power from public to the
government and no more money supply.
• Financial Institutions – Financial institutions, other than the
commercial banks, like Provident Fund, Insurance Companies,
Finance and Investment Companies, Co-operatives, Mutual
Funds, etc. are the important source of public debt. These
institutions normally provide loans to government to reduce
their cash-holdings to earn some interests, for the safety of
funds and to maintain liquidity. Normally, these institutions
prefer to invest on government securities in a situation when
there is no sufficient for loan advancements on
other activities. Borrowing from this source is likely to
inflationary as the funds would not have been spent if it was
not loaned to government.
1.Commercial Banks – Commercial banks provide loans to
government out of the excess cash reserves and by credit
creation. Like other financial institutions, the commercial banks
also provide loans to government in a situation when there is no
sufficient demand for bank credit. Borrowing from commercial
banks increases money supply in the economy, and is likely to
exert inflationary pressure in the economy.
2.Central Bank – The Central bank is the lender of the last resort
to the government. The central bank, as being the monetary
authority of the government, is responsible to manage the public
debt on behalf of the government out of its reserve funds and by
credit creation against the government securities. bullions and
foreign exchange reserves. Borrowing from the central bank has
double-fold possibility of credit creation leading to excess
money supply in the economy leading to inflation.
External borrowing. It refers to money borrowed from a source outside the country. Description: External debt can be obtained from foreign commercial banks, international
financial institutions like IMF, World Bank, ADB etc and from the government of foreign nations. ...

1.Foreign Nationals and Private Organizations – Government may

borrow from this source by issuing its securities in the international
financial market.
2.Donor Governments – Normally the developed countries’
governments provide loans to the developing countries for
development projects in the form of foreign aids.
3.International Financial Institutions - The international financial
institutions like World Bank, IMF, UNCDF, IFC, and ADB, etc. provide
loans to governments to finance development projects and to manage
the BOP problems.
4.Funds of Some Countries and Business/Economic Forums –
Governments may borrow from the funds created by some countries
and business or economic forums like Saudi, Kuwaiti, and OPEC funds.
Fiscal policy
• Fiscal policy refers to the use of government spending and tax
policies to influence economic conditions, especially
macroeconomic conditions, including aggregate demand for goods
and services, employment, inflation, and economic growth.
• Fiscal policy is the use of government spending and TAXATION to
influence the economy. When the government decides on the goods
and services it purchases, the transfer payments it distributes, or the
taxes it collects, it is engaging in fiscal policy.
• Types of fiscal policy
• Expansionary fiscal policy
• Contractionary fiscal policy.
Instrument\tool of fiscal policy
• Government Revenue Tools
• Indirect Taxes
• Indirect taxes refer to taxes imposed on specific goods such as
cigarettes, alcohol, fuel and services. VAT is an example of an indirect
tax. Health and education can be excluded from indirect taxes.
• Direct Taxes
• Levies on profit, income, and wealth are direct taxes. Taxes charged on
deceased property can both raise revenue and distribute wealth. They
include capital gains taxes, national insurance taxes, and other
corporate taxes.
• Public spending:
Public spending includes subsidies, transfer payments, like
salaries to a govt. employee, welfare programs, and public
works projects. Those who get the funds have more money to
spend.
. PUBLIC DEBT: Public debt is a sound fiscal weapon to fight against inflation
and deflation. It brings about economic stability and full employment in an
economy.
(a) Borrowing from Non-Bank Public (b) Borrowing from Banking System
3. DEFICIT FINANCING: WHEN THE GOVERNMENT MEETS ITS BUDGETARY DEFICIT BY BORROWING
FROM THE CENTRAL GOVERNMENT IT IS CALLED DEFICIT FINANCING. AS A RESULT OF DEFICIT
FINANCING INCOME OF THE PEOPLE GOES UP AND HENCE INCREASE IN THE AGGREGATE DEMAND
Fiscal federalism
Component of fiscal federalism
• 1. expenditure assignment
• 2. revenue assignment
• 3. inter- governmental fiscal transfer
• 4.sub- national borrowing
• 1. expenditure assignment.
 Expenditure assignment
• EXPENDITURE ASSIGNMENT
• Expenditure assignment is the first step in designing an international fiscal system.
Designing revenue and transfer components of a decentralized inter-governmental fiscal
system without concert expenditure responsibilities would weaken decentralization
process. The key success of a decentralized system is matching expenditure
responsibilities with the objectives of service assignment. A report prepared by the US
Advisory Commission on Intergovernmental Relations (ACIRs) on Governmental Functions
and Process (1974) lists four criteria is assigning services such as economic efficiency,
fiscal equity, political accountability and administrative effectiveness. The characteristics
of expenditure assignments should be made to government units that can
• (1) Supply a service at the lowest possible cost,
• (2Finance a function with the greatest possible fiscal equalization,
• (3) Provide a service with adequate popular political control,
• (4) Administer a function in authoritative technically proficient and co-operative fashions.
