UNIT 6

Structure

FISCAL POLICY, EQUITY AND SOCIAL JUSTICE

Objectives Introduction Fiscal Policy-Meaning Objectives of Fiscal Policy Fiscal Policy in Operation-Some Highlights Fiscal Policy-Equity and Social Justice Let Us Sum Up Key Words References Answers to Check Your Progress Exercises

6.0

OBJECTIVES

After going through this unit, you should be able to : explain the meaning and scope of fiscal policy indicate the important objectives of fiscal policy highlight the contribution of fiscal policy in defusing the recent crisis in the balance of payments faced by the country; and discuss fiscal policy instruments and their; utility in bringing about a significant measure of equity and social justice in the society. '

6.1

INTRODUCTION

The term "fiscal" has been derived from the Greek word 'fisc' for basket which symbolised the treasury or the public purse. It simply means the exchequer or the government treasury. Fiscal policy is that part of economic policy which is mainly concerned with the revenues and expenditures of the government. It often includes public debt. Resources are raised through taxes, non-tax sources and borrowings within the country and from abroad. The policies that the government pursues in respect of raising revenues, levying taxes on income, commodities, services, exports, imports and those relating to public expenditure have a tremendous impact on the economy. In this unit we will discuss the meaning, scope and objectives of fiscal policy. We will also highlight the significance of various instruments of fiscal policy in bringing about equity and social justice in the society.

6.2

FISCAL POLICY-MEANING

Broadly speaking, fiscal policy is concerned with raising and spending financial resources and public debt operations to influence the economic activities of the community in desired ways. It is also concerned with the allocation of resources between the public and private sectors and their use in accordance with national objectives and priorities. It aims at using its three major instruments-taxes, public expenditure and public debt-as balancing factors in the development of the economy. According to Premchand "Formulation of fiscal policy presumes the identification and clear recognition of the institutional aspects of government finance, such as tax

systems, their incidence and shifting, budget formulation and execution, and financial management ." Since the state has come to occupy a pivotal role in the economic development of a country, fiscal policy is being increasingly used, through a policy of taxation of Income, commodities, imports and exports, a well designed policy of public expenditure and a policy of borrowings, to influence the economic development of the country. Government budgeting is clearly the most important instrument through which the fiscal policy is channelled. In fact, fiscal policy has come to be identified with budgetary policy and the two terms are often used interchangeably.

6.3

OBJECTIVES OF FISCAL POLICY

The important objectives of fiscal policy include :

i) To increase the rate of capital formation In order to promote and sustain economic development, the rate of capital formation has to be much higher than that prevailing in most of the underdeveloped countries. A high rate of economic growth, sustained over a long period is an essential condition for achieving a rising level of living. Since an increase in the rate of growth does not come about automatically, the main objective of fiscal policy is to allocate more resources for investment and to restrain consumption.
ii) Reduction in economic inequalities of income and wealth A major contribution of fiscal policy consists in minimising the adverse distributional impact of government policies. For instance, in a developing country like India, the need for alleviation of poverty is self-evident. There is, however, yet no evidence that the process of economic development has had any positive economic impact on the impoverished classes. Mobilisation of resources for financing the anti-poverty programmes, such as Integrated Rural Development Programme, Jawahar Rozgar Yojana, employment guarantee schemes, etc., is an important objective of fiscal policy in India. In any case, in a democratic society political realities would not permit a further widening of the distribution patterns than at present. Either by itself, or in conjunction with other measures of social and economic reforms, the current fiscal policy has considerable potential for reducing inequalities of income. CumuIative inequalities may take time to melt away. iii) Balanced growth A primary feature of the economic scenario in developing countries i s their excessive dependence on agriculture rather than on industries and other non-agricultural occupations. The process of economic development gives rise to a greater variety of economic occupations, lesser dependence on land, and the need to provide employment to additional labour which results from mounting population pressure. Balanced development not only across income groups, but also across regions in the country can be achieved through appropriate fiscal policy instruments. Another kind of balance is that between the public sector and the private sector. There is no such thing as a pure market economy or a total centrally planned economy. Once the appropriate mix and the economic role of the state have been decided on, fiscal policy instruments a r e pressed into service to bring about the desired policy changes. iv) Economic and social overheads Fiscal policy has to be so formulated that adequate resources are available to the government for funding social expenditure which benefit the poor. Heavy investments have to be made in infrastructure for sustaining growth in agriculture and industry. The development of transport and communication, water management and irrigation projects, large scale investments in health and education, cannot be left to the private sector. Such investments are heavy and generally beyond the capacity of the private sector. Privatesector is generally interested in projects with adequate and quick returns. The government, therefore, has to have a fiscal policy which will alIow such investments in social overheads. Such investment will allow private capital to come in and by raising the productive capacity and production, the government can generate profits.

v) Control of inflation There are various causes of inflation. There can be too much money in the hands of people and two few goods and services availrble for buying. An increase in government expenditure results in an increase in payment of salaries, wages, purchase of goods and services. This puts more income in the hands of the people. An increase in wages of industrial workers also increases money income. Wages also constitute costs of inputs. If costs go up, so do prices. This is cost-push inflation. Thus inflation results either because there is too much demand (because of increased purchasing power) for too few goods or because the costs of inputs having gone up the prices rise. An appropriate fiscal policy can help in controlling inflation. A noninflationary financing of planned development will require a greater reliance on surplus generated by the budget and public sector undertakings and a reduced dependence on borrowed funds. vi) Progressive tax structure Taxes and subsidies have direct consequences for the poor to the extent that they bear the burden of taxes or benefits from the subsidies. In a developing country like India, the tax structure relies heavily on indirect taxes. This is not surprising, given the stage of development, low income levels of the majority of the people and the scope for commodity taxes offered by the growth of industry and trade. The government should try to increase the scope oT the indirect tax system, both through low tax rates on essential commodities and through subsidised distribution of foodgrains, edible oils and sugar. At the same time, an effort has to be made to increase the share of direct taxes in total tax revenue over a period of time, so that the fiscal system as a whole becomes progressive. What matters, however, is not the tax rates on paper, but the actual collections and their incidence. Fiscal policy must, therefore, ensure that taxes, as levied, are fully collected and strong action is taken to curb tax evasion. Check Your Progress I Note : i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit. 1) What is the central concern of fiscal policy? What are the major aspects of government finance that fiscal policy is concerned with?

Flscd PoUq, EquYy md Sodd Jurtkc

2)

Indicate the important objectives of fiscal policy.

6.4

FISCAL POLICY IN OPERATION -SOME HIGHLIGHTS

Control of Inflation Currently, inflation has been described as the most important problem that the economy is faced with. A number of demand-pull and cost-push factors have been mentioned as potential causes. The inflationary surge is led mainly by agricultural goods. The prices of manufactured goods have not even kept pace with average inflation, and, have lagged well behind the rise in agricultural prices. Along with demand-pull factors, supply factors (scarcity or short supply) have determined the pattern of relative price changes. Agricultural prices were increased by a rather *or kharif crop of 1990 which followed on the heels of a poor rabi crop earlier in the

same year. Imports could not be used to increase supplies and dampen prices because of the severe balance of payments problem being faced by the economy. The sharp increases in procurement prices for foodgrains have also contributed to the inflationary pressure. The excess demand pressures in the economy were primarily generated by expansionary fiscal policies of the central and state governments. Firstly, the investment expenditure of the government has far exceeded their savings. The excess demand of the government represented by its excess over saving has been met from these sources: (I) domestic borrowing; (2) foreign borrowing; and (3) borrowing from Reserve Bank of India. While borrowing from the commercial banking system cannot go beyond a point, foreign borrowings are also no longer freely available to finance excess of expenditure over receipts from domestic borrowings. If ,the recourse to foreign borrowings is to be reduced, either domestic investment must be reduced. with undesirable consequences, or domestic savings must be raised. The third source for borrowings is the Reserve Bank of India. This is directly connected to the expansion of money supply and consequently to inflation. The monetised deficit (that is, the part of the fiscal deficit that leads to an increase in money supply) has been rising. The monetised deficit of the central government shows a fair degree of correspondence with the rate of inflation. Apart from the immediate net increase in expenditure, monetisation of the deficit builds up a level of liquidity which leads to a general increase in demand, and hence inflation, in the succeeding years. Thus the government needs to reduce its reliance on all the three present sources of funds : compulsory borrowings through the banking system, the monetised deficit and foreign borrowings. In order to reduce the fiscal deficit, the government has had to permit an increase in the administered prices of some basic goods and services. It incidentally increased input costs in the rest of the economy, thereby bringing about cost-push inflation also. Devaluation of the rupee in July, 1991 led to an increase in import costs. In order to combat inflation, the Government launched a massive effort to correct the fiscal imbalance by reducing the fiscal deficit from 8.4 per cent of Gross Domestic Product (GDP) in 1990-9 1 to 6.5 per cent in 1991-92 and further to about 5 per cent in 1992-93. Other measures in this direction include containing the growth of aggregate demand; tightening of selective credit controls; and revamping and extending the public distribution system. Results will take some time to show up. Balance of Payments The domestic and external sectors of an economy are interrelated. When domestic income is equal to domestic expenditure, the external accounts are in balance. Excess domestic demand caused by an excess of investment over saving leads to domestic inflation. It can also result in a deficit in the balance of payments. India entered the decade of nineties with large internal and external financial imbalances which made the economy highly vulnerable to external shocks. The Gulf crisis resulted in a higher import bill and a further loss of export markets and remittances. External commercial borrowings declined sharply. The drying up of commercial loans was accompanied by a substantial net outflow of deposits by NonResident Indians. The rapid loss of reserves prompted the government to take,a number of counter measures leading to a reduction in imports. Import reduction beyond a point would affect the entry of the essential inputs into industry and transport, petroleum products and fertilisers. This led to a decline in industrial production and a fall in exports as import compression had reached a stage when it threatened widespread loss of production and employment and verged on economic chaos. The government, therefore, moved to implement a programme of macroeconomic stabilisation through fiscal correction. A key element in the stabilisation effort was the attempt to restore fiscal discipline. Both the balance of payments problems which were building up over the past few years and the persistent inflationary pressure were the result, of large budgetary fiscal

deficits which characterised the economy year after year. The budget deficit was about Rs. 11,000 crore in 1990-91. A reversal of the trend of fiscal 'expansionism was essential to restore macro-economic balance in the economy. The budget for 1991-92 brought down the deficit to about Rs. 7,000 crore. Similarly, reduction in the fiscal deficit (the overall resource gap of the Government) was envisaged by about two percentage points from around 8.4 per cent of GDP to 6.5 per cent of GDP. This was to be followed by a further reduction in 1992-93 to 5 per cent of the GDP. These improvements in fiscal performance were made possible by the decision to abolish export subsidies, increase fertiliser prices, as well as the steps taken to keep non-plan expenditure (including defence expenditure) in check. These measures have reduced total expenditure, thereby reducing the current account deficit. These fiscal policy measuns have been complemented by (i) exchange rate adjustment (devaluation of the rupee), (ii) a programme of structural reforms of trade, and (iii) industrial and public sector policies. The objective is to evolve an industrial and trade policy framework which would promote efficiency, make the economy internationally competitive, promote exports and generally integrate the Indian economy with the global economy. While the crisis has blown over, the policy reforms introduced by the government are necessary from the long term point of view. Cut in Expenditure Ever since the beginning of the planning era in India, the central government expenditure has increased enormously. The total expenditure which was Rs. 529 crore in 1950-51 has gone up to Rs. 1.19.087 crore in 1992-93 (budget estimates), an increase of 225 times. Revenue expenditure has grown at a faster rate. It went up from Rs. 347 crore in 1950-51 t o 89,570 crore in 1992-93. Capital expenditure, however, grew at a slower pace. It increased from Rs. 183 crore in 1950-51 to Rs. 29,5 17 crore in 1992-93, an increase of 161 times. All this when the national income during the same period went up from Rs. 8,938 crore to Rs. 4,25,672 crore (estimated), which is about 48 times. (For further details, see Unit 10 of Block 3.) Another disturbing feature of the Union Budgets is the mismatch between revenues and expenditure of the wrong kind. Beginning with second plan right up to fifth plan, the revenue account of the budget always had a surplus and this partly offset the deficit in the capital account. But during the sixth plan the revenue account no longer assumed the "compensatory role". Beginning 1988-89, the capital account has been showing a surplus and thus playing the reverse role of moderating the revenue account deficit. Thus the plain meaning of this situation is that the government cannot raise enough revenues to sustain the ordinary business of governing the country. It has to borrow from the capital market to pay for its day to day expenses. What an underdeveloped country should aim at is to have a surplus in its revenue account by raising maximum resources, through taxation, and by keeping the consumption expenditure as low as possible. This surplus should be used to finance the capital budget. The deficit on the revenue account is either an index of an inadequate tax policy or possible extravagance in public expenditure on consumption or both. Such deficits would mean negative savings and consumption of capital. The effect of deficit financing is to cause a rise in the domestic price level and to generate demands for wages. This leads to an increase in prices of input costs making the economy noncompetitive. Substitution of foreign goods for domestic goods may lead to balance of payments problems and depreciation of the exchange value of the rupee. A reduction in government expenditure, by reducing excess demand, will soften inflationary pressure. Can government expenditure be reduced? "The newly evolving analysis of bureaucracy by economists provides more rigorous underpinning for an old conclusion popularly known as 'Parkinsons Law' (Refer to Section 6.7 for explanation). Bureaucrats maximise their own utility and the principal variable in their "utility function" is power. Power can be roughly measured by a proxy such as the size of the bureaucrat's budget, or the size of the department by the number of employees. Bureaucrats identify themselves with the stated goals of their department and achieve their satisfaction in life in large part by expanding their activity. They will strongly resist any attempt to dismantle a government organisation. The governments, even when they make genuine efforts to reduce expenditure, usually d o

so by slowing down the rate of expenditure growth. Reduction in the absolute level of expenditure is rarely possible. Dahl and Lindblom pointed out in 'Income Stabilization in a Developing Democracy' (Max Milliken, ed. Yale University Press. New Haven 1956), government expenditures generally mean that "services are performed, values are realised, administrative organisations developed, expectations expanded, clienteles formed, interest groups created, pressures mobilised, and once these are set in motion, they cannot easily be contracted". The balance of payments crisis that overtook the government left it with no option but to take corrective fiscal action immediately. Containing and reducing non plan expenditure has been the avowed policy of the government for some years now. It is only with the budget for 1991-92 and 1992-93, that a serious effort has been made in this direction. The important policy initiatives introduced in the 1991-92 budget included (i) reduction in the fertiliser subsidy; (ii) abolition of cash compensatory scheme; and (iii) disinvestment in some selected public sector enterprises. As a result of these adjustments, the provision for nonplan expenditure, excluding interest payments, in 1991-92, represented a reduction of about 5 per cent compared with the provision in the revised estimates for 1990-91, and a reduction of almost 15 per cent in relation to what would have had to be provided, but for the fscal correction. Interest charges are the largest single item of nonplan expenditure and account for Rs. 32,000 crore in the budget estimates for 1992-93 and account for about 27 per cent of the total expenditure and about 38 per cent of the nonplan expenditure. The provision for 1992-93 represented an increase of Rs. 4,750 crore over the revised estimates for 1991-92. lnterest charges are a committed expenditure reflecting the cumulative effect of past deficits. These charges can be controlled by reducing the reliance on borrowed funds, and making the debts productive and self-liquidating. In the ultimate analysis, a reduction in revenue expenditure and hence revenue deficit can alone provide a solution of lasting nature. This indeed is a daunting task. Expenditure on defence and subsidies are the other major components of nonplan expenditure. In real terms, the defence expenditure has already been contained, if not marginally reduced. The question of subsidies is being investigated by a Parliamentary Committee. In any effort at reducing expenditure and hence deficits, the first casualty usually is plan expenditure. Even though in nominal terms, plan expenditure is marginally Higher, in real terms it represents a significant reduction. This is in tune with the new economic philosophy of the government which accords larger economic space to the private sector. With this multipronged strategy, the government has been able to bring down the fiscal deficit from 8.4 per cent of the GDP (1990-9 1) to 6.2 per cent in 1991-92and hopes further to reduce it to almost 5 per cent in 1992-93. This shows a welcome recognition of the paramount need to restore macroeconomic balance and manage the balance of payments.

6.5

FISCAL POLICY-EQUITY JUSTICE

A N D SOCIAL

According to the long term fiscal policy, the major contribution of fiscal policy to poverty alleviation has to come through an effective programme for (i) mobiIisation of additional resources which can be used for financing the anti-poverty programmes, (ii) for improving the social and economic services on which the poor mainly,rely and (iii) for financing the heavy investments in infrastructure, which are necessary for sustaining growth in agriculture and industry. The anti-poverty programmes and social services have to be financed by the government. Fiscal policy has to be so formulated that adequate resources are available to the government for funding social expenditure which benefits the poor. Alleviation of poverty has been an objective of the government policy, particularly after the fourth five year plan. Several special programmes have been in operation over the last two decades focusing on the poor as the target group. As a result, the extent of incidence of absolute poverty had declined over the years. The overall improvement in human resources, as evident from the estimates of incidence of poverty made by the Planning Commission, is given in the table below:

D t h m of Incidence of Poverty (per cent)

Urban
All India

41.2

38.2 48.3

.28.1 37.4

20.1 29.9

51.5

The reduction in the incidence of poverty is being brought about both by (I) the growth of the economy, particularly in agriculture, and (2) by the implementation of development programmes especially designed to improve the incomeearning opportunities of the poor. In the coming years, the Centre's expenditure policies will accord an even higher priority to programmes benefiting the poor, such as the Integrated Rural Development Programme, the National Rural Employment Programme and the Rural Landless Employment Gaurantee Programme. In addition to the budgetary allocation for Rural Development programmes, an additional allocation (1992-93) is to be made available from the corpus of the National Renewal Fund for employment generation schemes to supplement the normal employment generation through the Jawahar Rozgar Yojana. An additional allocation of foodgrains, through the Public Distribution System, in the 1700 most backward blocks at a subsidised rate, is another step for protecting these vulnerable sections of society from the pressure on prices. Another important way in which fiscal policy can contribute to the reduction of poverty is to encourage rapid economic growth and fast expansion of productive employment opportunities. Taxation has significant effects on savings and investment in the economy,on the allocation and uses of resources between alternative sectors, and on the efficiency with which resources are utilised. A progressive tax structure becomes inevitable if inequalities of income are to be process of industrial development always benefits the affluent reduced. Nor~ml sections of society. It is from them that resources can be mobilised for financing poverty alleviation programmes. Such a tax structure would rely heavily on direct taxes on income and wealth. Our tax structure, unfortunately, relies largely on indirect taxes. The time is ripe to have a look at the tax system which has evolved over a long period and has become extremely complex. The taxation system has to be simplified, made more progressive so that none of our basic objectives of growth and social justice are compromised. Food subsidy is a pan of the system of food security for the poorer and weaker sections of the population and is a basic element in the social policy. This is being continued. Fertiliser subsidy has become the largest single subsidy in the fiscal system. There is no doubt that fertiliser is an essential ingredient for agricultural production. Agricultural development is vital not only for economic growth in general, but also to ensure rising levels of income and employment in rural areas. In 1980-81, fertiliser subsidy was just 12 per cent of the total allocation in the Central and State Plans taken together, for Agricultural Rural Development Special Area Programmes and Irrigation and Flood Control. It increased to 33 per cent in 199192. Measures for better targeting and containing it are under investigation. For the present, this is being continued. Thus ends of social justice and equity are being served by the fiscal policy. Once the economy goes through the macro-economic stabilisation and structural reforms come to fruition, it should be possible to do much more in programmes of poverty alleviation, employment generation, public distribution systems, etc.
peck Your Progress 2

'Note : i) Use the space given below for your answers.

I

ii) Check your answers with those given. at the end of the unit. riefly describe the contribution made by fiscal policy in defusing the recent balance of payments crisis in India.

......................................................................................... ......................................................................................... ......................................................................................... .........................................................................................

2) How has fiscal policy helped in reducing inequalities of income?

......................................................................................... ......................................................................................... .........................................................................................

6.6

LET US SUM UP

Fiscal policy is concerned withi(l) raising financial resources and spending them and

(2) public debt operations to influence the economic activities of the community in
desired ways. It is also concerned with the allocation of resources between the public and private sectors and their use in accordance with national objectives and priorities. The objectives of fiscal policy are (i) to increase the rate of capital formation for promoting and sustaining a high rate of growth; (ii) reduction in economic inequalities of income and wealth through poverty alleviation programmes, generation of employment opportunities, a progressive tax structure and a system of subsidies which benefit the poor; (iii) balanced growth; (iv) provision of economic and social overheads; (v) control of inflation; and (vi) a progressive tax structure. How has fiscal policy contributed to the attainment of the objectives it is credited with? As we have discussed in the unit, three of the most important aspects are: control of inflation, balance of payments and reduction in public expenditure. The economy is an integrated whole. The best contribution that fiscal policy has made is in helping to pull the country away from the brink of an economic disaster. The balance of payments crisis could be defused through a series of policy measures which included fiscal corrections, trade policy reforms and industrial policy reforms. The excess demand pressures in the economy were generated by expansionary fiscal policies of central and state governments. The government had to cut down on its fiscal deficit. The reckless increase in the fiscal deficit had spilled over to the external sector and triggered the balance of payments crisis. Several measures were, therefore, taken to introduce fiscal discipline in the country. A serious effort was made to (i) contain nonplan expenditure; (ii) undertake disinvestment in the public enterprises; (iii) increase some administered prices to generate revenues; (iv) bring about devaluation of the rupee so that exports could be encouraged; and (v) introduce structural reforms in trade. industrial policy, public sector etc. In order to tide over the crisis, massive credits were negotiated with the International Monetary Fund and the World Bank. The crisis has blown over. But fiscal discipline will need to be observed for many years before the economy can turn the corner.

6.7

KEY WORDS

Budget Deficit : It is the difference between all receipts and expenditure, both revenue and capital. This difference is met by the net addition to the treasury bills issued by the central government and drawing down of cash balances kept with the Reserve Bank of India. .

Cost-Push Inflation : It is a situation in which consumer and industrial prices keep rising owing to a cantinuing demand for higher wages.

Gross Domestic Product :The total value of goods and services that are produced within a country over a specified period. usually one year, excluding all those goods and services used during that period to produce further goods and-services.

G n a FLpd ~ Dclldt :It refers to the total resource gap in terms of excess of total government expenditure over revenue receipts and grants. This concept fully reflects the indebtedness of the government.
Integrated R u n l Development Programme (IRDP) :This is an antipoverty programme introduced in the sixth five year plan period during 1978-79 with the objective of bringing about economic, social and cultural transformation of rural. sector by generating additional employment opportunities and reducing the number of those living below the poverty line. The programme aimed at raising income and employment opportunities of landless, marginal farmers, poor rural artisans, scheduled castes and tribes through agricultural, and animal husbandry practices, village craft and services etc. J a m b Rozgar Yojam : This is an employment programme announced during the seventh five year plan in 1989. The earlier existing two rural wage employment programmes i.e. NREP and RLEGP got merged into this scheme. The intention of this scheme is to provide employment to atleast one person in every family living below the poverty line in rural area for atleast 50-100 days in a year.
'

Market Economy : An economic system in which the question of what to produce, how much to produce and for whom to produce are decided in an open market through the free operation of supply and demand.

Monethcd Deficit : It is the increase in the net Reserve Bank of India credit to the central government. It is the part of fiscal deficit which leads to an increase in money supply. N a t i o d R u n l Employment P r q n m m e (NREP) :This was started in 1980, with the objective of generating additional employment opportunities for the rural people, particularly to that segment which is without assets.
Natiolul Renewal Fund : It was set up by the government recently with the aim of taking care of workers, who go out of employment by the proposed closure of terminally sick public sector units in the country. It will be used to provide a safety net to workers in sick enterprises and to finance their retraining and redeployment. Revenue Ddidt :It denotes the difference between revenue receipts and revenue expenditure. Rrkhmn's Law :This gives Cyril Northcote Parkinson's satirical view of the effectiveness of human beings and their organisations. The law holds that 'work expands so as to fill the time available for its completion'. It was then formulated to apply to government redtape and bureaucratic inefficiency in Britain. R u n l Landless Employment Guuantee Programme (RLEGP) :This was initiated in 1983 with the objective of providing gainful employment for the rural landless labourers by creation of productive assets, strengthening rural socioeconomic infrastructure and thereby improving the overall quality of life in the rural areas.

REFERENCES
Government of India, 1985. Long Term Fiscal Policy, New Delhi. Government of India, 1991. Economic Survey 1991-92, Manager. Government of India Press, h e w Dclhi. Government of India, 1992. Annual Budget 1992-93, Manager, Government of India Press, New Delhi. Gowda, Venktatagiri K.. 1987. Fiscal Revolution in India, Indus Publishing Company, New Dewi. Thavaraj, M J.K., 1978. Financial Administration in India, S u l t a n - C h d & Sons,

N . . .naw;

ANSWERS TO CHECK YOUR PROGRESS EXERCISES

Check Your Progress 1

I)

Your answer should include the following points : Fiscal policy is concerned with (I) raising financial resources and spending them and (2) public debt operations to influence the economic activities of the community in desired ways. It is also concerned with the allocation of resouras between the public and private sectors and their use in accordance with national objectives and priorities. It aims at using its three major instruments-taxes, public expenditure and public debt as balancing factors in the development of the economy.

2) Your answer should include the following points : The important objectives of fiscal policy include'the following : To increase the rate of capital formation. reduction in economic inequalities of income and wealth. help in achieving balanced growth. emphasise on the provision of economic and social overheads. guidance in designing d progressive tax structure.
Check Your Progras 2

I) Your answer should include the following points : Fiscal deficit had to be reduced substantially so that the primary cause of inflation could be eliminated. Balance of payments crisis had to be defused through several policy measures including fiscal corrections.
A significant reduction in total government expenditure was achieved through a series of measures.

2) Your answer should include the following points : Poverty alleviation programmes such as rural development programmes, rural implement generation schemes etc., have been financed by the government. Pressures on prices in respect of essential commodities have been softened through public distribution system. System of taxes and subsidieu which benefit the poor has been put in place.

UNIT 7 -GOVERNMENT BUDGETING :PRINCIPLES A N D FUNCTIONS

Structure
7.0 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 Objectives Introduction Budget-Meaning Characteristics of Budget Functions of Budget Classification of Budgets Budget-An Illustration Let Us Sum Up Key Words References Answers to Check Your Progress Exercises

7.0

OBJECTIVES

After studying this unit. you should be able to : state the meaning and components of budget explain the general characteristics of budgeting systems identify the important functions which budgets usually perform; and describe the classification system according to which budgeted expenditures are classified.

7.1

INTRODUCTION

A single item of public expenditure or that of public revenue cannot be judged in isolation. Whereas public expenditure is designed to promote welfare, the taxes impose costs on the tax payers. The welfare and costs, utility and disutility of government financial transactions, need to be balanced. The demands for expenditure have to be balanced against the available resources. A b-udget is, therefore, a financial plan for rationing scarce resources amongst various demands for expenditure. Over the last few decades, however, budgets have become extremely complex and pervasive. According to Gladstone "they are no longer affairs of arithmetic but in a thousand ways go to the root of prosperity of individuals, the relations of classes and strength of kingdomsw.Thus the concerns of budget makers are not just financial, that is, producing a balance between expenditure and revenues; rather these are economic, political, social and administrative in nature. In this unit, we will discuss the meaning, characteristics and functions of budget. The three-fold classification of budget shall also be examined.

7.2

BUDGET-MEANING

qrbudget is a statement containing a forecast of revenues and expenditures for a period of time, usually a year. It is a comprehensive plan of action designed to achieve the policy objectives set by the government for the coming year. A budget is a plan and a budget document is a reflection of what the government expects to do in future. While any plan need not be a budget, a budget has to be necessarily a plan. It shows detailed &location of resources and p r o p o d taxation or other measures for their realisation. More specifically, a budget contains information about :

-8 sydwm-I

M P Y

i)

plans, programmes, pro~ects, schemes and activities-current as well as new proposals for the coming year;

ii) resource position and income from different sources, including tax and non-tax revenues; iii) actual receipts and expenditure for the previous year; and iv) economic, statistical and accounting data regarding financial and physical performance of the various agencies and organs of the government.
A budget is, however, not a balance sheet (exhibiting total assets and liabilities) of the government on a particular date but refers only to information explained above. It is a financial blueprint for action and is, therefore, of great advantage to government departments, legislatures and citizens.

7.3
i)

CHARACTERISTICS OF BUDGET

The basic characteristics of government budgeting are as follows : There is a strong emphasis on expenditure control with itemised ceilings and sanctions. The French system of budgeting is largely based on this principle, viz. : a strong financial control system. For historical and administrative reasons, Indian budgetary system is also set in a framework of strong financial control. Although, after Independence, this feature has become diluted through various schemes of delegation of powers and decentralisation.

ii) Another characteristic is the tendency towards incrementalism. The bulk of ongoing activities is left untouched. Only marginal adjustments are made in raising and allocating resources from one year to the other. In spite of various budgetary innovations, budgetary systems the world over are essentially incremental in nature. iii) There is usually no attempt to relate inputs to outputs or expenditure to performance and benefits. Any such attempt, if at all it is made, is limited to the economic function and the largest component of government activities, perse, are mainly expenditure-oriented. iv) Generally budgets are prepared for a time span of one year. Since budgeting presupposes planning it must, therefore, adopt a longer time frame. v) Some of the budgetary systems (Netherlands) reflect application of commercial principles t o budget, including provision of depreciation allowances and in some systems, accrual-based aqounting. The Italian budgetary system shows the availability of funds beyond the financial year with parallel operation of the preceding and current year's budgets. vi) In some countries, special accounts are maintained (Japan) and these are outside the budgetary process. In other countries, extra-budgetary devices of various types are resorted to

Check Your Progress 1 Note : i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit.
I) What are the components of a budget?

2) Discuss the characteristics of government hl~dget.

.......................................................................................
2

Government Budgeting :Prhdplr and Functbm

7.4

FUNCTIONS OF BUDGET

A budget is a powerful instrument in the hands of government. It has manifold objectives. Some of these are as follows:

Aecount.bility In the early phase, legislative control and accountability were the primary functions of the government budget. This arose from the legislature's desire to control (impose, amend and approve) tax proposals and spending. The executive was accountable to the legislature for spending-within limits approved by the latter, under several heads of expenditure, and only for approved purposes. Similar accountability was to exist within the executive on the part of each subordinate authority to the one immediately above in the hierarchy of delegation. Accountability continues to be an important function of the government budget even today owing to its usefulness in budget execution and plan implementation. Management Budgeting is an executive or managerial function. As an effective.tool of management, budgeting involves planning, coordination, control, evaluation, reporting and review. Many of the budgetary innovations such as :
functional classification, performance measurement through norms and standards, accounting classsification to correspond to functional classification, costing and performance audit and use of quantitative techniques have become important aids to management. Various budgetary systems like performance budgeting and zero base budgeting are specifically management-oriented systems.

Coatml Control essentially implies a hierarchy of responsibility, embracing the entire range of executive agencies, for the money collected and expenditure, within the framework of overall accountability to the legislature. In a democracy, control assumes new dimensions and gives rise to exceedingly difficult problems. The basic concern in a truly representative government is to bring about suitable modifcations in the uesign and operation of the financial system so as to ensure executive responsibility to the legislature which is the law-making, revenue determining and fund-granting authority.
Legislative control would mean that the legislature can meaningfully, and not merely formally, participate in the formulation of broad policies and programmes, their scrutiny, approval and implementation through the annual budget. It also means that the legislature can effectively relate performance and achievement of the executive to the objectives and policies as laid down by it. Members of the legislature are not always adequately acquainted with the complexities of financial administration, nor can they always understand the enormity of the vast scale of operations and therefore the level of funds required. Various devices are, therefore, used to assist legislatures in exercising their legitimate powers over the executive. The Congressional committees of the United States and the Parliamentary Select committees of the United Kingdom and India help the legislature in exercising their control over the public purse. We shall be discussing in detail about the role of financial Committees in Unit 19 of Block 6 of this course. Statutory audit also examines the accounts and other relevant records to ensure that the moneys granted by the legislature are spent strictly in accordance with law. Also, audit tries to ensure that the government obtains value for the tax-payers' money and that the norms of economy, efficiency and effectiveness are observed.

Planning Budgeting provides a plan of action for the next financial year. Planning, however, involves the (i) determination of long term and short term objectives,

6udg&al and Budgetary

Sy*1111-l

($determination of quantified targets, and (iii) fixation of priorities. Planning also spans a whole range of government policies keeping the time factor and interrelationships between policies in view. Planning envisages broad policy choices. At the level of projects and programmes, the choice is between alternative courses of action so as to optimise the resource utilisation. The goals of public sector, viz., (i) optimal allocation of resources, (ii) stabilisation of economic activity. (iii) an equitable distribution of income, and (iv) the promotion of economic growth are all pursued in an organisational context. In the short-run, achievement of these goals has to be co-ordinated by means of administrative and legal instruments among which budget policy and procedure are the most important. Planning in the budget process reflects political pressures as well as financial pressures and financial analysis.

7.5

CLASSIFICATION OF BUDGETS

Information on the working of the budgetary process is obtained from the systems of classification. Since such a process has a multitude of functions and objectives, different types of classification are needed, either singly or in combination to serve the purpose of appropriation, programme management and review, evaluation of plan implementation and financial and economic analysis. Transactions of the government can be classified by objects such as salaries, wages etc.; organisation or department; functions such as defence, education, agriculture, etc.; their economic character such as consumption expenditure, capital formation, etc. The system of classification of expenditure is a very important aspect of the budget for the fulfilment of budgetary functions. It is through the classification system that the managerial potential of budgeting process may be realised. Let us now discuss some of the most important classification systems. They are : Object-wise or line-item or traditional classification Functional classification ~conomic classification
Object-whe CLurllication Traditional budgeting ensures control of expenditure and the need t o ensure accountability of the executive to the legislature as well as that of the subordinate formations of the executive to the higher echelons. The budget is divided into sections according to organisational units, departments, divisions and expenditure is detailed by each category such as salary, wages, etc. A typical classification would be as follows :

I) 2) 3) 4) 5)
6)

7) 8) 9)

Salary Wages Travelling allowance Office expenses Machinery and equipment Works Grants-in-aid Other charges Suspense account
As a l m d y stated, the rationale for this type of classification was the need to facilitate control and accountability. Inter-agency, inter-organiation and interdepartment comparison of expenditure could easily be made. This information would also be available on a time-aeries basis, that is, from year to year, so that the departments conarned could be pulled up if the expenditure trends, as revealed through this classification, were not satisfactory.

M e r i t 8
i)

ri) It shows clear allocation of funds. For example, what percentage of the expenditure is on salaries, travelling allowances, etc. iii) In times of financial stringency, this classification enables across-the-board cuts on specific heads such as travelling allowances, foreign travel etc.
Deadta

Covannmt Bdgdhg :PrMpla and Functbm

i)

The basic philosophy of budgets with this type of classification is that spending the budgetary allocation is in itself a virtue. Whatever the amount allocated to a particular object it has to be spent, without emphasis on the likely outcome of that expenditure. Since control is not related to performance, it easily degenerates into wastefulness and extravagence. Performance thus takes a back seat.

ii) Emphasis is laid on procedural considerations, legality and regularity of expenditure and all the complex rules that are framed to satisfy regularity audit. Evaluation, justification for expenditure and obtaining value for money become only incidental. iii) Inadequate information is available about the government's objectives and programmes. The emphasis on control and accountability exerts an influence on the criteria which govern budget decisions. Programme control, contribution to development, programme co-ordination and efficient resource allocation are neglected. iv) Any duplication, redundant activities and expenditure are hard to detect and avoid. v) It is only the most pressing demands which receive attention of the budget makers. Policies, programmes and projects which have only long term benefits, usually get postponed year after year.

Functional Claesificrtion
Performance budgeting is based on a "conviction that the way in which revenue and expenditure are grouped for decision making is the most important aspect of budgeting''. A functional classification of the budget is necessary under the system of performance budgeting. The presentation of budgeted expenditure should, therefore, be in t e r n of functions, programmes, activities and projects. Such a classification is an aid to the managerial function of performance measurement relative to the costs incurred. The output of a prograrnmelactivity in terms of physical targets has to be related to the inputs required. These are translated into financial terms and shown as the budget provision asked for the implementation of the programmelactivity. The scheme of functional classification is outlined below :

FUNCTIONAL CLASSIFICATION
Fuaction A major division of governmental efforts which provides distinct services. A segment of a function usually having an end identfible with a major organisation. 1)
2) 3) 4)

Education Health Defence Agriculture Elementary education Secondary education Higher education Technical] Vocational education National Malaria Eradication Programme Development of High Yielding Crops

Propamme

1)

Activity/

RoPct

A division of a prognmme into homopneour typa of work or rbcma

I)

Construction of echo01 buildings Stmngihening of kbonlories Purchase of seeds/ fenilLcn

2)

Another example of a functional classification of roads will classify the system as :

Funct~on Programmes
: Roads : 1)

National Hi%ways Roads of Economic or Inter-State importance Strategic Roads State Highways Major District Roads Rural Roads

2) 3)

4)

5)
6)

Activity/(under the Programme : National Highways) Project : 1) Maintenance of Roads 2) Construction of Bridges on the National Highways Km x I .................to .................x 10

3) Restoration of Missing Links

4) Widening of Roads

5) Construction of Bye-pass
6) Grade Improvement etc.
The terms function, programme, activity and project have definite connotations; in practice, however, these can be quite flexible, the only requirement being that these terms should be used in a consistent manner over the entire span of a departmental budget and also as between different departments of the government. This type of classificat~on provides information about the nature of sources of the government and the share of public expenditure directed towards that particular budgetary control-administrative accountability. An important point to be noted is that the total budget provision, however classified, s the same budget which is submitted to the legislature for has to be the same; as it i approval. Economic Clasification The budget of the government has an impact on the economy as a whole. Because of its sheer magnitude, receipts and expenditure of the government and various policies that are articulated through the budget, are easily the most significant factors that can and do change the very nature, content and direction of the economy. It is, therefore, important to group the budgetary provisions in terms of economic magnitudes, for example, how much is set aside for capital formation, how much is spent directly by the government and how much is transferred by government to other sectors of the economy by way of grants, loans, etc. Economic classification categorises government's total expenditure into meaningful economic heads like investment, consumption, generation of income, capital formation etc. According to the Economic and Social Council of the United Nations (Economic classification provides) "an analysis of the transaction of Government bodies according to homogenous economlc categories of transactions with the other sectors of the economy directly affected by them". This analysis is contained in a separate document called Economic and Functional Classification of the Central Government Budget, and is brought out by the Ministry of Finance. A broad categorisation is as follows : Economic Classification of Total Expenditure
1)

Consumption Expendir'ure

a) Defence b) Other Government Administration 2) Transfer Payments (current) a ) Interest Payments b) Subsidies c) Grants to States and Union Territories d ) Others
3) Gross capital formation of budgetary resources

a) Physical Assets b) Financial Assets

4) Others 5) Total Expenditure

An annual comparison would show whether the expenditure on capital formation is increasing or declining. A decline would be due to increase either in consumption expenditure or in the transfer payments, say interest.

Covult#lnmtB o d H n :Prhdpk mod Functlom

7.6

BUDGET-AN ILLUSTRATION

The Budget 1992-93 of the Government of India is reproduced below. It indicates brief receipts and disbursements along with broad details of tax revenues and other receipts. A broad break-up of expenditure-plan and nonplan, capital and revenue is also given. The excess of government's menue expenditure over revenue receipts constitutes revenue deficit of government. Taking into account the capital expenditure and the capital receipts also, there is a gap of a year between receipts and expenditure. This total borrowing requirement of the government from all sources equals the fiscal deficit. This is the difference between the total expenditure of Government by way of menue, capital and loans (net of repayments) on the one hand and revenue receipts of governments and capital receipts which are not in the nature of borrowing but which finally accrue to the government, on the other.