• REVENUE ASSIGNMENT
• Once the assignment of expenditure responsibility has been determined
the second key question as: who gets what resources? “The revenue
assignment acquisition as tax policy is known in the context of inter-
governmental fiscal relation is often considered the second main pillar or
building block of fiscal decentralization policy” (Bird, 2011). No universal
model for local government and revenue assignment is applicable for all
countries around the world and the best model depends on many other
factors on (Steffensen and Holm, 2000):
•  The type of local government,
•  The size of local government,
•  The type of functions they are going to perform,
•  The cultural context of the country and historical experiences, and
•  The administrative capacity at the local level.
• In assigning taxes to the government at state and local level, the
following considerations should be kept in mind (Hicks, 1955: 115):
• (a) Revenue from taxes should not be subject to inherent fluctuations.
The jurisdiction of these governments is small. Their power of
manoeuvre is limited. So, they need steady incomes.
• (b) From administrative point of view, these taxes should be easy to
assess and collect. It is an admitted fact that general level of state
administration is lower than that of the national governments.
• (c) For the sake of convenience, it is necessary that, at lower levels of
government, tax base be localized in order to avoid dispute over
jurisdiction
• INTER-GOVERNMENTAL FISCAL TRANSFERS (IGFTS)
• Inter-governmental fiscal transfers (IGFTs) are transfers of funds from
one level of government to another. This may be to fund general
government operations or for specific purposes. Since revenue
assignment often does not provide regional and local governments
with sufficient revenues to fund their expenditure functions, inter-
governmental transfers are often necessary to assure revenue
adequacy. Transfers are often necessary to assure revenue adequacy.
Transfers are grants from one level of government to another (often
from higher to lower) for the purpose of funding government
activities. The term transfer is often used interchangeably with the
term grants, subsidies or sub-ventions.
• SUB-NATIONAL BORROWING
• Borrowing in sub-national level would be for capital expenditure only
in federal structure. Sub-national level-especially the province and
local governments would be given the right of borrowing but only
from within the country. International lending, if necessary to sub-
national level, would be allowed in condition of permission from the
centre in advance.
Fiscal federalism in Nepalese context
• The current fiscal decentralization process in Nepal began in 2015 with promulgation of the new
constitution and deceleration of the country as a Federal Democratic Republic by the second
Constituent Assembly. Under the federal structure, the country has three tiers of government:
• central,
• provincial,
• and local governments.
• The country has seven provinces and 753 local governments. Under the new governance system in the
country, sub-national government (provincial and local governments) are assigned various authorities
and responsibilities such as planning, delivery of public services at local level, active participation of
citizens at governance, and fiscal autonomy through fiscal decentralization by the constitution of the
country. As Nepal continues its transition towards a federalized state, sub-national governments take
on a variety of responsibilities that include managing their own administrative and fiscal affairs
including the subnational revenue mobilization. Sub-national revenue mobilization is important for
sustainability of the economic growth of the country and of sub-national governments. Also, the sound
revenue system, especially own source revenue (OSR) at sub-national government is critical
prerequisite for the success of fiscal federalism in Nepal. OSR here refers to the revenue generated by
sub-national governments from taxes assigned to them by the Constitution, service charges, and fees
• Mobilization of OSR is important for sub-national government's improved ability
to provide public goods and services, lower poverty, capacity development at
local level, and economic development. Improving OSR by sub-national
government can also reduce the pressure of central government in the face of
rising public debt and recurrent expenditure. In addition, strengthening OSR
generation can also help improve fiscal autonomy, increase source of revenue,
and achieve control over development agenda of sub-national government. In
principle, the most important benefit from fiscal decentralization is the increased
efficiency and increase in welfare gain resulting from moving governance closer
to the people as local government has best interest of its constituents (Oates,
1972). Sub-national governments being closer to the people they are governing
can respond to the preferences of the people in their area with tailored policies
and budgets to achieve locale specific goals. This can also help foster political and
administrative accountability of by empowering local governments (Oates, 1999).
In addition to efficiency and accountability, fiscal decentralization can also help in
efficient allocation of resources whereby subnational governments can play
pivotal role as they have better information regarding local level demand, needs,
and expectations (Sewell, 1996
• People’s propensity to pay taxes is also higher in a decentralized
structured, where taxes collected in one region are spent exclusively on
that region’s public goods, than in a centralized tax structure, in which
taxes paid in all jurisdictions are pooled and redistributed5 (Güth et al.
(2005). Finally, fiscal decentralization can also help increase revenue and
reach greater share of 5 For other reviews literature on Proximity Principle
see Vincent (2017). country's GDP by the tax system when sub-national
governments are directly involved in taxation (Bahl and Bird, 2008). For
further discussion on fiscal federalism see Shah (2007). For discussion of
fiscal federalism in context of Nepal, its legal provisions, its challenges, and
its prospects see (Adhikari, 2019; Thapaliya et. al., 2018). The benefits of
fiscal decentralization depend on factors such as autonomy to make
independent fiscal decision, however this degree of autonomy depends on
the level of resources owned by sub-national governments. Thus, sub-
national revenue mobilization and more specifically OSR mobilization is of
vital importance for success of fiscal federalism in the country.