W W E WW

Budget at a Chnee
,.
(*

m)(In crores of Rupees)

I ~ I - 9 2 192-93 rJrr

1-1-92 rJrr

mfh
=T-

=TBudget Estimates

=Tt s d & I Estimates

Revised Estimates

I. Revenue Receipts 2. Tax Revenue

54954 42978 .I1976 ,39015 5712

3.
4. 5. 6. 7.

(Net to Centre) Non-Tax Revenue Capital Receipts Recoveries d Loano Other Receipts Borrowings and other liabilitica Total Receipts (1 + 4)

...

33303

8.

Y3%9 76198 60850 1 5348 291 18 12666 16452

9. Non-Plan Expenditure 10 On Revenue Account II. On Capital Account 12. Plan Expenditure 13. On Revenue Account 14 On Capital Account 15. Total Expenditure (9 + 12) 16. Revenue Expenditure ( l o + 13) 17. Capital Expenditure (11 + 14) 18. Revenue Dcfrit (1-16) 19. Budgetary Defic~t (8- 15) 20. Fiscal Deficit [(I + 5 +6)-15= 7 + 191

105316 73516 31800 18562 11347

44650

21. m-&rft*dk BPJ*tiWm

*@T mmif
#

Increase in net RBI Credit to Central Government #

14745

7719

8800

5389##

m - & r ~ b 3 m ~ U W K

d h ~ W i T * @ ~

w-w
'

Including other variations in Reserve Bank of India's credit to Central Government.

##

e a ~ a ~ m a ~ l f t m ~ m n l

##

Not independently estimated.

\Check Your Progress 2 / Note : i) Use the space given below for your answers.

1 '

ii) Check your answers with those given at the end of the unit. 1) What are the functions of a budget?
,

.......................................................................................... .........................................................................................
2)

What is object-wise classification of budget? Discuss its demerits.

.........................................................................................
......................................................................................... ......................................................................................... .........................................................................................
3) Explain economic classification of budget.

......................................................................................... ......................................................................................... ............................................................................................

7.7

LET US SUM UP

4 budget is an annual financial statement containing a forecast of revenues and expenditures of the government for a financial year. It shows a break up of expenditure, proposed taxation or other measures for raising resources. Budget is usually for one year, is incremental in nature and expenditure-oriented. As discussed in the unit, budget is a powerful instrument with manifold objectives in the hands of government. Primarily it was viewed as an instrument of legislative control and accountability. In the modern times, however, budgeting has become management-oriented and various budgetary innovations have specific managerial objectives. Budget also serves as a vehicle for implementing the developmental plans of the nation.
I -

Information on the working of the budgetary process is obtained from the systems of classification. Transactions of the government can be classified by objects such as salaries, wages etc; by function as defence, agriculture, industry etc., or by their economic character such as consumption, capital formation etc. These are respectively known as object-wise classification, functional classification and economic classification.

7.8

KEY WORDS

Accrual-baaed Accountin# : An accounting system where a system of charging income and expenditure to the period in which they are earned or incurred is followed, rathei than to the period in which they are actually received or paid. Accountability : Responsibility of the various agencies of the government for the proper management of funds allocated. Depreciation AUowmce : Allowance provided for the dimunition or reduction in the value of an asset due to use and/or lapse of time. Economic C l d c a t i o n :Grouping the budgetary provisions in terms of economic magnitudes such as consumption expenditure, transfer payments, capital formation, etc. Functional Clursification : Presentation of the budgeted expenditure in terms of functions, programmes, activities and projects. InmmenW Budgetin# :A system of budgeting in which the bulk of expenditure on the on-going activities of the government is left untouched, only marginal adjustments (incremental) are made in raising and allocating revenues. Line-item CLesiiication :The system of classifying expenditure by organisations (Ministries and departments of the government) and objects of expenditure such as salary, transport, material contingencies etc.

7.9

REFERENCES

Burkhead jesse, 1956. Government Budgeting, John Wiley & Sons: New York Premchand A, 1983. Ciovernrnerit Budgeting and Expenditure Control: Theory and Practice, JMF: Washington DC Thavaraj, M. J. K., 1978. Financial Administration of India, Sultan Chand & Sons : Delhi

7.10 ANSWERS TO CHECK YOUR PROGKESS EXE.RCISES

Check Your Progress 1 I) Your answer should include the following points : A budget essentially includes the information about : plans, programmes, projects, schemes and activities, current as well as new .year, . proposals for the c o m i n ~ resource position and .income from different sources including tax and nontax revenues.
actuil receipts and expenditure for the previous year, and -economic, siatistical, and accounting data regarding financial and physical performance of the various agencies and organs of the government.

2) Your answer should include the following points : Strong emphasis on expenditure control with itemised ceilings and sanctions.
Tendency towards incrementalism. No attempt to relate inputsto outputs or expenditure to performance benefits. Short time-span of one year.

~udgahg and Budgauy

SyJ~ras-1

Check Your Progress 2 I ) Your answer should include the following points : Accountability Management Control Planning
2)

Your answer should include the following points : Object-wise classification of budget is one where the budget is divided into sections according to organisational units, departments, divisions etc. and expenditure is indicated by each category like salary, wages, travelling allowances etc. Demerits of classification are : Control is not related to performance. Procedural considerations, legality and regularity of expenditures, complex rules are given importance; evaluation and justification for expenditure become incidental. Inadequate information is available about objectives and performance of government. Duplicate, redundant activities and expenditure are hard to detect and avoid.

3) Your answer should include the following points : Economic provisions in terms of economic magnitudes should for example, indicate how much is set aside for capital formation, how much is spent directly by the government and how much is transferred by government to other sectors of economy by way of grants, loans dc. It categorises government expenditure into meaningful economic heads like investment, consumption, generation of income, capital formation.

UNIT 8
Structure
8.0 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 8.10

INDIAN BUDGETARY SYSTEM

Objectives Introduction Evolution of Budgeting System in India Principles or Budgeting Financial Year The Budgetary Process Budgetary Cycle Let Us Sum Up Key Words References Answers to Check Your Progress Exercises

8.0

OBJECTIVES
--

After studying this Unit you should be able to: explain the evolution of budgeting system in lndia state the principles underlying the budgetary process discuss the rationale for the financial year identify the various dimensions of practical budget making; and describe budget cycle.

INTRODUCTION
Even though budgetingin ancient and medieval lndia was known not only in its essentials but in fairly great detail, modern budgetary practices started taking shape with the governance of the country being taken over directly by the British Crown. Broadly, the evolution of budgeting has passed through three stages. Firstly, the budgeting system was a sub-system of the British administration. The financial objectives were subordinate to the limited objectives of the colonial power. Control of expenditure and accountability were the hallmarks of this period. Secondly, with the attainment of Independence, the developmental priorities of the nation superseded the limited objectives of the British Raj. In the third phase, a planningorientation has been sought to be imparted to the budgetary exercises. These three phases correspond to the systems known as incremental budgeting, performance budgeting and zero base budgeting respectively. The system described in the following sections is that which is currently practised and is the end result of all the budgetary innovations introduced with varying degrees of success. In this unit, we Will discuss the evolution of budgeting system in India, principles of budgeting and rationale of the financial year. The various steps of budget making and budgetary cycle shall also be focused in the unit.

8.2

EVOLUTION OF BUDGETING SYSTEM IN INDIA

Kautilya's Arthashastra, which describes the administration during Mauryan period makes reference to an excellent budget system with very detailed, minute rules about the maintenance, preparation, submission and scrutiny of accounts. Every year, the Finance Minister made a note of the opening balance in the Treasury, of all current . expenditure, including capital projects in hand (Karaniya) as well as those which had been completed (Siddham). Along with this there was a detailed statement of receipts

from all sources; and also a statement of the clos~ng balance anticipated at the end of the year. Full and precise accounts were kept of all receipts and outgoings, on Revenue and Capital accounts; plans were also prepared and included in the budget of all proposed new and profitable expenditure for investment. The accounts included estimates for the coming year, and the actual results of the year just ended. The entire Cabinet sat in a conclave, so to say, to scrutinise them and to pronounce upon their accuracy, fullness and satisfactory nature in all respects. And their business was not only to verify the actual figures, to tally expenditure with outlay by vouchers and receipts, they also had to see that full valuc was received for every pie spent; that the clerks, officers and departmental heads hac done their duty honestly and efficiently. A system of fines or rewards helped t o mak the system very effective. The rewards a s well as punishments fell a? much upon clerks as upon the superior officers, inspectors o r even the Auditor-General. The rulers of the Delhi Sultanate and the Mughal empire also continued a financial system not very different from the Mauryan system. With the advent of the British rule, the lndian financial administration came effectively under the control of the East lndia Company. Till 1833, the presidencies of Bengal, Bombay and Madras were quite independent in finance and there was hardly any centralised financial system. This position changed with the Charter Act of 1833 which vested the superintendence, direction and control of all the revenues in the Governor General of India-in-Council. The main activity of the East lndia Company being territorial expansion, expenditure on costly wars mounted. Huge sums were remitted to England on account of interest payable on lndian debt, interest on investment on Railways, civil and military charges supposed to have been incurred in England on behalf of India, including the expenses on the maintenance of the O f f i e of East lndia Company in India. That the Governors of the three presidencies hardly had any powers can be seen from the fact that no governor could create a permanent post carrying a princely salary of more than Rs. ten per month. Following the first war of Independence, in 1857, there was chaos in financial administration. With the takeover of the Indian administration by the Crown, the financial system came t o be fashioned on the lines of the system prevailing in England. lmperial objectives dictated a highly centralised system of financial and administrative control. As we have discussed in Unit 2, the first budget was formally introduced in lndia in 1860 by Sir James Wilson, the then Finance Member of the Governor-Generak-in-Council. There was a t that time no elected legislature in India. The budget was also not presented to the British Parliament. The budget, however, made the Viceroy/Governor-General-in-Council accountable to the Secretary-ofState-in-Council in London who, as a member of the British Cabinet, looked after lndian affairs. The Secretary of State became the fountainhead of all authority. He delegated powers to the Governor-General of India. The powers had to be exercised within the ambit of rules and regulations which had to be strictly followed. According to Thavaraj, the basic features of the financial system in India during the period 1858- 1935 were : i) The Secretary-of-State-in-Council was the chief regulator of the financial system; ii) Governor-General-in-Council exercised delegated financial authority; iii) Finance Department was the custodian of Indian finance8 and iv) Controller General had combined responsibility for lndian Audit and Accounts. The Secretary of State controlled Indian finances through : a) acceptance of the lndian budget; b) regulation and control of expenditure through voluminous rules, regulations and codes; and c) through numerous executive orders.
I

I!.

The budgetary system, more or less, retained these features in spite of the reforms introduced by Lord Mayo in 1870, Lord Lytton in 1877, Lord Rippon's Quinquennial Settlements of 1882 and Lord Curzon's Reforms, 1904. The scene,

however, changed significantly following Montague-Chelmsford Reforms of 19 19. From 1921 onwards, the Central Legislative Assembly, with a non-official majority, was for the first time given the right to discuss and pass the annual budget of the Government of lndia in respect of 'non-reserved' subjects, as also to pass the Finance Bill embodying taxation proposals. The Governor-General was, however, empowered to "certify" the financial proposals in the event of their rejection by the legislature. Before these reforms were introduced, the provincial governments had to seek the approval of the Central Government for every rupee spent. The MontagueChelmsford Reforms for the first time introduced realistic provincial autonomy. Central and provincial heads of revenue were clearly demarcated. Consequently, the importance of the supervisory role of Finance Member over the provincial finance departments declined considerably and vanished altogether after 1935. The Secretary of State, however, did not suffer any diminution in his supreme authority after the 1919 d o r m s . Nothing of significance could happen without his knowledge. But he intervened only when the imperial interests were in jeopardy. The Government o f India Act, 1935, delivered a body blow to his powers. Except for the control over the services, the Secretary of State gave up direct exercise of most of his powers. The Governor General and the Governors exercised special powers and prerogatives over what were called reserved subjects which together with charged items were outside the purview of legislative financial control. They could also restore a demand rejected or reduced by the legislatures. Again, no expenditure could be incurred even if it was duly authorised by the legislature unless it was included in a schedule of expenditure authenticated by the Governor-General or the Governor. Thus the system of financial control, both at the tlme of budget formulation and approval for incurring expenditure, turned out to be very rigid, rule-oriented and complex. This system naturally inhibited and suppressed any popular initiative towards change and development. Understandably, the control over financial administration was a necessary adjunct of the fundamental imperial objectives. It was never meant to facilitating solutions to national problems. It was this system, with all its distortions and rigidities, which India inherited from the British.

Indian Budgetry Syslem

8.3
i)

PRINCIPLES OF BUDGETING

The essential principles generally observed in government budgeting in India are : Principle of annuality. The budget should be on an annual basis; this leads to another rule "the rule of lapse". The operation of this rule leads to a rush of expenditure towards the end of the year. However it has the merit of enforcing parliamentary sanction-which is always for an amount for a specific period after which it must be obtained again. This implies that if the funds voted are not used by the end of the financial year, the unspent balance lapses.

ii) The government budgets are on cash basis. iii) There should be one budget for all financial transactions of the government. In the absence of one common budget it would be difficult to assess the true financial position of the government. Railways and other public enterprises, however, have separate budgets. In the case of railways, total receipts and expenditure are incorporated in the Central Government Budget. The estimates of capital and loan disbursement and also the extra budgetary resources for financing the plans of public enterprises are also shown in the Central Budget. iv) The budgeting should be gross and not net. Gross transactions, both in the case of receipts and expenditure of each department, should be shown. It is not permissible to deduct any receipt accruing to the department from the charges of collection or any other expenditure. This is intended to ensure that the parliamentary control over expenditure is meaningful. In the absence of this provision, the budget coming up before the Parliament would be reduced only to the net deficit, if any. v) Budgeting should be close. It should not be guess work or guess estimates which result in wide fluctuations and can lead to improper allocation of funds. supplementary grants.

Budnctlnn .nd B u d l a u ~ system-I

'

vi) The form of estimates should correspond to the accounting heads since the estimates eventually get converted into actual accounts of receipts and expenditure.

FINANCIAL YEAR
When the first modern budget was presented in 1860, the financial year adopted by the government was from 1st May to 30th April. Beginning with the year 1866, however, the financial year was changed to April-March, in conformity with the practice in England. This practice has been the subject of debate and various committees and commissions which examined the issue have been critical of it. The Administrative Reforms Commission in its Report on Finance, Accounts and Audit observed. "The financial year starting from the 1st of April is not based on custom and needs of our nation. Our economy is still predominantly agricultural and is dependent on the behaviour of the principal monsoon. A realistic financial year should enable a correct assessment of revenue, should also synchronise with a maximum continuous spell of working season and facilitate an even spread of expenditure. For centuries, people in India have become accustomed to commence their financial year on the Diwali day. This practice has its roots in their way of life. The business community and other sections of society start the Diwali day with the feeling that they have finished with the old period of activity and have embarked upon a new one. It is, therefore, appropriate that the commencement of the financial year should be related to Diwali and in order to prescribe it in terms of a date, we have recommended that the 1st November should be the beginning of financial year." The commission also thought that a budget year commencing on the 1st November would be better suited for the transaction of Parliamentary business. It is normally argued that the effect of south-west monsoon, which is responsible for over 90 per cent of the total annual rainfall in India, would be known by September, and the likely agricultural production during the year can be estimated fairly accurately. The commercial and industrial activities are also largely dependent on the performance in the agricultural sector. Besides, the monsoon months can be utilised for budget formulation and the critical fiscal parameters can be decided upon in the light of anticipated level of economic activity in the ensuing year. Under the present arrangements, soon after the expenditure sanctions reach the executing agencies, the onset of monsoon renders it difficult to start construction of the budgeted works. These works have to wait till the rains are over. The speed of works is affected because of the intervention of monsoons when barely the preparatory work of projects has been completed. The delayed execution of works results in the rush of expenditure towards the end of the year leading to surrender of funds at the close of the financial year. Essentially a budget year should help in performing the following functions: i) making a fairly accurate estimates of revenue; ii) making a fairly accurate estimates of expenditure; iii) it should facilitate an efficient execution of projects; and iv) the budget calendar should be convenient to the legislators and administrators. Different dates have been suggested by the various experts who have examlned the question of fina-ncial year. These are 1st July, 1st October, 1st November or 1st January. While there is a merit in each one of these suggestions, none of these can reconcile the conflicting criteria proposed. Considering only the criterion of better predictability of revenues, no single budget year provides enough scope for the various states to make a realistic assessment for both Kharif and Rabi crops. Rabi crops are very important for some of the states. The estimation of total agricultural production would, therefore, remain a guess work. It has, therefore, been argued that the balance of advantage lies in not disturbing the present fiscal year. The database of the economy relates to the existing financial
.

year and any dislocation in this year will lead to statistical, accounting and administrative problems. One has to weigh the advantages of changing over to a different fiscal year against the disadvantages inherent in such a switchover. And one has to remember that there is no general agreement on the alternative fiscal year. The only practical appioach, therefore, is to continue with the present financial year.

lndim Budgauy system

Cbeck Your Progress 1 Note : i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit.
I) Highlight the basic features of the financial system in lndia during the period 1858-1935.

2) State the essential principles of government budgeting in India.

3) What are the functions of a budget year?

8.5

THE BUDGETARY PROCESS

With the attainment of Independence, the objectives, the policy framework and the environment of financial administration underwent a radical change. The conflict between popular will and aspirations and the policy and procedures which had characterised financial administration in the country disappeared overnight. Even though the basic features of the Government of lndia Act, 1935, with regard to financial administration, were retained, there was no fundamental disharmony between these instruments and the national priorities. These instruments could be and were refashioned according to the changed objectives. The budgetary processes in India follow the procedure laid down in Articles 112 to 117 of the Constitution. Accordingly, annual budget of the Union, called the Annual Financial Statement of estimated receipts and expenditure, is to be laid before both Houses of the Parliament in respect of every financial year. The Budget shows the receipts and payments of government under three parts in which government accounts are kept : i) Consolidated Fund, ii) Contingency Fund, and iii) Public Account.

Budgdlng and Budgduy Systems-I

Consolidated Fund of India

All revenues received by government, loans raised by it, and also its receipts from recoveries of loans granted by it form the Consolidated Fund. All expenditure of government is incurred from the Consolidated Fund and no amount 'can be withdrawn from the fund without authorisation from the Parliament.
Contingency Fund

Occasions may arise when government may have to meet urgent unforeseen expenditure pending authorisation from the Parliament. The Contingency Fund is an Imprest placed at the disposal of the President to incur such expenditure. Parliamentary approval for such expenditure and for withdrawal of an equivalent amount from the Consolidated Fund is subsequently obtained and the amount spent from Contingency Fund is recouped to the lund. The corpus of the fund authorised by the Parliament, at present, is Rs. 50 crore.
Public Account

Besides the normal receipts and expenditure of government which relate to the Consolidated Fund, certain other transactions enter government accounts, in respect of which government acts more as a banker; for example, transactions relating to Provident Funds, small savings collections, other deposits etc. The moneys thus received are kept in the Public Account and the connected disbursements are also made therefrom. Generally speaking, Public Account funds d o not belong to government and have to be paid back some time or the other to the persons and authorities who deposited them. Parliamentary authorisation for payments from the Public Account is, therefore, not required.
Charged Expenditure

Under the Constitution, certain items of expenditure like emoluments of the President, salaries and allowances of the Chairman and the Deputy Chairman of the Rajya Sabha and the Speaker and Deputy Speaker of the Lok Sabha, salaries, allowances and pensions of Judges of the Supreme Court and the Comptroller and Auditor-General of India, interest on and repayment of loans raised by government and payments made to satisfy decrees of courts etc; are charged on the Consolidated Fund. These are not subject to the vote of Parliament. The budget shows the charged expenditure separately in the Consolidated Fund. Government budget comprises : i) Revenue budget; and ii) Capital budget
Revenue Budget

It consists of the revenue receipts of government (tax and non-tax revenues) and the expenditure met from these revenues. The estimates of revenue receipts shown in the budget take into account the effect of the taxation proposals made in the Finance Bill. Other receipts of government mainly consist of interest and dividend on investments made by government, fees, and other receipts for services rendered by government.
Capital Budget

It consists of capital receipts and payments. The main items of capital receipts are loans raised by government from public which are called Market Loans, borrowings by government from Reserve Bank and other parties through sale of Treasury bills, loans received from foreign governments and bodies and recoveries of loans granted by Central Government to State and Union Territory governments and other parties. Capital payments consist of capital expenditure on acquisition of assets like land, buildings, machinery, equipment, as also investments in shares etc. and loans and advances granted by Central government to State and Union Territory governments, government companies, corporations and other parties. Capital budget also incorporates transactions in the Public Account.
Demands for Grants

The estimates of expenditure from the Consolidated Fund included in the budget and required to be voted by the Lok Sabha are submitted in the form of Demands

for Grants. Generally, one Demand for Grant is presented in respect of each ministry or department. However, in respect of large ministries or departments, more than one demand is presented. Each demand normally includes the total provisions required for a service, that is, provisions on account of revenue expenditure, capital expenditure, grants to State and Union Territory governments and also loans and advances relating to the service. Where the provision for a service is entirely for expenditure charged on the Consolidated Fund, for example, interest payments, a separate appropriation, as distinct from a demand. is presented for that expenditure and it is not required to be voted by Parliament. Where. however, expenditure on a service includes both 'voted' and 'charged' items of expenditure, the latter are also included in the demand presented for that service but the 'voted' and 'charged' provisions are shown separately in that demand. Plan expenditure forms a sizeable proportion of the total expenditure of the central government. The Demands for Grants of the various ministries show the plan expenditure under each head separately from the non-plan expenditure. The document also gives the total plan provisions for each of the ministries arranged under the various heads of development and highlights the budget provisions for the more important plan programmes and schemes. A large part of the plan expenditure incurred by the central government is through public sector enterprises. Budgetary support for financing outlays of these enterprises is provided by government either through investment in share capital or through loans. The budget shows the estimates of capital and loan disbursements to public sector enterprises in the current and the budget years for plan and non-plan purposes and also the extra-budgetary resources available for financing their plans, The Railways and Telecommunication services are the principal departmentally-run commercial undertakings of government. The budget of the Railways and the demands for grants relating to Railway expenditure are presented to parliament separately. However, the total receipts and expenditure of the Railways are incorporated in the Central Budget. The demands for grants of the Department of Telecommunications are presented along with other demands of the central government.
.
-

Indian Budgduy System

8.6

BUDGETARY CYCLE

In order to allow time for the executive and legislative processes to go through, budgeting is geared to a cycle. The process of approval is very significant in a responsible form of government. The cycle consists of four phases: Preparation and submission; Approval; Execution; and Audit At any given point of time, several cycles would be in operation and would be overlapping.'Nevertheless, various segments of a cycle have different operational life. Budget Preparation In India, budget preparation formally begins on the receipt of a circular from the Ministry of Finance sometime during September/October, that is, about six months before the budget presentation. The circular prescribes the time-schedule for sending final estimates separately for plan and non-plan, and the guidelines to be followed in the examination of budget estimates to be prepared by the department concerned The general rule is that the person who spends money should also prepare the budget estimates. Budget proposals normally contain the following information: i) Accounts classification ii) Budget estimates of the current year iii) Revised estimates of the current year iv) Actuals for the previous year; and

.geting and Budgetary tern-1

V)

Proposed estimates for the next financial year (which is the budget proper).

Budget estimates normally involve : a ) Standing charges or committed expenditure on the existing level of service. Thiis can easily be provided for in the budget, as it is more or less based on a projection of the existing trends. b) New expenditure which may be due to : i) expansion of programmes involving expenditure in addition to an existing service or facility; and

i ) new service for which provision has not been previously included in the grants.
\ \ , ,

~ h i l e \ W (i) ) can be estimated with reference to progress made and the likely expenditure during the next financial year, budget provision for (b) (i) and (ii) cannot be made unless the scheme relating to it is finally approved. The budget estimates prepared by the ministries/depanments according to budget and accounts classification are scrutinised by the Financial Advisors concerned. The plan items of the Central Budget are finalised in consultation with the Planning Commission and are based on the Annual Plan. Parlinmentary Approval The estimates of expenditure prepared by ministries/departments are transmitted to the Ministry of Finance by December where these are scrutinised, modified where necessary and consolidated. The estimates of revenue are also prepared by the Finance Ministry and thus the budget is finalised. The budget is presented to the Parliament generally on the last working day of February. In the first stage, there is a general discussion on the broad economic and fiscal policies of the government as reflected in the budget and the Finance Minister's speech. This lasts about 20-25 hours. In the second stage, there is a detailed discussion on the demands for grants, usually in respect of specific ministries or departments. Each demand for grant is voted separately. At this stage members of parliament may move motions of various kinds. Generally these are policy cuts, economy cuts, and token cuts. The policy cut motion seeks to reduce the demand to rupee one and is indicative of the disapproval of general or specific policy underlying the service to which the demand pertains. The motion for economy cut is to reduce the proposed expenditure by a specified amount. A token cut in a demand is moved to reduce it by a nominal amount say Rs. 100 and may be used as an occasion to ventilate a specific grievance. Since it is never possible to accommodate a detailed discussion on each demand for grant separately, the demands that cannot be so discussed are clubbed together and put to the vote of the Parliament at the end of the period allotted for discussion. Though the budget is presented before both Houses of Parliament, the demands for grants are submitted only to the lower house. Demands for grants, are the executive's requisitions for sanction to spend, and only the lower house can have a say in the matter. While the legislature can object to a demand for grant, reject it or reduce it, it cannot increase the same. It may also be mentioned here that since no demand for a grant can be made except on the recommendations of the President or the Governor (in the case of State), private members cannot propose any fresh items of expenditure. If this were allowed it would necessitate revision of receipts and consequently the budget and sometimes may lead to improper appropriation of public funds. Even after the demands for grants have been voted by the Parliament, the executive cannot draw the money and spend it. According to the Constitutional provisions, after the demands for grants are voted by the Lok Sabha, Parliament's approval to the withdrgwal from the Consolidated Fund of the amount so voted and of the amount required to meet the expenditure charged on the Consolidated Fund is sought through the Appropriation Bill. The Appropriation Bill after it receives the assent of the President becomes the Appropriation Act. Thus, without the enactment of an Appropriation Act, no amount can be withdrawn from the Consolidated Fund. Since the financial year of the government is from 1st April to 31st March, it follows that no expenditure can be incurred by the government after 31st March unless the

Appropriation Act has heen passed by the close of the financial year. This is generally not possible as the process of discussion of the budget usually goes on up to the end of April or the first week of May. Thus, in order to enable the government to carry on its normal activities from 1st April till such time as the Appropriation Bill is enacted, a Vote on Account is obtained from Parliament through an Appropriation (Vote on Account) Bill. The proposals of government for levy of new taxes, modification of the existing tax structure or continuance of the existing tax structure beyond the period approved by Parliament are submitted to Parliament through the Finance Bill. The members can utilise the occasion of discussion on the Finance Bill to criticise government policies, more specifically the proposals regarding the taxation and tax laws. In certain cases, taxation proposals take effect immediately. Since, however, passing of the Finance Bill may entail a time lag, a mechanism under which the taxation proposals take effect immediately pending the prissing of the Finance Bill exists in the form of Provisional Collection of Tax Act, 1931, which empowers the government to collect taxes for a period of 75 days till the Finance Bill is passed and comes into effect. The budget of the Central Government is not merely a statement of receipts and expenditure. Since Independence, with the launching of five year plans, it has also become a significant statement of government policy. The budget reflects and shapes, and is in turn shaped by, the country's economic life. A background of the economic trends in the country during the current year enables a better appreciation of the mobilkation of resources and their allocation as reflected in the budget. A document, Economic Survey, is prepared by the government and circulated to the members of Parliament a couple of days before the budget is presented. The Survey analyses the trends in agricultural and industrial production, money supply, prices, imports and exports and other relevant economic factors having a bearing on the budget.
Indian Budgduy System

Execution of the budget The execution of the budget is the responsibility of the executive government. The procedures for execution of the budget depend on the distribution anddelegation of powers to the various operating levels. As soon as the Appropriation Act is passed, the Ministry of Finance advises spending Ministries/ Departments about their respective allocation of funds. The controlling officers in each ministryldepartment then allocate and advise the various disbursing officers. The expenditure is monitored to ensure that the amounts placed at the disposal of the spending authorities are not exceeded without additional funds being obtained in time.
Thus the financial system broadly consists of the following levels : a) controlling officers; normally the head of the ministry/department acts as the
controlling officer;

b) a system of competent authorities who issue financial sanction; c) a system of drawing and disbursing officers; and d) a system of payments, receipts and accounts. The Department of Revenue in the Ministry of Finance is in overall control and supervision over the machinery charged with the collection of direct and indirect taxes. Such control is exercised through the Central Board of Direct Taxes and the Central Board of Indirect Taxes. These Boards exercise supervision and control over the various operational levels which implement different taxation laws. The Reserve Bank of India is the central banker of the government. The nationalised banks and the network of treasuries are also performing the service of collection (receipts) and disbursement of funds.

Audit The executive spends public funds as authorised by the legislature. In order to ensure accountability of the executive to the legislature, public expenditure has to be audited by an independent agency. The Constitution provides for the position of the Comptroller and Auditor General of India to perform this function. It is his/ her duty to ensure that the funds allocated to various agencies of the government have been made available in accordance with law; that the expenditure incurred has the sanction of the competent authority; that rules, orders & procedures governing such

expenditure have been duly observed; that value for money spent has been obtained and that records of all such transactions are maintained, compiled and submitted to the competent authority. This is the last stage in completing the budgetary cycle (for details see units no. 22 and 23).
Check Your Progress 2 Note : i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit.

1 ) Distinguish between revenue and capital budget.

2) State the phases of the budgetary cycle.

3) What are the main functions involved in the execution of the budget?

8.7

LET US SUM UP

Although, in ancient India, a fairly developed budgetary system was prevalent, it is only after the British Crown took over from the East lndia Company in I860 that a modern budget was introduced. The Secretary of State in the Council was the chief regulator of the financial system in lndia and the Governor General in the Council exercised delegated financial authority. Finance Department was the custodian of lndian finances. As we have discussed in the unit many reforms were introduced, particularly in 1919 and later in 1935. The system of financial control which lndia inherited in 1947, turned out to be very rigid, rule-oriented and complex. Necessarily it was an adjunct of the fundamental imperial objectives rather than an instrument to solve national problems. The budgetary process under the Constitution follows the procedure laid down in Articles 112 to 117. The budget shows receipts and payments under three parts in which government accounts are kept; these are Consolidated Fund, Contingency Fund and Public Account. The budget comprises Revenue Budget and Capital Budget. The budget estimates of expenditure which are to be voted by the Lok Sabha are submitted in the form of Demands for Grants. Generally, one Demand for Grant is presented in respect of each ministry or department. The budgeted expenditure is also classified as plan and non-plan. Bulk of the expenditure represents standing charges or committed expenditure and is non-plan. X large part of the plan expenditure incurred by the Central Government is through public sector enterprises.

These are the four stages in the budgetary cycle. viz; preparation, approval, execution of the budget and audit. Preparation of ihe budget usually begins on the receipt of a circular from the Ministry of Finance during Se?tember/October. It contains iriformation relating to the budget estimates of the current year, revised estimates, actuals for the previous year and the proposed budget estimates for the next financial year. The budget is presented to the Parliament on the last working day of February. A general discussion is followed by a detailed discussion on each demand for grant. The Parliament may reduce or reject but may not increase any budgetary provision which is subject to its vote. After the Parliament has voted the demand for grants, an Appropriation Act has to be passed by it to enable the government to withdraw money from the Consolidated Fund of India. The executive spends the money in accordance with the powers delegated to the operational levels. Finally, the expenditure is audited by the Statutory Audit to ensure that the public funds have been used as authorised and that rules and regulations have been observed.

Indian Budgetary System

KEY WORDS
Resaved Subjects : The Montague-Chelmsford Reforms introduced the division of subjects at the provincial level into reserved and transferred subjects. The resewed subjects included important departments which were in charge of councillors who along with the Governor were responsible to the Secretary of State and British Parliament. The transferred subjects were in charge of ministers who were responsible to the provincial legislature.
Rule of h p a e : This is a budgetary principle which implies that no part of the grant which is unspent by any departmentlministry in any year can be carried forward to the next year. Secretary of State :The Act of 1858 ended the rule of East India Company and Indian administration was brought directly under the British Crown. This Act created the Office of the Secretary of State who was a Cabinet minister in the British Cabinet entrusted with the responsibility of managing affairs in India on behalf of the Crown. Supplementary Crrrntr : If original estimates in budget are insufficient to carry on any activity, additional funds are sought by the government from the Parliament in the course of the financial year through supplementary grants. Vote-on-Account : Even though the financial year starts on 1st April, the budget takes some time to be passed. So, to meet the expenditure that will be incurred in the first few months of financial year till the budget is passed, the Parliament/legislature is required to pass vote on account which is an advance grant.

8.9

REFERENCES

Burkhead, Jesse, 1956. Government Budgeting, John Wiley & Sons : New York. Premchand A, 1983. Government Budgeting and Expenditure Control: 7'heory and Practice, IMF : Washington DC. Thavaraj, M.J.K., 1978. Financial Administration of India, Sultan Chand and Sons : Delhi.

ANSWERS TO CHECK YOUR PROGRESS EXERCISES

Check Your Progress I 1) Your answer should include the following points :

Remote control through Secretary of State.

Budgeting and Budgetary

Delegated financial authority to Governor General in Council. Centralised financial control in the Finance Department. Complex rules, regulations and procedures. 2) Your answer should include the following points : Principle of annuality.

Systems-l

r Rule of Lapse.
The government budgets are on cash basis. Principle of one budget for all financial transactions of the government. Budgeting should be gross and not net. Budgeting should be close. The form of estimates should correspond to the accounting heads. 3) Your answer should include the following points : Making a fairly accurate estimates of revenue and expenditure. Facilitate an efficient execution of projects. Budget calendar should be convenient to the legislators and administrators.

Check Your Progress 2 I ) Your answer should include the following points :
Revenue budget consists of the revenue receipts of government (tax and nontax revenues) and the expenditure met from these revenues. Revenue receipts include interest and dividend on investments made by government, fees and other receipts for services rendered by government. Revenue expenditure is for normal running of government departments and various services, interest charges on debts incurred etc. It does not result in creation of any assets. Capital budget consists of capital receipts and payments. Capital receipts include loan raised by government from public, borrowings, extirnal loans etc. Capital pay;nn:,ts comprise capital expenditure on acquisition of assets like land, building etc., loans and advances given by central government to states and union territories etc. 2) Your answer should include the following points : Preparation and submission of budget estimates by ministriesldepartment. Parliamentary approval. Execution of the budget by government audit. 3) Your answer should include the following points : Collection of revenues. Custody of the collected funds, and Distribution of funds.

UNIT 9 CLASSIFICATION OF GOVERNMENT EXPENDITURE

Structure
9.0 9.1 9.2 9.3 9.4

9.5 9.6 9.7 9.8 9.9 9.10

Objectives Introduction Classification of ~ o v k r n m e nExpenditure t Revenue and Capital Expenditure Developmental and Non-Developmental Expenditure Plan and Non-Plan Expenditure An Evaluation of the System of Classification of Expenditure Let Us Sum U p Key Words References Answers to Check Your Progress Exercises

9.0 OBJECTIVES
After reading this unit, you should be able to: explain the various classifications of government expenditure differentiate between revenue and capital expenditure distinguish between developmental and non-developmental expenditure differentiate between plan and non-plan expenditure; and evaluate the present system of classification of government expenditure.

9.1 INTRODUCTION
This unit deals with one of the important issues in Financial Administration i.e. the classification of government expenditure. The economy of a country is greatly influenced by the level of government o r public expenditure. It is one of the major processes by which the welfare of the people is ensured and it is a vital aspect of a government's budget. It is an important instrument in the hands of government that can be utiIised for the maximisation of public satisfaction. Again, it helps in overcoming the inefficiencies of the market system in the allocation of economic resources. It also helps in smoothing out cyclical fluctuations in the economy and ensures a high level of employment and price stability. Thus, government expenditure plays a crucial role in the economic growth of a country. Government expenditure covers all the expenditure incurred by government under the account heads of "Revenue", "Capital" and "loans". Revenue expenditure can be classified into two categories : Nondevelopmental expenditure and Developmental expenditure. Classification of government expenditure is closely related to the objectives of the government i.e. economic growth, financial control, price stability etc. For instance, the accounting classification of expenditure into 'Plan' and 'Non-plan', 'Capital' and 'Revenue' enables the Parliament to exercise financial control over expenditure and within the government, to exercise financial control over the spending departments. Similarly, the economic classification of government expenditure helps the government in determining how much of the economic resources are allocated by government to various economic activities and their contribution to the economic growth of the nation. Again, the cross classification of expenditure (i.e. Functional-cum-Economic classification) serves the social objectives of the government by determining the expenditure incurred on consumption and non-consumption. Thus, each classification of government expenditure serves one or other objectives of the government viz., financial control, economic growth, price stability etc.

Financial Administration

In this unit, we shall deal with the various classifications of government expenditure, points of distinction between capital and revenue, developmental and non. developmental, plan and non-plan expenditure.

9.2 CLASSIFICATION OF GOVERNMENT EXPENDITURE

Since the latter part of the 19th century and earlier part of the 20th century, most of the capitalistic and socialistic countries switched over to the concept of welfare state. During this period, most governments of independent countries concentrated their energy on economic development. T o achieve speedy economic development, governments had stepped up their expenditures.

Nature of Government Expenditure: Public expenditure is incurred in the form of purchases of goods and services, transfer payments and lending. Purchase of goods and services is intended to carry out governmental activities by the direct utilisation of economic resources for example, purchase of articles from the market right from paper clips to military aircraft. Transfer payments and lending are intended to provide enterprises and households with purchasing power to enable them to buy goods and services in the market. In many developed countries, transfer payments for social welfare constitute a sizeable portion of government budgets. In developing countries, some of the functions of transfer payments are performed by subsidies to consuiners in the form of below cost sales by state enterprises. Examples of such subsidies are supply of bread, foodgrains, cooking oils, sugar and tea to public below the normal cost. ' Classification of Expenditure: Government expenditure can be broadly classified into four categories: (i) Functional Classification or Budget Classification (ii) Economic Classification (iii) Cross Classification and (iv) Accounting Classification. As already mentioned, each classification of expenditure in government serves one objective or other i.e. financial control, economic growth, price stability etc. i) Functional or Budget Classification: In India, the classification of accounts was structured so as to correspond to the organisation in which the transaction occurred and within the organisation to the inputs on which expenditure was incurred. For example, construction of a hospital would be classified and displayed in accounts as "public works expenditure" and not as expenditure on a programme like "Medical Relief" under social services. The classification indicated the nature of expenditure but not its purpose. It did not enable identification of expenditure with functions, programmes, activities and projects. It lacked management approach in accounting in as much as it did not provide the facility for monitoring and analysis of expenditure on functions, programmes, activities and projects.
The Government of lndia introduced in April, 1974 a revised accounting structure, which attempts to serve the purposes of management as well as the requirement of financial control and accountability. Under this scheme, a five-tier classification has been adopted i.e. sectoral, major head, minor head. subhead, and detailed heads of account. Sectoral classification has grouped the functions of government into three sectors, namely, General Services, Social and Community services and Economic services. In the new scheme of accounts, a major head is assigned to each function and minor head is allotted to each programme. Under each minor head. there would be subheads assigned to activities/schemes/organisations covered by the programme Under the new system, the object classification has been retained and placed at the last tier. It is meant to provide item-wise control over expenditure and ensure financial control and accountability. Functional classification established adequate links between budget and account heads and the plan heads of development. This has facilitated obtaining information of progressive expenditure on plan programmes and projects. The principle adopted in the new accounting classification is that all expenditures on a function. programme or

.'

activity should be recorded under the appropriate major, minor or subhead. Functional classification has provided the necessary facility for monitoring and analysis of expenditure on functions, programmes and activities to aid the management function. (For further details, please refer to Unit 21 of Block 7 of this Course.)
ii) Economic Classification:Economic classification refers to the resources allocated by government to various economic activities. It involves arranging the public expenditures and receipts by significant economic categories, distinguishing current expenditure from capital outlays, spending for goods and services from transfers to individuals and institutions, tax receipts by kind from other receipts and from borrowing and inter-governmental loans, grants etc. This classification brings out such important aggregates as public expenditure of the consumption kind, public investment and the draft of public authorities on public savings for financing the development oulays in the public sector. In short, this classification analyses the total governmental f the economy. transactions and records government's influence on each sector o iii) Cross Classification or Economic-cum-Functional Classification: Cross classification provides the breakup of government expenditure not only-by economic categories but also by functional heads. For instance, expenditure on medical facilities (a functional head) is split between economic categories such as current expenditure, capital expenditure, and various types of transfers and loans. Conversely, cross classification shows how expenditure on a particular economic category, say capital formation, is divided according to different public activities like education, labour welfare, family planning etc.

Classilkationof Government Expenditure

Under a scheme of cross classification, functional classification of expenditure can be analysed according t o its economic character and economic classification of expenditure can be analysed according to the functions performed by it. The two types of classification therefore supplement each other and give a clear picture of the total transactions of government.
iv) Accounting Classification: Accounting classification of government expenditure can be analysed under (i) Revenue and Capital (ii) Developmental and NonDevelopmental and (iii) Plan and Non-Plan. Each classification of expenditure serves one objective or other of the government. For instance, Revenue and Capital expenditure classification indicates how much government expenditure results in creation of assets in the economy and how much expenditure is unproductive. Again, developmental and non-developmental classification indicates how much government expenditure is spent on social and community services and economic services as against general services. Similarly, the Plan and Non-Plan expenditure classification helps the Planning Commission and Finance Commission in determining the pattern of central assistance on plan schemes to state governments, and union territories. Thus, each classification of government expenditure serves one objective or other in government.

9.3 REVENUE AND CAPITAL EXPENDITURE

The difference between Revenue and Capital expenditure is the difference between expenditures that result in the creation of new assets and those which do not. Goods and services consumed within the accounting period may be included in the current is expenditure; alternatively, the allocation may be based whether an expend~ture "revenue producing or not". The main purpose of the capital account is to show the gross and net capital formation in the public sector during the accounting period (i.e. say from 1st April to 31st March). Under the Indian Constitution, budget has to distinguish expenditure on Revenue account from other expenditures. Government budget comprises Revenue Budget and Capital Budget. Revenue budget consists of revenue receipts of government (taxrevenues and other revenues) and the expenditure met from these revenues. Tax revenues comprise proceeds of taxes and other duties levied by the Union. Revenue expenditure is for the normal running of government departments and various services, interest charges on debt incurred by government etc. Broadly speaking, expenditure which does not result in creation of assets is treated as 'Revenue expenditure'. All --

. %

Financial Administration

grants given to state governments and other parties are also treated as revenue expenditure. Capital budget consists of capital receipts and payments. The main items of capital receipts are loans raised by government from public which are called market loans, borrowings from Reserve Bank of India and other parties through sale of Treasury Bills, loans received from foreign governments and loans granted by Central government to state and union territory governments and other parties. A Capital expenditure may be defined as any expenditure other than operating expenditure, the benefits of which extend over a period of time exceeding one year. The main characteristic of capital expenditure is that atleast a major portion of the expenditure is made at one point in time and the benefits are realised at different points in time in the ensuing years. In other words, Capital expenditure is the expenditure which is intended for creating concrete assets of a material character in the economy. Examples of Capital expenditure are the aquisition of assets like land, buildings machinery, equipment and also investment in shares and loans and advances granted by Central government to state and union territory governments, government companies etc. With the advent of planning in India in 1951, Capital expenditure incurred on plan account has assumed an enormous significance. It has also its economic effects depending on whether the projects financed by capital expenditure are quick yielding or long yielding in economic benefits. Also, it has its impact on the revenue budgets of the Centre. In brief, the difference between revenue and capital expenditure is the difference between expenditures which result in creation of new assets and those which do not. Revenue expenditure is for the normal running of government departments and various services, interest charges etc. On the other hand, capital expenditure or at least some portion of it results in creation of assets in the economy.
check Your Progress 1

Note: i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit.

1) Explain the meaning of Government expenditure. Distinguish between 'revenue' and 'capital' expenditure.

2) Explain the significance of Economic and Cross Classification of government

expenditure.

DEVELOPMENTAL AND NON-DEVELOPMENTAL EXPENDITURE

Government expenditure can be classified into e eve lop mental" and "NonDevelopmental" expenditure. Developmental expenditure comprises expenditure
z-nm.--c.A

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c.Am.n-+:--

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kc.-lth o n A f 0 m i 1 . 1 n l o n n i n m l ~ h n n - v QnA

employment, agriculture, cooperation, irrigation, transport and communication and other miscellaneous services. Expenditure incurred on these items both on Revenue and Capital accounts is also treated as development expenditure. Non-Developmental expenditure, on the other hand, comprises expenditure incurred on items like defence, collection of taxes and duties, administrative services, interest on debt and other services, stationery and printing and other expenditure on general services. Developmental expenditure is an accounting concept that has grown in conjunction with economic plans. It constitutes the main target of the plan. It enables planners to specify a measurable level of achievement that the economy may attain within the planning period. By providing a target for developmental expenditure in the plans, the economic aspirations of citizens are focused. Certain classes of public expenditure are treated as developmental by fiat and they are treated as component of plan expenditure or government contribution to economic growth. Developmental expenditure is said to be directly related to the promotion of backward economy; non-developmental expenditure does not help development. But in reality, capital expenditure on administration, rehabilitation, relief does help directly or indirectly the economic development of the country. Hence, it is difficult to follow a rigid distinction between developmental and non-developmental expenditure, though it is customary to make such a distinction for broad analytical purposes. 1tiswell-known that no developmental expenditure is "developmental" indefinitely or advantageous to the economy, irrespective of the amounts being spent by government departments. T o the best of government's knowledge, each item of expenditure (i.e. Developmental and Non-Developmental) must contribute equally on the margin to economic welfare. ,Too much emphasis on "Developmental" and "Plan expenditure" will ultimately lead to a reduction in "Non-Developmental" expenditure and thereby indirectly affects the growth of the economy. In brief, Developmental expenditure leads to economic growth whereas Non-Developmental expenditure does not. Developmental expenditure comprises the expenditure incurred on social and community services and economic services. Non-Developmental expenditure comprises the expenditure incurred on general services. The distinction between "Developmental" and "Non-Developmental" expenditure beyond a certain point, gives a distorted picture of the whole government expenditure, as Non-Developmental expenditure also contributes to economic growth indirectly and as such it is not totally unproductive. For example expenditure on defence, though it is non-developmental, is very much required for establishing defence preparedness of the country which cannot be weakened.

Clssslfica~ion of Government Expenditure

9.5 PLAN AND NON-PLAN EXPENDITURE

Government expenditure can also be classified into "Plan" and "Non-Plan" expenditure. Plan expenditure refers to the expenditure incurred by the Central Government on Programmes/Projects, which are recommended by the Planning Commission. Non-Plan expenditure, on the contrary, is a generic term used to cover all expenditure of government, not included in the plan. Non-Plan expenditure consists of many items of expenditure, which are obligatory in ndture and also essential obligations of a state. Items of expenditure, such as interest payments, pensionary charges, statutory transfer to states come under the obligatory nature. Defence, internal security are essential obligations of a state. Any neglect of these activities can lead to collapse of government. Besides, there are special responsibilities of the Central Government like external affairs, currency and mint, cooperation with other countries and the expenditure incurred in this connection are treated as "non-plan" expenditure. Of all the major items of Non-plan expenditure of the Central Government, interest payments, defence, subsidies take the lion's share of expenditure. The distinction between 'plan expenditure' and non-plan expenditure' is purely an administrative classification and is in no way related to economic or national accounting principles. For instance, in many cases 'plan expenditure' becomes non-plan expenditure, after the plan is over. Again, an item of plan expenditure during a

Financial Administration

particular five year plan becomes "non-plan" in the following plan, if its responsibility is shifted on to the state governments, as in the case of centrally sponsored and central sector schemes or if the expenditure spills over from one plan to the next or the expenditure is agreed to be incurred outside the plan outlay of the state governments approved by the Planning Commission. The classification of expenditure between "Plan" and "Non-Plan", "Developmental" and "Non-Developmental" of certain schemes/projects in government gives a distorted view of government's classification of expenditure. After all, the test of public expenditure is the amount of satisfaction it gives to the public by the quantity or quality of services it makes possible. But classification like 'Developmental' and 'NonDevelopmental' expenditure may ignore the point, unless a sense of proportion is maintained. For instance, maintenance expenditure of a building is likely to suffer, whereas a plan scheme, even if it is not important, acquires a priority and urgency, out of its proportion, because it is a 'plan' item of expenditure. Again, it is possible to create posts under plan schemes, even if a ban exists on creation of posts. Thus, the classification of expenditure into 'Plan' and 'Non-Plan', sometimes, endows certain schemes with more than necessary legitimacy and thereby acts to distort one's view of public expenditure.

9.6 AN EVALUATION OF THE SYSTEM OF CLASSIFICATION OF EXPENDITURE

The classification of government expenditure is done mainly to achieve the objectives of government i.e. financial control, estimation of revenues and expenditures of government, allocation of funds to the various sectors of the economy, economic growth etc. In order to achieve these objectives, public expenditure has been classified into four categories, viz., Functional classification, Accounting classification, Economic classification, and Cross classification. Accounting classification classifies government expenditure into "Revenue" and "Capital", 'Developmental" and "NonDevelopmental", "Plan" and "Non-Plan" expenditure. Developmental expenditure is said to be directly related to the promotion of the backward economy, whereas non-developmental expenditure does not. However, in actual practice, non-developmental expenditure in the form of the capital outlay on rehabilitation, administration and relief does contribute directly or icdirectly to the economic development of the country. The classification of government expenditure into "Plan" and "Non-Plan" is purely an administrative classification and is not related to economic or national accounting principles. Also, the "Plan" and "Non-Plan" do not correspond exactly to "Developmental" and "Non-developmental" categories respectively because we find both these types of expenditure under "Plan" and "Non-plan" heads. For example, the expenditure related to new projects/programmes becomes 'Plan' expenditure during the period of a five year plan. If the projects/programmes are completed within the five year plan period, then their maintenance will be brought under 'non-plan' expenditure, during the next plan period. Again, the 'plan' expenditure, during a particular five year plan, becomes 'non-plan' in the following plan, if the responsibility is shifted on to the state governments, as in the case of centrally sponsored and central sector schemes. Thus,4y classifying expenditure into "Plan" and "Non-Plan", undue influence is given to 'plan' expenditure at the expense of non-plan in government, even though non-plan expenditure also includes capital expenditure and contributes to the economic development of the country. However, this classification is found useful by the Planning .Commission and Finance Commission for determining the central assistance tostates for plan schemes from time to time. The classification of expenditure into "Developmental" and "Non-Developmental" is also not based on any rational principle. Developmental expenditure is said to be directly related to the economic growth of the country, whereas non-developmental expenditure does not. In practice, non-developmental expenditure, in the form of capital outlay on rehabilitation, administration and relief, does help directly o r indirectly in the economic development of the country. Hence, it is difficult to follow a rigid distinction between "Developmental" and "Non-Developmental" expenditure.
Riit

i t i c r i i c t n m a r v tn m a k c = c n n ~ h a rlictinrt;nn

fnr

hrnarl analvtiral nllrnncpc

The classification of government expenditure into "Plan" and "Non-Plan", "Developmental" and "Non-Developmental" gives a distorted picture of the whole classification pattern of government expenditure, because Developmental and NonDevelopmental heads are also part of "Non-Plan" expenditure. After all, the test of public expenditure is the amount of satisfaction it gives to the public by the quantity or quality of the services it makes possible. But classifications like the "Developmental" and "Non-Developmental" may ignore this point, unless a sense of proportion is maintained. However, all the three classifications, viz., Accounting, Economic and Cross classification of government expenditure are essential to determine the allocation of expenditure to various sectors, capital formation, employment opportunities, price stability, economic growth and also for ensuring financial control by Parliament and by government within the departments.
'

I d Governmen1 ~
Expenditure

Check Your Progress 2 Note: i) Use the space given below for the answers. ii) Check your answers with thosegiven at the end of the unit.

1) What are the basic differences between 'Plan' and 'Non-plan' expenditure?

2) Distinguish between 'Developmental and Non-developmental' expenditure

3) Comment on the usefulness of distinction between 'plan' and 'non-plan' and 'developmental' and 'non-developmental' expenditure in government.

9.7

LET US SUM UP

We have seen that the classification of government expenditure serves a number of purposes i.e. parliamentary control over expenditure, economic development, price stability etc. Today, government expenditure has become a part of the life of the citizens. In this unit an attempt has been made to explain the differences between "Plan" and "Non-plan", "Revenue" and "Capital" as well as "Developmental7' and "NonDevelopmental" expenditure. Also. the meaning and usefulness of Economic and Cross classification of government expenditure, has been discussed.

9.8 KEY WORDS

Revenue Budget: It consists of the revenue receipts of government and the expenditure met from these revenues.

Financlal Administration

Revenue Expenditure: It is for the normal running of government departments. Capital Budget: It consists of capital receipts and payments. Capital Receipts: These are loans raised by government from public, which are called market loans, borrowings from the Reserve Bank of India etc. Capital Expenditure: Expenditure incurred on acquisition of assets like land, buildings, machinery, equipment etc. Plan Expenditure: Plan expenditure forms a sizeable proportion of the total expenditure of the Central government. It refers to the expenditure incurred by the Central Government on programmes/projects on the recommendations of the Planning Commission.

9.9. REFERENCES
Chelliah R.J. 1969. Fiscal Policy in Underdeveloped Countries with Special Reference to India, 2nd Edn, George Allen & Unwin: London. Peacock A.T. and J. Wiseman, 1967. The Growth of Public Expenditure in the United Kingdom, George Allen and Unwin Ltd. : London. Reddy K.N., J.V.H. Sarma, and N. Sinha, 1984. Central Government Expenditure, Growth, Structureand Impact, 1950-51to 1977-78, National Institute of PublicFinance and Policy: New Delhi. Singh M.P., 1988. Economics of Government Expenditure and Growth, Reliance Publishing House: New Delhi. Sury M.M., 1990. Government Budgeting in India, Commonwealth Publishers: New Delhi.

EXERCISES
Check Your Progress 1

1) Your answer should include the following points: Government expenditure covers all the expenditure incurred by government under the accounting heads of "Revenue", "Capital" and "Loans". Revenue expenditure is the expenditure incurred for running the government departments, payment to various services and interest charges etc. Revenue expenditure does not result in creation of any assets. ~evenue receipts comprise taxes and other duties levied by the Union. Capital Receipts are loans raised by government from public, which are called market loans, borrowings from R.B.I. etc. Capital expenditure is the expenditure intended for creating concrete assets of a material character in the economy. 2) Your answer should include the following points: Economic classification refers to the resources allotted by government to various economic activities. It divides government expenditure into meaningful economic aggregates like public consumption, investment, generation of income, etc. It enables policy makers to step up expenditures in those sectors, which contribute to the economic development of the country. Cross classification or Economic-cum-Functional classification helps in analysing expenditure, according to its economic character as well as functions. It is found useful in drawing up a programme of projected expenditure covering a period of years and in evaluating the progress of actual expenditure against budget provisions.
Check Your Progress 2
11 Y n i ~ r nnpwer shn~ild inrliide the fnllnwin~ nnints:

Plan expenditure refers to the expenditure incurred by the Central government on programmedprojects, on the recommendations of the Planning Commission. Non-plan expenditure is a generic term used to cover all the expenditure of government, not included in the plan. Examples are expenditure on defence, interest payments, subsidies etc.

C'BbSincatiOn OrGOVernment

Expenditure

2) Your answer should include the following points: Developmental expenditure is an accounting concept that has grown in conjunction with economic plans. It constitutes the main target of the plan. Developmental expenditure covers the expenditure incurred on social and community services and economic services. Non-developmental expenditure is an unproductive expenditure, even though some portion of it contributes indirectly to economic growth.
3) Your answer should include the following points: Classification of expenditure into "Plan" and "Non-Plan" is purely administrative and has nothing to d o with economic o r national accounting principles. Similarly, the classification of expenditure into "Developmental" and "Non-developmental'', beyond a certain point, distorts the whole classification of government expenditure, as Non-developmental expenditure also includes Plan and Non-plan expenditure. Notwithstanding these limitations, these classifications of government expenditure are essential for achieving the objectives of government.

UNIT 10 PUBLIC EXPENDITURE: THEORIES AND GROWTH

Structure
Objectives Introduction Determinants of Public Expenditure Impact of Public Expenditure Growth of Public Expenditure in India Let Us Sum U p Key Words References Answers to Check Your Progress Exercises

10.0 OBJECTIVES
After studying this unit you should be able to: evaluate the various theories and approaches by different schools of thought regarding the determination of public expenditure; explain how public expenditure policies and measures affect different aspects of the economy; trace the growth of public expenditure in India and analyse it with the help of theories discussed; and highlight the recent trends in public expenditure policies in India.

1 0 1 INTRODUCTION
Consistent with the earlier concept of state as a police state, minimum expenditure by it was considered to be the best level of expenditure. The analysis of public expenditure was not, therefore, recognised as a worthwhile field of economic research. Public finance concentrated on the study of public revenue and issues relating to taxation rather than the expenditure therefrom. In the post Second World War period, there has been a phenomenal increase in the level of government or public expenditure both in absolute terms and also in relation to the national income. There has, therefore, been a great amount of scholarly interest in understanding the causes of public expenditure, and its incidence, that is, who benefits from the various components of public expenditure. The major area of concern has been to channelise public expenditure into those areas of the economy where its effects will be optional in terms of growth, consumption and distribution. More recently, however, serious concern has been voiced regarding the effective utilisation of government funds and the paramount need. to avoid wasteful expenditure. A correct perspective on Central Government expenditure, reasons for its massive growth, pattern and direction of its increase, effects on the economy, recent trends and the need to control it, are issues which are central to the understanding of financial administration. These are precisely the issues which will be examined in this unit.

10.2 DETERMINANTS OF PUBLIC EXPENDITURE

Various theories have been formulated during the last three decades to explain different aspects of public expenditure. As said in Section 10.1 the analysis of trends in public expenditure and its determinants caught the attention of researchers for the past few years. In spite of all these attempts, no comprehensive theory of expenditure has been developed. 'Let us now discuss some of the important theories which seek to explain the factors that determine increasing public expenditure.

Marginal Utility Approach This is one of the important theories developed in the 1920s which suggested an economic approach to determine the composition of expenditure and budgeting. According to this theory, the government spends its limited income on alternative services in such a way that the marginal benefit is the same on all items. Just as an individual, in order to satisfy hisher wants, spends in a manner to achieve a certain balance among different types of expenditure which would ensure, some marginal return of satisfaction from all of these. According to Pigou, "Expenditure should be so distributed between battleships and poor relief in such wise that the last shilling devoted to each of them yields the same real return." The same principle has been restated by Dalton thus "Public expenditure should be carried just so far that the marginal social advantages of expenditure in all directions are equal and just balance thc marginal social disadvantages of all methods of raising additional public income". Though the principle of maximum social advantage is quite attractive in theory, there are practical problems in making it operational. Firstly, it is not easy to quantitatively measure the benefits flowing from diverse.items of public expenditure for instance, expenditure incurred on defence and social security. Secondly, this theory cannot be subjected to a test. Evaluation of activities of the government is difficult due to the vast a'rray of services and goals of the government and absence of an acceptable measure. Thirdly, it is not only the level of present satisfactions of the 'Community' that a government will be concerned with. The future interests of the community are also important. Fourthly, what the community can afford also depends on how the money is raised and how it is spent. Expenditure on unnecessary wars or departments of the government may result in social disadvantages. Expenditure on sustaining loss-making public enterprises with a social service content may, on the other hand, be easily justified. This principle is thus, at best, applicable to the use or distribution of a fixed sum rather than as a standard for determining the total size of public expenditure. Public Goods Approach Public goods are those for which no private mechanism exists for providing themand which are consumed in equal amounts by all. People who have not paid for them cannot be excluded from their enjoyment, e.g. public parks or security. Public goods usually correspond to all goods and services provided by government and include a wide variety of goods and services. The demand for such public goods becomes an important element in the determination of public expenditure. Public Choice The recognition of the importance of the political processes in revealing public preferences has, in due course, contributed to the growth of "public choice" theories. Anthony Downs offered useful analysis of these political processes. Downs' theory, which was based primarily on the US systems, provided a general framework for explanation of public expenditure. In democratic societies, it is held, governments determine revenues and expenditure to maximise their chances for winning the election. The budgeted expenditure is determined not with reference to overall spending and taxation but through a series of separate policy decisions based on estimates of gains and losses of votes. According to Downs, government will provide what voters want and not necessarily what is beneficial. Thus the central reality for governments is the citizen's vote and not his welfare. In order to fulfil voters' demands, promises made at election time, their aspirations for projects or services, the expenditure has to expand making for larger government, larger bureaucracies, bigger budgets and more problems in trying to find resources for financing the budgeted expenditure.
-Ic Positive Approaches The positive approaches are concerned with the actual growth of public expf over a period of time and deal with the formulation and verification @F'~~* hypothesis. These include: Q , -49 .no

Public Expenditure:

Theories and Growth

Financial Administration

Wagner's Law The earliest theory advanced is that of Adolph Wagner in 1876 which came to be known as "Wagner's law". He propounded the "Law of increasing expansion of public and particularly state activities" which is referred to as the "law of increasing expansion of fiscal requirements". The law suggests that the share of the publicsector in the economy will rise as economic growth proceeds, owing to the intensification of existing activities and extension of new activities. According t o Wagner, social progress has led to increasing state activity with resultant increase in public expenditure. He predicted an increase in the ratio of government expenditure to national income as per capita income rises. It is the result of growing administrative and protective actionsof government in response to more complex legal and economic relations, increased urbanisation, and rising cultural and welfare expenditures. Another reason is the decentralisation of administration and the increase in the expenditure of local bodies. According to Musgrave, however, it is not fruitful to seek an explanation for the total expenditure. Tests carried out by various researchers have shown that the increase in expenditures is far more complex than is evident from the tests carried out on empirical data. Therefore, according to Musgrave, it may be far more rewarding to adopt a desegregated approach (an approach which divides the study of expenditures of government) through a study of expenditures of government on capital formation, consumption and transfer payments. Displacement Effect Hypothesis of Peacock and Wiseman Peacock and Wiseman based on a study entitled "The Growth of Public Expenditure in the UK, 1961", provided an explanation to fluctuations in public expenditure over time. The hypothesis put forward is that public expenditure grows due to growth in revenue. During settled times, people call be expected to develop notions of acceptable rates of taxation. This can be known as the tolerable level of taxation and this level cannot be high. With real economic growth, the more or less stable level of taxation will produce increasing amounts of revenues as well as expenditure. This, however, does not explain the relative increasing growth in public expenditure. Large scale social disturbances, like wars, influx of refugees change the tolerance limit of people to the burden of taxation which arises as a result of increased spending. The result is called a "displacement effect" which shifts expenditures and revenues to new higher levels. So a displacement effect is created when the earlier lower tax and expenditure levels are displaced by new and higher budgetary levels. Even after the event is over, new levels of tax tolerance change and the society feels capable'of carrying a heavier tax burden. The level of public expenditure does not return to the low level it was before the event. According to Buchanan "the single best explanation for tremendous growth in the jublic sector of the economy and also for the increased concentration of expenditure in . :federal government is provided by the predominant importance of expenditures, :ct or indirect made necessary by wars and threats of war". While war and military atures are the most important factors responsible for an increase in public jditure, other "social upheavals" and natural calamities like droughts, famine and cause a substantial upward shift in public expenditure. These events create new xgency demands on government -new social welfare schemes, war pensions, affordable previously all leading to maintaining the level of expenditure fter social upheavals.

rstr lent u. e in favc )rough a t

sually has the important policy objective of securing better distribution of the less fortunate citizens. A reduction in inequalities of income *tthrough a progressive tax structure, public distribution system, programme, large scale transfer payments e.g., pensions, ooverty alleviation programmes aimed at reducing rural and *rammes involve large scale outlays atleast till such time as a ' q assured to all. outlined above do throw light on the determinants wssible to lay down a law which will explain the

behaviour of public expenditure in different environments. The factors that have so far influenced public expenditure are environmental, technological, economic, administrative and political in nature.
Check Your Progress 1 Note: i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit.

Public Expenditure: Theories and Growth

1) What are the practical problems involved in the marginal utility approach?

..........................................................................................................
2) Explain public choice theory as a determinant of public expenditure.

..........................................................................................................
3) Discuss Peacock-Wiseman hypothesis on public expenditure.

10.3 IMPACT OF PUBLIC EXPENDITURE

'

Public expenditure diverts economic resources into channels determined by the government in accordance with national objecti4es and public policy. As a . consequence, the scale and direction of public expenditure may affect the pattern and levels of consumption of the community volume of production allocation of resources distribution of incomes levels of prices and employment. These effects are discussed below:
Consumption

Public expenditure enhances the quality of life of people by providing recreational, cultural, educational and public health facilities, such as public parks, playgrounds, libraries, educational institutions, hospitals and dispensaries and scientific, cultural and commercial exhibitions. Consumption, after all, is the end objective of economic activity of individuals. By promoting the level of economic activity and a more equitable distribution of income, the state can bring about a greater sense of social and economic security in the lives of individuals. The government enables them to live a fuller and richer life.
Allocation of Resources

Public expenditure allocates resources in accordance with national priorities. The priorities may be defence, agricultural production and self-sufficiency in food, industrial development, generation of employment opportunities, an equitable distribution of income, balanced regional development, population control, a better ecological

Financial Administration

balance etc. Public expenditure in these areas is bound to raise the community's productive power. According to Dalton "increased public expenditure in many of these directions is desirable in order to bring about that distribution of the community's resources between different uses, which will give the best results, balancing without bias the present and future". Changes in national priorities, from time to time, will be reflected in the pattern of public expenditure. Again, resource allocation has to take into account the balance between present needs and future requirements. Apart from imparting a sense of fairness as between generations, projects with long gestation periods can be undertaken only by the state. Hence allocation has to keep in view the fact that market economy cannot always take care of social needs. These can be taken care of only by the state.
Production The roles of private and the public sectors are complementary. The public sector provides the infrastructure, transport and communications, power, education and public health programmes. In the absence of goods and services provided by the government sector, private sector can hardly make any meaningful contribution towards production and development: According to Dalton, other things being equal, taxation should not adversely affect production and public expenditure should increase it as much as possible. Public expenditure can affect (i) the ability to work, save and invest, (ii) the desire to work, save and invest, and (iii) allocation of resources as between different uses. Public expenditure can influence these factors either favourably o r unfavourably.

The economies of ,developing countries cannot make significant progress unless they concentrate on development of investment goods sector. This may not result in production in the immediate future, as in education and health programmes, infrastructural projects and projects with long gestation periods. This would, however, certainly build up growth potential in the economy, and help take the economy to a self-generating level.
Distribution In Dalton's words, "other things being equal, that system of public expenditure is best, which has the strongest tendency to reduce the inequality of incomes." A system of grants and subsidies is equitable in the measure in which it is progressive. This leads to maximum social benefit. An approximation to this principle would be provided by a system of grants which would bring all incomes below a certain level to that level (say, above the poverty line), without adding anything to incomes above that level. A public distribution system which makes available essential commodities at subsidised prices to the poor, will also achieve the same result. Free provision of services to all members of the society e.g., free health service o r free education, "narrows the area of inequality". Social security measures and social insurance schemes, which are helped partly or wholly from public funds, e.g. oldage pensions, sickness and maternity benefits, unemployment relief, industrial injury compensation, widows pension etc., improve distribution by reducing inequality of incomes. Economic S tabilisation Business activity in an economy is usually characterised by fluctuations of a cyclical nature. A boom in the economy may burst and lead to a depression. While during boom, prices rise beyond the reach of common person, spelling misery. During depression, employment and production levels fall drastically causing colossal damage. During depression, when employment, production and national income start declining, government can undertake compensatory spending. This may imply heavy public works programmes so that employment and incomes may pick up leading to economic recovery. During boom, public expenditure should be strictly curtailed, leading to surplus budgets. During depression, public expenditurepolicy would lead to heavy outlays on public works; expenditure would thus be in excess of revenues, leading to deficit budgets. Thus public expenditure, if properly planned and conscientiously undertaken, will have the favourable effect of raising employment, production and national income, after pulling the economy ont of depression and thus bringing about ereater economic stabilitv.

10.4 GROWTH OF PUBLIC EXPENDITURE IN INDIA

The total expenditure of the Central government has grown from Rs. 529 crore in 1950-51to Rs. 1,19,087crore in 1992-93 (budget estimates) (225 times). Of this revenue expenditure grew even faster. It went up from 347 crore in 1950-51to Rs. 89,570 crore in 1992-93(B.E.) (258 times). But capital expenditure grew at a slower rate. It increased from Rs. 183crore in 1950-51to Rs. 29,517 crore (161 times). It is, however, clear that the total expenditure of the Central government has grown at a much faster rate than the growth rate in national income which went up from Rs. 8,938 crore in 1950-51to Rs. 4,25,672 crore (estimated) in 1991-92 (48 times). One can say, that the total expenditure has been increasing at a rate about 5 times higher than the growth rate of national income (Gross National'Product).
Table 10.1: Growth in Central Government Expenditure

Public Expenditure: Theories and Growth

(Rs. crores) 1950-51 1992-93 Growth over (B.E.) 1950-51 1,19,087 89,570 29,517 4,25,672 Over225 times Over 258 times Over 161 times ,About 48 times

Total Expenditure Revenue Expenditure Capital Expenditure National Income (1991-92) estimated

529 347 183 8,398

Source: Annual Budgets and Economic Survey 1991-92. Another way of looking at this absolute and relative increase would be to relate the expenditure to GNP, as shown in the table below.
Table 10.2: Growth of Central Government Expenditure

(Rs. crores) Year GNP at current prices Expenditure of the Central Government (Capital+Revenue) (3) Col. (3) as per cent of (2)

(1)

(2)

(4)

The trends of the Central government expenditure seem to support two of the most widely discussed approaches to the behaviour of public expenditure. First, there has been an increase in public expenditure that conforms to Wagner's law of increasing state activity. This is obviously the result of the planned economic development undertaken in India since 1950-51. Second, there have been several discontinuities in the trend, suggesting the pressure of Peacocli-Wiseman "displacement effect". As already stated, this effect hypothesizes that government spending rises by discrete stages in response to the periodic occurrence of "social upheavals". Some of the discontinuities in Indian government spending, however, can be attributed to events that may not qualify as "social upheavals". It has been shown that the "displacement effect" was a factor responsible for increase in spending during and after the IndoChinese hostilities of 1962. Other factors are: rehabilitation of displaced persons from Pakistan, oil price hike in 1973 and the inflation that followed, and Indo-Pak war in 1971. Another salient feature of the growth of government expenditure is the increase in the relative share of revenue expenditure in the total expenditure. This share was 65.5 per cent in 1950-51. When planning got underway and gathered momentum in the first two

Financial Adminidration

',.

decades, revenue expenditure always stood at less than 50 per cent of the total outlay of the Central government. The balance, over 50 per cent, was accounted for by capital expenditure. Since the seventies, however, the rate of growth of revenue expenditure has far exceeded that of capital expenditure. In the eighties, revenue expenditure has increased at twice the rate of increase in capital expenditure. Recent Trends: During the two years (1991-92 & 1992-93) (BE) the pace and direction of expenditure have changed radically. The revenue expenditure in 1991-92 increased by 13.8 per cent over that in 1990-91 whereas capital expenditure actually declined by seven per cent. In 1992-93(BE), while the revenue expenditure increased by only seven per cent (down from 13.8 per cent increase in 1991-921, there was a standstill in respect of the capital expenditure. There are two reasons responsible for the downward trend in the rate of increase in government expenditure. Firstly, the fiscal crisis faced by the country beginning with the year 1990-91, deepened in 1991-92. The government initiated corrective measures to restore fiscal discipline in the economy. Some of the key elements in this structural adjustment were containment of non-plan expenditure including defence expenditure and subsidies. Secondly, the economic philosophy of the government has undergone a revolutionary change. The investment programme of the government is no longer aimed at increasing investment in public sector enterprises. With the iiberalisation of the economy -changes in industrial and trade policy, financial sector reforms etc., are all aimed at less government intervention rather than more. Hence, the relative decline in government expenditure. This is every reason to believe that this trend will continue in the foreseable future. Check Your Progress 2 Note: i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit. 1) Examine the impact of public expenditure on distribution.

2) Analyse the increase in Central government expenditure in the light of Wagner's Law & Peacock-Wiseman Hypothesis.

3) Indicate broadly how the various components of the Central government expenditure have been registering an increase since 1950-51.

10.5 LET US SUM UP

The study of public expenditure has become worthwhile because the role of state has been expanding. There has been a phenomenal increase in public expenditure consistent with the welfare functions assumed by governments. As we have discussed in the unit, various theories and approaches have sought to explain the factors determining the growth in public expenditure. Among them, Wagner's Law of increasing state activities and the Peacock-Wiseman Hypothesis are more important. The factors are mainly environmental, technological, economic, administrative and
--1:+:-,.1

:+ .-...

. .

Public expenditure diverts economic resources into channels determined by the government in accordance with national objectives and priorities and public policy. A s a consequence, the scale and direction of public expenditure may affect the pattern and levels of consumption of the community, volume of production, allocation of resources, distribution of incomes, levels of prices and employment. There has been a phenomenal growth in public expenditure both in absolute terms and also in relation to growth in national income. This growth is a consequence of the state taking over the function of economic development. Other factors influencing rise in public expenditure have been wars, rehabilitation of displaced persons, oil price hike, and natural calamities. The government is now making a conscious and vigorous effort to reduce the magnitude of public expenditure.

Public Expenditure: Theories and Growth

10.6 KEY WORDS

Economic Stabilisation: Smoothing out business fluctuations of cyclical nature..These fluctuations are boom conditions and depression which affect prices, production and employment. Maximum Social Advantage: Net social advantage of an additional unit of expenditure on all items should be equal to the net social cost of raising additional revenue. Public Goods: Public goods are those for which no private mechanism exists for providing them and which are consumed in equal amounts by all. Individuals cannot be excluded from consuming them even if they d o not pay for them. Also, consumption by one individual does not preclude others from enjoying it.

Gowda Venkatagiri K , 1987. Fiscal Revolution in India, Indus: New Delhi. Jain, P.C., 1989, Economics of Public Finance, Vol. I , Atlantic: New Delhi. Prem Chand, A . 1983. Government Budgeting and Expenditure Controls: Theory and Practice, IMF: Washington.

10.8 ANSWERS TO CHECK YOUR PROGRESS EXERCISES

Check Your Progress 1 1) Your answer should include the following points: Quantitative measurement of benefits flowing from diverse items of public expenditure becomes difficult. The level of present satisfactionsof the community are mainly kept in view by the government whereas the future interests of the community are equally important. The principle is applicable to the use or distribution of a fixed sum rather than for determining the total size of public expenditure. 2) Your answer should include the following points: Public choice theory as propounded by Anthony Downs based primarily on the system of USA, provided a general framework for explanation of public expenditure. According to this theory, public expenditure is determined by the governments desire to maximise their chances for winning the election. 9 Bzdgeted expenditure is determined not with reference to overall spending and taxation but through a series of separate policy decisions based on gains and losses of votes. Citizen's vote is the determining factor in public expenditure. The expansion in expenditure is to fulfil voter's demands - promises made at election time.

Financlai Administration

3) Your answer should include the following points: The increase in public expenditure is due to growth in revenue. During settled times, ;,eople can be expected to develop notions of acceptable rates of taxation which is known as the tolerable level of taxation. Large scale social disturbances, like wars change the tolerance limit of people to bear the burden of taxation to meet the expenditure. This is called a "displacement effect". This effect shifts revenues and expenditures to new higher levels, which continues after the completion of the event. The new levels of tolerance which emerge make the society feel capable of carrying a heavier tax burden.

Check Your Progress 2 1) Your answer should include the following points: Introduction of a system of grants and subsidies which lead to maximum social benefit. Public distribution system which makes available essential commodities at subsidised prices to the poor. Social security measures and social insurance schemes like oldage pensions, unemployment relief etc. to improve distribution by reducing inequality of incomes.
2) Your answer should include the following points: The increase in expenditure of the Central government due to planned economic development undertaken since 1950-51,conforms to Wagner's law of increasing state activity. Events which may not be called 'Social upheavals' like Indo-China war of 1962, rehabilitation of displaced persons from Pakistan, oil price hike in 1973, etc. resulted in "displacement effect" leading to increased spending by the government. This effect hypothesizes that government spending rises by discrete stages in response to periodic occurrence of social upheavals. 3) Your answer should include the following points: Total expenditure of the Central government from 1950-51till 1992-93 (B.E:) has increased about 225 times. Revenue expenditure has gone up 258 times during the same period. Similarly, capital expenditure has risen 161 times. National income, during the same period went up only about 48 times.

UNIT 11 PERFORMANCE BUDGETING

Structure
Objectives Introduction Performance Budgeting : Concept and Objectives Steps in Performance Budgeting Performance Budgeting System in India Performance Budgeting System -A Critical Evaluation Let Us Sum U p Key Words References Answers to Check Your Progress Exercises

11.0 OBJECTIVES
After studying this unit, you should be able to: explain the concept and objectives of performance budgeting describe the steps in performance budgeting discuss the performance budgeting system in India; and evaluate the performance budgeting system.

11.1 INTRODUCTION
In a planned economy, it is logical to think in terms of budgeting both as the nearest link in a well-integrated system of planning, programming and budgeting and as a tool of management. It provides a system of information for decision-making, coordination, evaluation and control to the appropriate levels of the organisation. During recent years, there has been a significant increase in public expenditure. Government's. involvement in the stabilisation of the economy, equitable distribution of wealth, stimulating forces leading to economic growth and increase in the price levels are some of the factors that have contributed to the increasing public expenditures. The increasing public expenditures which brought with them a good deal of complexity, led to two significant questions: i) how to control and regulate the increasing public expenditures; and ii) how to introduce efficiency into the public expenditures. In this unit an attempt has been made to explain the concept of performance budgeting and its genesis in Indian administration. A critical review of the system has also been done in the unit.

11.2 PERFORMANCE BUDGETING :CONCEPT AND

As we have discussed in Unit 2 of Block 1 of this course, the financial system of our country during the British period was characterised by high degree of centralisation, adh2rence to rigid financial rules and procedures, integration of accounts and audit etc. After independence, attempts have been made to make the financial administration performance-oriented, with a view to bringing about efficiency and economy in the implementation of plans, programmes and activities. Efforts were made to make the budget an efficient tool of plan implementation. The result has been the introduction o f the performance budgeting system in the government. We shall discuss in detail itbout the evolution of performance budgeting system in India in Section 11.4 of this unit.

Financial Administration

Performance budgeting is generally understood as a system of presentation of public expenditure terms of functions, programmes, performance units, viz. activities1 projects, etc., reflecting primarily, the governmental output and its cost. It is essentially a process which brings out the total governmental operations through a classification by functions, programmes and activities. Through suitable narrative statements and workload data that form an integral part of the presentation, it indicates the work done, proposed to be done and the cost of carrying these out. The main thrust of performance budgeting has been on providing output-oriented budget information within a long range perspective so that resources could be allocated more efficiently and effectively. Its emphasis is on accomplishment rather than on the means of accomplishment. The purpose of government expenditure is more important than the object of expenditure under performance budgeting. Thus performance budgeting is a programme of action for any given year with specific indicators regarding tasks, the means of achieving them and the cost of achieving them. It tries to define the physical and financial aspects of each programme and activity and thereby establish the relationship between output and inputs. Performance budgeting has to operate within the framework of clearly defined objectives which are to be achieved through successful implementation of various programmes and activities undertaken by the concerned agency. Performance budgeting, therefore, involves the development of more refined management tools, such as work measurement, performance standards, unit costs, etc.

7'

Objectives: Performance budgeting seeks to: i) correlate the physical and financial aspects of programmes and activities; ii) improve budget formulation, review and decision-making at all levels of management in the government machinery; iii) facilitate better appreciation and review by the legislature; iv) make possible more effective performance audit; v) measure progress towards long-term objectives as envisaged in the plan; and vi) bring annual budgets and developmental plans together through a common language. Components of Performance Budget The performance budgets have certain vital ingredients that need to be constantly kept in view: i) a programme and activity classification that represents the range of work of each organisation;

ii) a framework of specified objectives for each programme; iii) a stipulation of the targets of work or achievement; and iv) suitable workload factors, productivity and performance ratios that justify financial requirements of each programme. Formulation of Performance Budget Each performance budget will in the first instance indicate the organisational structure and the broad objectives that govern the approaches and work of the administrative agency. This is followed by a Financial Requirements Table. This Table is the most important part of the performance budget and has three basic elements: - a programme and activity classification indicating the range of work of the agency in meaningful categories - object-wise classification showing the same amount distributed among the different objects of expenditure such as establishment charges; and - sources of financing indicating the budgetary and account heads under which the funds are being provided in the budget.

11.3 STEPS IN PERFORMANCE BUDGETING

Four basic steps are involved in the introduction of performance budgeting: i) Establishing a meaningful classification of public expenditure in terms of functions,

ii) the establishment, improvement and extension of activity schedules for all measurable activities of the government; iii) the establishment of work output, employee utilisation, standard or unit costs by objective methods, i.e. bringing the system of accounting and financial management into accord with the classification; and iv) the creation of related cost and performance recording and reporting system. The important requirement for performance budgeting is a programme of action for any given year with specific indications regarding the tasks, the means of achieving them and the costs of achieving them. This is important even in traditional budgeting process. The distinction, however, is that under performance budgeting the organisations are compelled to think of their future activities not merely in terms of financial plans but in terms of the results, work assignment and organisational responsibilities. It isnormally held that in the context of planningfor economic growth, planning is a thinking process and budgeting is a doing process. Since the physical and financial aspects go together and the programme structure is expected to be the same, performance budgeting facilitates the functional integration of the thinking and doing process. The formulation of programmes for achieving the organisationuLgoals is an important task in the budgetary process. A programme is a segment of an important function and represents a homogeneous type of work. These programmes of work need to be developed for meeting the short-term plans, medium-term plans and long-term plans and involve formulation of schemes, laying down their targets, measuring the financial costs and benefits. The programme has to be assessed in the light of financial and economic factors i.e. ensuring adequate resources for the programme so chosen and examination of the impact of the proposed outlays on the economy as a whole through cost-benefit analysis. Complex programmes are divided into sub-programmes to facilitate execution in specific areas. Each programme or sub-programme further consists of many activities which are shown in the respective budgets. For example immunization programme is a programme under the function 'health'. As each programme has many activities, provision for storage of vaccines could be an activity under the programme. The real commencing point in the budgetary process is allocation of resources. In the conventional system primary emphasis is laid on the previous level of allocations and spendings and no emphasis is laid on its performance in terms of its objectives and the programme of action that it has set out for itself for the next year. Under performance budgeting the primary agency prepares the budget, submits its requirements as per programme classification. It indicates its past activities, their costs, the activities to be taken up during the next year, the results expected and the pattern of assignment of responsibilities. The very basis of the performance budgeting is commitment to achievement and the awareness of accountability. The budget so prepared is reviewed at higher level and resources are allocated keeping in view the priorities of the proposal. Some times due to financial constraints resources may not be available in full and a cut has to be imposed. However, this may be done in full awareness of the implications of the cut on the programme. Under performance budgeting, the programme classification and the rationale behind it indicate a group of choices with their priorities, already'made. This minimises the dislocational effect of cuts and ensures a better identification of their impact on programme achievement. Resource allocation is followed by budget execution. Budget execution must ensure achievement of objectives and for that the following budgetary and managerial considerations must be kept in view: i) Communication of the grants to the various subordinate agencies well in time ii) Ensuring the initiation of action for implementing the schemes provided for in the budget iii) Overseeing the regular flow of expenditures iv) Prevention of cost over-runs; and v) Time phased plan for expenditure and work. The final stage in the performance budgeting process is appraisal and evaluation.

Performance Budgeting

l Administration

Under the existing system evaluation of the physical achievements in certain sectors is being undertaken by the Programme Evaluation Organisation. Under performance , budgeting, each programme would lend itself to an evaluation by the agency concerned, even before it is undertaken by an outside organisation. The important ,aspect is that evaluation should, as far as possible, follow the completion of a programme and the administration should be enabled t o formulate its future course of action in the light of results obtained.

Check Your Progress 1 Note: i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit.
1) Explain the concept of performance budgeting.

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A

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2) List the objectives of performance budgeting.

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3) Describe the budgetary process involved in performance budgeting.

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11.4 PERFORMANCE BUDGETING SYSTEM IN INDIA

The need for performance budgeting in India was felt ever since India entered into planning era. The then existing budgeting and control system was found inadequate as no input-output relationship could be established between financial outlays and physical targets. The first study regarding the relevance of performance budgeting to our institutional set-up and needs was made by Dean Appleby in 1953. At that stage, however, the system of performance budgeting was still incipient in the federal government and Dean Appleby was not very certain of the outcome of the system. The Estimates Committee of the Lok Sabha, in its 20th report recommended that "... the Performance-cum-Programme System of budgeting would be ideal for a proper appreciation of the schemes and outlays included in the budget, especially in the case of large scale developmental activities. The Performance Budgeting should be the goal which should be reached gradually and by progressive stages without any serious budgeting dislocation." The recommendation was primarily made to strengthen the parliamentary control over expenditure. The Estimates Committee raised the issue again in their 73rd report in 1960 and suggested that the recommendation regarding performance budgeting be implemented at the earliest possible. These recommendations brought results. In 1961, the Union Finance Ministry accepted the recommendations of the 73rd report of the Estimates Committee and issued instructions exhorting the public enterprises to adopt performance budgeting. However due to operational problems, no undertaking implemented the instructions. In 1964 performance budgeting again became a focus of attention when the Planning

Commission held that "the stage has reached when appropriate methods of Performance Budgetingshould be evolved, so that these become an integral part of the machinery for planning and supervision over plan fulfilment." As a part of the implementation of this suggeston, the planning commission formed a Performance Budgeting unit in the Committee on Plan Projects in 1965. In order to identify the benefits this unit conducted a number of studies which provided the database for Administrative Reforms Commission. When Administrative Reforms Commission was set up, a working group on performance budgeting was established by the Commission. The working group recommended the introduction of performance budgeting in India in the developmental departments both at the Centre and in the States, in a phased. manner. The Administrative Reforms Commission further recommended that the introduction of Performance budgetingshould be initiated with the budget of 1969-70and completed by 1970-71. In view of this, the Union Finance Ministry submitted a document known as "Performance Budgets of Selected Organisations 1968-69'' to the Lok Sabha in April 1968. The Government of India, on the recommendation of A R C (Administrative Reforms Commission) issued guidelines for the adoption of Performance Budgeting in all ministries, departments and State Governments w.e.f. 1973-74. American budget experts were also invited to advise the Government of India on the introduction of performance budgeting.

11.5

PERFORMANCE BUDGETING SYSTEM -A CRITICAL EVALUATION

The government accepted performance budgeting and initiated the process of change, gradually and cautiously, almost two decades ago. The system has since been introduced in all development departments at the centre. Some of the states like Maharashtra, Punjab, Rajasthan, Tamil Nadu and Uttar Pradesh have introduced performance budgeting in a large number of departments. The progress has, however, been very slow in most of them, it is, therefore, necessary to take stock of the gains and limitations relating to performance budgeting. This shall help in consolidating gains and tackling problems and making performance budget an effective tool of internal financial management at all levels of government. Performance Budgeting improves legislative review by presenting a comprehensive view of the various departments and agencies of the government. In fact this system ensures all the advantages that are likely to accrue from an organic integration of the process of planning and budgeting. Performance Budgeting helps to improve public relations by providing clearer information for a rational public appraisal of responsible government. The welfare content of a progressive budget on an activity basis would strengthen the democratic process and evoke meaningful participation of the citizens in the implementation of the tasks set out in the budget. In any organisation decision-making with regard to allocation of resources, determining order of priorities and the structure of responsibilities, is dependent upon the efficiencyof the system of information and communication. Only performance budgeting , accompanied by decentralised accounting and systematic reporting could provide such informational support. Functional classification (about which we have discussed in Unit 7 of Block 2) facilitates integration of the process of planning, programming and budgeting. If annual budget is essentially a part of the long-term development plan relating to the public sector, the traditional budget does not facilitate the interweaving of the physical and financial aspects. The advantages of performance budgeting in such a situation is that it brings the financialand physical aspects together right from the beginning of the proposal to the final stage of the scheme.

Finanrial Administration

In brief, performance budgcting provides for more effective controls, makes legislative control more meaningful, helps to gear the process of decentralisation of authority in conformity with responsibility and improves public relations. Having considered the different aspects of the technique it shall be in the fitness of things to briefly enlist some of its limitations as well. Important among these are as under: i) work The very basis of performance budgeting is classification of goverr~mental into functions, programmes and activities. But in practice it may not be possible to have such well-organised categories.

ii) The programme and activity classifications developed are sometimes too broad to reveal the significant activities of the department to serve as a basis for budgetary decisions and management. iii) This technique focuses on quantitative than a qualitative evaluation. iv) The process of allocation of cost estimates over programme elements is difficult and often these estimates may not be as meaningful as they should be. v) Performance budget aids but does not solve the greatest problem in budget decision making, viz., the comparative evaluation of projects, functions or activities, unless it is supported by cost-benefit analysis which itself is far from perfect especially when the indirect and intangible costs and utilities are involved in a big way.

Check Your Progress 2 Note: i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit.
1) Trace the events which led to the adoption of performance budgeting in India.

2) Critically evaluate the suitability of performance budgeting.

11.6 LET US SUM UP

Performance budgeting is a system of presenting public expenditure in terms of functions and programmes reflecting the govemment output and its cost. It is designed to serve the purposes of long range planning. If it is to be of operational significance, it must be built from operating levels of responsibility and summarised suitably for higher level of management. It must be remembered that performance budgeting is a tool. Whether it is manageable or unwieldy depends largely on the skill of the toolmaker. Efficacy of its application depends on the skill, imagination, energy and strength of purpose of the user. All it can provide is meaningful basis for administrative planning, executive coordination, legislative scrutiny and administrative accountability at all levels of government.

11.7 KEY WORDS

Cost Benefit Analysis: A systematic comparison between the cost of carrying out a n y service or activity and the value or the benefit of that service or activity. An attempt is made to quantify as far as possible all costs and benefits arising from that activity.

Financial Requirements Table: It refers to the table indicating programme and objectwise classification of activities indicating budgetary and account-heads under which the funds are provided. Performance Budget: An output-oriented budget emphasising the accomplishment rather than means to accomplishment. Performance Audit: Assessment of the performance of an organisation with a view to know that the results achieved have been commensurate with the expenditure of resources. Work Measurement: It is a method of establishing the time taken by a qualified worker to carry out a specified job at a defined level of performance.

Performance Budgeting

11.8 REFERENCES
Prem Chand A , 1969. Performance Budgeting, Academic Book: Bombay. Thavaraj M.J.K., 1979. Performance Budgeting in India in B.C. Mathur et. al., ed. Management in Government, Publications Division, Ministry of Information and Broadcasting, Government of India: New Delhi. Thavaraj, M.J .K., 1978. Financial Administration of India, Sultan Chand & Sons :New Delhi. United Nations, 1966. A Manual for Programme and Performance Budgeting, U.N. Publications : New York.

11.9 ANSWERS TO CHECK YOUR PROGRESS EXERCISES

Check Your Progress 1 1) Your answer should include the following points: It is a system of presentation of public expenditure in terms of functions, programmes and performance units. Output-oriented budget information. Accomplishment based.

2) Your answer should includi the following points:

Correlating the physical and financial aspects of programmes and activities. Improves budget formulation, review and decision-making at all levels of management in the government machinery. Facilitates better appreciation and review by the legislature. ~ a k e possible s more effective performance audit. Measures progress towards long-term objectives as envisaged in the plan; and Brings close annual budgets and developmental plans.
3) Your answer should include the following points:

Formulation of programmes and establishment of meaningful classification in terms of functions, sub-functions, programmes, sub-programmes, activities, etc. Allocation of resources. Budget Execution. Appraisal and Evaluation. Check Your Progress 2 1) Your answer should include the following points: Inadequacy of budgeting and control system in the early era of planning. Suggestions of Estimates Committee of Lok Sabha in its 20th report.

Setting up of Administrative Reforms Commission and its recommendations. Implementation of performance budgeting in India.

2) Your answer should include the following points: Improves legislative review. Meaningful participation of the masses. Provides informational support. Integration of process of planning, programming and budgeting. Some of the limitations of performance budgeting include: - Classification of work difficult and broad. - No qualitative evaluation. - Dependent upon support from other techniques.

CTNIT 12 ZERO BASE BUDGETING

Structure
12.0 12.1 12.2 12.3 12.4 12.5 ,'12.6 12.7 12.8 12.9 12.10 12.11 Objectives Introduction Concept and Meaning of Zero Base Budgeting Zero Base Budgeting and Traditional Budgeting: A Comparison Genesis of Zero Base Budgeting StepsIElements of Zero Base Budgeting Introduction of Zero Base Budgeting in India Implementation of Zero Base Budgeting -Benefits and Problems Let Us Sum Up Key Words References Answers to Check Your Progress Exercises

After studying this unit, you should be able to: explain the concept and meaning of zero base budgeting distinguish zero base budgeting from traditional budgeting trace the developments which necessitated the introduction of zero base budgeting describe the process involved in implementation of zero base budgeting; and discuss the problems and benefits in implementation of zero base budgeting system.

12.1 INTRODUCTION
India has been passing through a tight financial position. The budgetary deficit over the years has been increasing and as a result strict financial control became an urgency. The Government has taken a number of steps to reduce the budgetary deficit through control of expenditure. However, it is a well-known fact that financial management can be toned up through budgetary reforms on the lines of Zero Base Budgeting. Zero Base Budgeting (ZBB) is a control technique which requires that an organisation while preparing its budget should not take earlier year's expenditure for granted but should start afresh. This concept implies that a complete re-examination of the ongoing programmes and activities should be carried out to assess their continued utility. In this unit an attempt has been made to explain the concept of Zero Base Budgeting, its objectives, historical background and the process followed for its implementation. It also discusses the benefits and problems arising from the implementation of zero base budgeting.

BUDGETING
Zero Base Budgeting is a management process that provides for systematic consideration of all programmes and activities in conjunction with the formulation of budget requests. It is a system whereby each governmental programme, regardless of whether it is new or existing programme must be justified in its entirety each time a new budget is formulated. It implies that, in defence of its budget request no department shall make reference to the level of previous appropriation. The analytical definition of Peter Sarant holds that "Zero Base Budgeting is a technique which complements and links the existing planning, budgeting and review process. It identifies alternative and efficient methods of utilising limited resources in the effective attainment of selected

Financial Administration

benefits. It is a flexible management approach which provides a credible rationale for re-allocating resources by focusing on the systematic review and justification of the funding and performance levels of current programmes or activities." The objectives of Zero Base Budgeting according to the Department of Expenditure, Ministry of Finance, Government of India are: "Zero base budgeting requires identification and sharpening of objectives, examination of various alternative ways of achieving these objectkes, selecting the best alternatives through cost-benefit and cost-effectiveness analysis, prioritisation of objectives and programmes, switching of resources from programmes with lower priority to those with higher priority and identification and elimination of programmes which have outlived their utility." Zero Base Budgeting, thus, is an operating, planning and budgeting process which requires each manager to justify entire budget requests in detail from scratch, and shifts the burden of proof to each manager to justify why any money should be spent at all, as well as how the job can be done better. This approach requires that (i) all activities be identified in decision packages (or programmes) that relate inputs (costs) with outputs (benefits), (ii) each one be evaluated by systematic analysis, and (iii) all programmes be ranked in order of performance. Zero Base Budgeting aims at achieving a state of affairs whereby the whole of the budget needs to be justified in order to (a) combat waste and complacency (b) ensure that the relative tasks and activities remain under constant watch and review alternative levels of action in each sector periodically. The concept of zero base budgeting is as old as the concept of budgeting. Since the first budget of any organisation is always prepared from zero, all the organisations experience this approach at least once. However, in zero base budgeting the idea is proposed to experience it year after year i.e. every time the budget for the next period is prepared. This does not mean that efforts made earlier are not taken into consideration at all. What it exactly means is that one must re-evaluate all activities to find out the level to which such activity should be funded; i.e. whether it should be eliminated or shall be funded at reduced level or increased level or similar level? It shall be determined by the priorities established by top management and by the availability of funds.

1 2 . 3

ZERO BASE BUDGETING AND TRADITIONAL BUDGETING: A COMPARISON

Zero Base Budgetineis more or less a self-defining term. As we have discussed earlier. in zero base budgeting all expenditures are thoroughly analysed from zero base, such that the current expenditure levels are justified. In contrast, traditional budgeting usually begins with estimation of current costs. These estimates serve as the starting point to which management will add data corresponding to price changes, estimated inflationary uplifts and planned additions, deletions or alternatives. The assumption is customarily made that current expenditure is justified, such that only the large budgeted increments from current expenditure levels need to be investigated. Failure to investigate current expenditure regarding its necessity and effectiveness will lead to funding of activities for which no increase, or perhaps a decrease in spending is warranted. Traditional budgeting has not proved to be a suitable tool for shifting resources from low to high priority areas. It does not involve the same rigorous approach as zero base budgeting and does not answer the question as to whether we are getting value for the money being spent. Zero Base Budgeting is a decision-oriented approach and focuses on old and new activities and connects short and long range goals by monitoring the achievements of objectives. On the other hand, traditional budgeting is accounting-oriented and focuses on increments and monitors expenditures. The logic behind traditional budgeting techniques stresses on three points:

Last year's spending level is extrapolated into next year, - Some growth factor is added on account of inflation, increase in prices of raw material and wages etc.

Zero Base Budgeting

- Spending level is further incremented for new projects and programmes.

e ZBB attempts to shift the traditional management approach towards a new m ~ d of thinking and operation whereby the managers not only justify the new proposals and the funds required, but also have to justify the ongoing activities and the funds required for them. In other words, in the conventional budgethg no review of ongoing activities is undertaken. It can be shown through the following diagram: Traditional Budgeting New Programmes
b

Zero Base Budgeting Review & Justify On-going Activities ------ _-

Thus ZBB helps managements to evaluate the claims on scarce resources in terms of organisation's objectives and to make trade-offs among current operations, development needs and profits, and allocate the financial and other scarce resources for the achievement of the objectives or goals of the organisation.
Check Your Progress 1

Note: i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit.
1) Discuss the concept of ZBB highlighting its aims and objectives.

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2) Distinguish between ZBB and traditional budgeting.

12.4

GENESIS OF ZERO BASE BUDGETING

The origin of the concept of ZBB can be traced back to the year 1924 when Hilton Young, the noted English budget authority stressed the need for annual re-justification of budget programmes. Later in 1960 the US Defence department introduced the Programme, Planning and Budgeting System (PPBS). It was based on cost-benefit analysis and was very much similar to ZBB. But the final attempt to introduce ZBB was made by the US Department of Agriculture in 1962,when the budget director suggested that each programme be justified from zero and in 1964, this department prepared the budget. This experiment however proved unsuccessful due to various reasons. The various agencies proceeded on the assumption that their programmes were necessary and formulated them accordingly. The new technique was taken as an additional exercise enhancing the volume of paper work, time and energy and as such it could not be

Financial Administration

managed properly by the concerned agencies However, it was Peter Pyhrr who designed its logical framework and implemented it successfully in the private industry in 1969 while working as a staff control manager in Texas Instruments USA. In 1968, Pyhrr reviewed the speech given by Authur F. Burns on the control of government expenditure which advocated that government agencies should start from ground zero, as it were, with each year's budget and present their appropriation in such a manner that all funds can be allocated on the basis of costbenefit analysis, resulting in substantial cost savings. Thus Pyhrr formulated this concept in order to reduce staff costs. He developed this system as a tool for planning budgeting and control. H e first applied it to research and development divisions of the company. Finding it successful, he extended it to other divisions of Texas Instruments. Based on this experience he published an article which caught the attention of the then Governor of Georgia -Jimmy Carter who invited Pyhrr to apply the approach to the State of Georgia. ZBB was introduced for the first time in a government system and was adopted for the formulation of the budget for the fiscal year 1973-74. Jimmy Carter was so much. influenced with its success that when he was elected President of the USA, he introduced the concept of ZBB in Federal Budgeting Control Systems and also made it mandatory through the legislation for the year 1979. President Carter claimed that an effective ZBB system will benefit the Federal Government in several ways e.g. it will:
- Focus the budget process in a comprehensive analysis of objectives and needs. - Combine planning and budgeting into a single process.

- Cause managers to evaluate in detail the cost-effectiveness of their operations.

- Expand management participation in planning and budgeting at all levels of the

federal government. Following the memo, the office of Management and Budget (OMB) issued Bulletin No. 779 on April 18,1977 providing budget guidelines and instructions to the agencies on the use of ZBB for the preparation and justification of 1979 budget requests. It stated ZBB as a management process that provides for systematic consideration of all programmes and activities in conjunction with the formulation of budget requests and programme planning. The principal objectives of ZBB were to:

- Involve managers at all levels in the budget process.

- Justify the resource requirements for existing activities as well as the new activities. - Focus the justification of the evaluation of discrete programmes or activities of each

decision unit.
- Establish, for all managerial levels in an agency, objectives against which

accomplishments can be identified and measured.

- Assess alternative methods of accomplishing the objectives. - Analyse the probable effects of different budget amounts or performance levels on

the achievement of objectives; and

- To provide a credible rationale for re-allocating resources, especially from old

activities to new activities. Though the conversion from conventional budgeting to ZBB did pose some problems, yet the implementation process proceeded smoothly. Thus in the USA ZBB achieved an unprecedented goal without going for a pilot experiment and the Federal government agencies became the experimental laboratory of ZBB. Since 1973, in the USA ZBB has become apopular management tool in both public and private organisations. A dozen states, 36 municipalities and 500 corporations have used it with a great degree of success as compared to government agencies.

12.5

STEPSIELEMENTS OF ZERO BASE BUDGETING

ZBB is a four step budgeting process which can be applied in a relatively simple way in any organisation. However, there are a number of conditions which must be fulfilled
fnr
9

c n n r r ~ c c f i irnnlement9tinn ~l nf

7RR

There must be a genuine need within the organisation.

Zero Bare Budgeting .

- Thc: management environment of an organisation should be objectively assessed. - A competent management accountant should,occupy a senior budgeting position

within the organisation.

- A ZBB programme must have the unqualified support and involvement of top
management.
- ZBB must be tailored to the technical requirements of the organisation intending to

implement it.
- A budget should be prepared for the organisation. - The implementation of ZBB programme will be aided by a commitment to post-

implementation review and maintenance of the programmes. The basic four steps are: 1) Review of organisational structure, and identification of decision units and their objectives.

2) Analysing the decision units, working and evolving documented decision packages. 3) Reviewing and ranking the decision packages on the basis of chosen criteria. 4) Allocation of organisation resources to rank decision packages and preparing detailed operating budgets.
Step 1. Decision Units

The first starting step in ZBB is the analytical review of the organisational structure and activities conducted. In every organisation there are meaningful interrelated hierarchical parts which are separated in order to verify the reporting relationships and functional responsibilities. This stage is intended to isolate key decision points in the organisation's hierarchy commencing with the lowest level and progressing to the top. The identification of the organisational entities (decision units) which will prepare budget requests for the organisation are accomplished through selection by higher level management. Selections are based on relationship to organisation, special analysis and re-organisation. Other factors are that units are not too low nor too high in the organisation to prevent meaningful review or analysis and the managers of these units make significant decisions on the amount of spending and the scope, direction, or quality of work to be performed. A decision unit is a distinct segment of an organisation for which budget is prepared. Decision units are identified by segmenting the organisation into discrete functions, operations or activities for review and analysis. These are the lowest units in the organisational hierarchy which are headed by responsible managers having authority to make decisions on the activities under their control. These should be capable of carrying out different programmes or activities to achieve an objective. The identifica.ion helps in deciding the levels in the organisation at which budgets should be formulated o r ZBB ought to start first. Instead of considering the whole department as decision units, individual sections or performing units of each of these departments should be treated as separate decision unit. The location of decision unit often is a difficult exercise. It is imperative that in the identification there should be a complete knowledge about the organisational structure, its management and objectives. Once the decision units have been identified, each of these must be analysed keeping in view (a) the functions of the department (b) whether any of the tasks are being performed due to some abnormal situations such as expansion, consolidation, (c) whether any of the tasks being performed be reduced or eliminated completely (d) the minimum staffing required to accomplish the normal functions of the decision units.
Step 2. Formulation and Development of Decision Package

Top level management completes two functions in the zero base budgeting process before decision packages (budget requests) are prepared. It decides as to which level of management develops the initial budget requests and budget guidance it needs to prepare the requests (decision packages). These two functions illustrate why ZBB is

first a "top-down" process before becoming a "bottom up" management process. A decision package includes comprehensive justification for budget estimates of an activity. Such a justification is built up by answering a number of questions. The first question to be answered is in regard to the need for the proposed expenditure as to what specific purpose it is serving. This would necessitate sharpening the objectives of the expenditure so that it could be evaluated by using the relevant evaluative techniques or measures of performance. In case the proposed expenditure is justified in the context of its objectives, a further question may be asked to know if there is a better alternative of incurring expenditure to achieve the specified objectives. To quote from Government of India's letter issued in 1986on the subject of "Introduction of zero base budgeting in the Government of India" a decision package is a budget request which should contain the following:

- A description of the functions or activities of the decision unit. - The goals and objectives of the various functions/activities of the unit. - Benefits to be derived from financing the activityJproject. - Relevance of the activityJproject to the overall objectives of the organisation/
department in the present context. - The consequences of its non-funding. - The projectedJestimated cost.

- The yearly phasing of the proposed expenditure. - Alternative ways of performing the same activity or same objective
As Pyhrr defines it "the decision package is a document that identifies and describes a specific activity in such a manner that management can (a) evaluate it and rank it against other activities competing for the same or similar limited resources and (b) decide whether to approve or disapprove it. One of the significant aspects of the decision packages is that it is used by a manager to define his or her objectives and responsibilities and how best to meet them at various levels of effectiveness. The manager also defines the methods for achieving the objectives. The manager can recommend elimination of some of the activities.

ZBB Decision Package Format

Decision Package Company Code Bank

Objective of Activity Level of: Resources Desired Results Required Personnel No. Description of Activity Wages Salaries Total staff variable

Dept. Discussion/Section Current Budget Year Year

% age of current

Total How and when accomplished Alternatives to achieve result Advantages of retaining activity Consequences if activity is eliminated Prepared by Date Approved by Date

Step 3. Ranking of decision packages After the construction of decision packages the next important step is to rank the decision packages. Ranking is the process of arranging the various service levels (decision packages) and benefits to be gained from the additional funds to be allocated. These are ranked in order of priority or decreasing benefits to the organisation. The process allows management to allocate scarce resources by concentrating on the following three key questions:

Zero B ~ s Budgeting e

1) Where to spend the money first?

2) How much should be spent in pursuing these goals and objettives? 3) What are the consequences of non-implementing those decision packages which are not going to be approved? The ranking is done on an ordinal scale (i.e. lst, 2nd and 3rd etc.) in order of priority. Because of the huge numbers involved the ranking process takes place at a number of levels depending on the size, geographical dispersion, levelsof management, volume of decision packages, unit managers, budget staff o r by ranking committee.

Cut off level of funding Ranking of decision packages in large organisations is more problematic as compared to smaller organisations. In large organisations identifying each discrete activity with several levels of effort could create a number of problems. If management has to review in detail and rank every decision package with conflicting needs, it may take valuable time and effort of the top management.
This problem could be reduced to some extent by: i) Concentrating management review on lower priority discretionary packages around which the funding levels o r cut off levels will be determined.

ii) Limiting the number of consolidation levels through which the packages will be processed. All packages presented for funding generally would fall into three categories i) Those with higher priority and high probability of funding. ii) Those with marginal priority and which may be funded or not funded dependingon the resources available; and iii) Those with low priority and low probability of funding. The cut off level of funding is usually established arbitrarily as a percentage of current year budget or actual expenditure level or in absolute rupee value. It is important to note that cut off level has nothing to do with the ultimate allocation of resources. It is only a means to help the ranking managers to cut down the time and effort needed to review and rank packages.

Ranking Process
Top level review A Senior level consolidation and ranking Middle level consolidation Preliminary ranking by managers who developed it

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B2

B3

B4

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c 3

c 4

c 5

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Each subordinate review level prepares a ranking sheet to submit to thenext higher review level. This sheet serves primarily as a summary sheet to identify the order of

Financial Administration

priority placed on each decision package. Each time a ranking sheet is filled out by the ranking manager who sends it to the next ranking manager. It serves the following purposes:

1) It identifies cumulative funding level which helps top management to know whether the total budget request has exceeded the total available resources or is still below it. 2) It allows top management to decide which package it wants to review in detail. 3) It provides a work sheet to top management to make funding decisions among several rankings readily, adjust the funding levels etc.
The ZBB can be adopted by any organisation willing to aggressively eliminate its budgetary deficit. But only managers intimately acquainted with the organisation culture can make it work effectively. Although the process is ideally suited for costeffective planned growth, most managers probably will be initially interested in its enduring cost-reduction aspects and the capability it provides for responding flexibility to sudden shifts in an operating environment.

12.6

INTRODUCTION OF ZERO BASE BUDGETING IN INDIA

The concept of ZBB has been in use in Indian private industry since long. For example Britannia Industries Ltd. and Union Carbide have been using it since 1977-78 without calling it Zero base budgeting. However in government context, it is of recent origin. The first application of the system was in the Department of Science and Technology in 1983. In view of the severe resource crunch for the seventh plan, several alternative steps were recommended to the government by the Eighth Finance Commission and the Planning Commission to prune the wasteful public expenditure and inefficiencies in implementation of government programmes. The Finance Ministry decided to introduce the system of ZBB in all departments of the Union Government in 1986-87, as it was important to control the government expenditure of the seventh plan which was showing a negative contribution. Unless the situation was remedied, the only alternative was to cut the plan outlay or to resort to more deficit financing than was envisaged in the plan document. Neither alternative was desirable and therefore the government, had launched a massive economy drive. On 10th July 1986, the Ministry of Finance issued a circular-cum-budget guidelines to all ministry departments, and State Governments and Public Sector Undertakings, impressing upon them the need to apply ZBB to all schemes and programmes with over Rs. One Crore outlay from the fiscal year 1987-88. For this purpose, a Central monitoring cell was formed. The Finance Ministry had identified around 150 redundant and low priority schemes with the estimated outlays over Rs. 1000 Crore which the Ministry wanted to eliminate. Among the State governments, Maharashtra has .been implementing ZBB in 42 departments. The budget for 1987-88 reflected a saving of Rs. 50 crore. Several , redundant and duplicative and low priority schemes have either been eliminated or merged. Similarly Karnataka Government experimented with ZBB in Public Health and Agriculture Sections and also had plans to apply it to all 45 departments. Among the public sector undertakings, Madras Refineries Ltd., HMT, BHEL, BEL, Indian Telephone Industries, Indian Oil, Neyveli Lignite Corp., a few steel plants and nationalised banks have planned to implement ZBB.

12.7

- BENEFITS AND PROBLEMS

IMPLEMENTATION OF ZERO BASE BUDGETING

The implementation of ZBB has certain benefits and some problems too. Let us now discuss these:

Benefits of Zero Base Budgeting The major benefits of the use of zero base budgeting can be the following: i) Zero base budgeting examines all existing and new programmes and activities. It also makes the managers analyse their functions, establish priorities and rank them. This exercise helps in identifying inefficient or obsolete functions within the area of responsibility. In this way resources are allocated from low priority programmes to high priority programmes.

7tq-o Hase Hudgeting

iI

ii) This system facilitates identification of duplication of effortsamong organisational units. Such inefficient activities are eliminated and some other activities are merged. iii) All expenditures, under this system are critically reviewed and justified and all operationslactivities are evaluated in greater detail in terms of their costeffectiveness and cost-benefits. This requires managers to find alternative ways of performing their activities which may result in more efficient procedures. iv) ZBB promotes the tendency to initiate studies and improvements during the period of operation as the persons at the helm of affairs know that the process would be exercised next year and their knowledge and training would enhance efficiency and cost-effectiveness. v) ZBB provides for quick budget adjustments during the year. If revenue falls short in this process, it offers the capability to quickly and rationally modify goals and expectations to correspond to a realistic and affordable plan of operations.

vi) ZBB ensures greater participation of personnel in formulation and ranking processes. This helps in promoting level of job satisfaction and thus resulting in better control and operational efficiency in the organisation. vii) Zero base budgeting is a flexible tool that can be applied on a selective basis. It does not have to be applied throughout the entire organisation or even in all the service departments. Keeping in view the limitations of time, money and persons available to instal, operate and monitor it the management thus can select priority areas to which zero base budgeting may be applied. The benefits of ZBB thus can be summed up as follows:

- It eliminates redundant activities and those which are being duplicated.

- It identifies low and high priority activities for resource deployment. - It justifies budget requests on cost-benefit and cost-effectiveness basis. - It allocates scarce resources rationally.
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It sharpens and quantifies objectives and formulates alternative methods of operations.

- It promotes involvement of line managers in budget formulation.

Problems in Implementatioo i) Managementfactors: Whenever any cost control technique like zero base budgeting is adopted there is resistance from certain individuals and groups having interest in the organisation. Since goals, objectives and targets are achieved through the actions of responsible people whose behaviour makes the system work or fail, it is essential for the organisation to examine the effects of adoption of new techniques on the people and the effects of people on techniques. This is very important for the adoption of ZBB as it challenges the past practices, methods, performance, attitudes, habits etc., of the people working in the organisation. As such it becomes very important for the management to effectively manage its internal organisation before taking any step towards implementation of the zero base budgeting. Thus effective management of the organisation is the primary requisite in implementation of the programme.
ii) ZBB is time consuming and is a more complicated process than the conventional budgeting. It requires more staff, a great deal of time and effort as compared to conventional budgeting system. For managers at all levels to understand the system thoroughly there is need for proper communication system. iii) ZBB involves voluminous paper work. Each d d s i o n unit is supposed to prepare decision packages and rjve prover iustification. In government de~artments.

Finnncinl Adminislrntion

where there are thousands of programmes and activities, the number of decision packages may run into several thousands. This is bound to create handling problems and confusion. iv) There is no standard formula for identifying the minimum level of funding. Generally minimum level of funding is identified on arbitrary basis which comes from top management as budget guidelines. But the viability of this procedure is questionable. v) The ranking of decision packages, particularly when the number of such packages is large, creates a big problem. The ranking may become an unwieldy process. vi) Zero base budgeting decision and the p v of fixing priorities become a political nightmare. Conflict may arise on ranking as managers have a tendency to assign a higher priority, to their own projects. Problems of ZBB can be summed up as: i) It challenges the past practices, performance, attitudes, of people. ii) It requires more time and effort. iii) Detailed costs and necessary information for decision packages often are not made available. iv) It increases paper work to unmanageable proportions. Ranking a large number of decision packages becomes an unwieldy process. vi) Identifying various levels of funding, particularly the minimum level is a difficult task.
v)

Check Yonr l'mgms 2 N o t e : i) Use the space given below for your answers. ii) Check your answers with those given at the end of the unit.

1) Trace the evolution of zero base budgeting system in India.

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2) Describe the stages in the implementation of zero base budgeting.

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3) What are the benefits of this technique?

LET US SUM UP
The ZBB is a technique which helps in achieving the goals of an organisation through better resource allocation. It is a system of helping managers at all levels to evaluate in

detail the Cost-effectiveness of their operations and specific activities. It permits the executives to better establish their priorities and allocate scarce resources. Under this system, new expenditure proposals are to compete on the same footing with the ongoing expenditure based on their respective merits so as to claim a share of the available resources. In India ZBB was formally introduced in 1986 but so far it has failed to take off. It has been implementedin the true sense only in the department of space. For the rest of the ministries the success is negligible. However, the economic crisis through which India is passing, makes it imperative that ZBB is implemented in true spirit. In fact the system has failed to take off due to administrative problems.

Zero Base Budgeting

12.9 KEY WORDS

Deer~lon Unit: It is a distinct segment of an organisation for which budget is prepared. It is identified on the basis of functions, operations or activities of the organisation. D e c i s i o n A document that identifiesand describesfacts about an activity from every possible angle.

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PInnning Rogpmdqj Bodgding System ( P P B S ) : It is a technique for optimising allocation of fundsin the budget through exercise of proper choice among programmes which compete for limited resources. This technique requires that the identification of goals or objectives to be achieved by the organisation be clear and specific. The next step is to search for alternative programmes for achieving these objectives most . effectively and at least cost. The costs of each programme should be related to the corresponding output from them. Ranking: Procxs of arraaging activities in the order of their priority.
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12.10 REFERENCES
Austin Allan, Cheek Logan, 1979. Zero Base Budgeting: A Deckion Package Manual, Amaclom: New York. Handa, K.L. 1991. Expenditwe Control and Zero Base Budgeting, Indian Institute of Finance: New Delhi. Joshi, P.L. & V.P. Raja, 1988. Techniques of Zero Base Budgeting: Text and Cases, Himalaya Publishing House: Bombay. Pyhrr A. Peter;1973. Base Budgeting, John Wiley and Sons: New York. Sarant Peter C.,1978. L o &irc Budgeting in Public Sector, Westley Publishing Company: Addison. Stonica Paul J., 1977.'Zero Base Planning and Budgeting, Don Jones: Home Wood.

12.11 ANSWERS TO CHECK YOUR PROGRESS EXERCISES

1) Youranswer should include the following points: Zero base budgeting is a system whereby each governmental programme, regardless of whether it is a new or existing programme must be justified in entirety each time a new budget is formulated. Whole of the budget must be annually justified from scratch in order to combat waste and complacency. It requires identification, examination, selection of the best alternatives through cost-benefit and cost-effective analysis.

2) Your answer should include the following points: in zero base budgeting all expenditures are thoroughly analysed from base zero while traditional budgeting usually begins with the estimation of current cost.

Financial-Administration

Zero base budgeting facilitates shifting of resources from low to high priority areas while it is not possible with traditional budgeting. While zero base budgeting is decision-oriented approach which focuses on old and new activities, traditional budgeting is accounting-oriented which monitors expenditure.

Check Your Progress 2

1) Your answer should include the following points: Introduction of ZBB in all departments of the Union Government in 1986-87 with a view to controlling government expenditure. Issue of budge guidelines by the Ministry of Finance to all ministry departments, state governments, public sector undertakings to apply ZBB to all schemes and programmes with over Rs. one crore outlay for the fiscal year 1987-88. Introduction of ZBB in some states like Maharashtra and Karnataka.
2) Your answer should include the following points:

Identification of decision units and their objectivies. Formulation and development of decision packages. Ranking of decision packages. Allocating resources to decision packages.

3) Your answer should include the following points: Identifies inefficient or obsolete duplication of activities. \ Facilitates critical review of all programmes/activities in terms of their costeffectiveness and cost-benefits. Ensures greater participation of personnel in formulation and ranking process. Provides for quick budget adjustments during the year. Allocates scarce resources rationally.