CITY OF MANILA
UNIVERSIDAD DE MANILA
Antonio Villegas St. Mehan Garden, Manila

REPORT ON THE TOPIC

EXPENDITURE THEORY, POLICY AND PERFORMANCE

In Partial fulfillment of the requirement in the subject

PA026A – PUBLIC FISCAL ADMINISTRATION

PREPARED AND SUBMITTED BY

GROUP V

Vincent Yuzon Rosales II
Frances Santos
Angelito Laderas
Antonio Vitan Jr.
Ma. Lourdes Cuenco

SUBMITTED TO

PROFESSOR CYNTHIA RAVELA CUBOS

June 28, 2011

THEORIES OF EXPENDITURE GROWTH

Three prominent theories that used the time-pattern of expenditure in the long-run to explain the expansion of the public sector are discuss in this chapter. Although this theories were formulated based on the experience of the now developed countries, the general idea of government expansion and the underlying concepts provide some explanations as to the pattern and growth of our government.

Adolph Wagner a 19th century German political economist. Who made one of the earliest attempts to explain public sector growth. Observe the tendency of the public sector in a number of industrialize countries such as Britain, USA, France, Germany, etc. to grow, both absolutely and relative to the rest of the economy. He predicted a public sector that would grow continuously, and considered society’s economic and social structure as factors that influenced this continuous growth. Wagner’s prediction was called the “law of increasing public and particularly state activities” or the “Wagner’s Law”.

The equation below shows Wagner’s presumption that the existence of a functional cause and effect relationship between growth of an economy and the relative growth of its public sector.

RPCOPG1 RPCOPG2 ____________ < _____________ RCPI1 RCPI2

He postulated that as per capita income and output increase in industrializing nations, its public sector necessarily grow as a proportion to total economic activity.

Wherein RPCOPG represents the “real per capita output of public goods”, RCPI represents “real per capita income”; and where the numerical values represent an earlier and later period respectively.

Wagner believes that social progress is the basic reasons for the relative growth of government in industrialize countries. Because it implies giving importance to distribution issues, and perhaps a desire for a more equitable distribution of resources. Accordingly, an increase in cultural and social welfare services is expected.

Public sector growth comes about in a chain reaction and over a long period of time, wherein social progress leads to growth in governmental functions, which in turn leads to an absolute and relative growth of governmental economic activity. The need for public regulatory and protective activities expands as the economy undergoes a process of industrialization. This makes a case for the state to expand administration and law and order to carry out the necessary protective and regulatory duties to enable the economy to develop in a n economically and socially efficient manner.

Wagner also made an explicit case on the need for public enterprises. He pointed out that private sector exists to make profit and may not put money into large scale investment with long-gestation period for recoupment of capital, too excessive for it to finance, or with strong social objectives. While a public enterprises may operate at a commercially profitable level, and thus contribute to government coffers.

He gives recognition to the importance of revenue as a limiting factor in the expansion of government activity. However, in the end, people in their desire for development will tolerate higher tax burdens, thus enabling the government to overcome financial difficulties.

Wagner further attributed the expansion of the public sector to the expansion of the fiscal needs of both the central and local governments. He said that both the state’s requirements grow and often even more so, those of local authorities, municipalities and urban areas.

THEORY OF PUBLIC EXPENDITURE DETERMINATION

Peacock and Wiseman explained the growth of public expenditures in the United Kingdom. They founded their analysis upon a political theory of public expenditure determination. They stated that the government keeps a close watch on the people’s reaction to taxation in allocating the budget. Even though voters dislike paying additional taxes, they enjoy the benefits of public goods and services.

The growth of the economy is accompanied by the growth in income. As this happens, tax revenue at constant rates will also increase, thereby enabling public expenditures to expand in line with the Gross National Product (GNP). During periods of social upheaval like war, famine or some large-scale social disaster, they argue that public expenditures increase rapidly, evolving in a step-like pattern, representing an upward shift in the trend line of public expenditures. They call this as the Displacement Effect. Public expenditures are displace upwards and for the period of the crisis displaces private expenditure for public situation, the higher level of taxation would be found acceptable to the taxpayers. Public expenditures so do taxes, do not fall back to their original level after the crisis. The greater governmental revenues are used intead to support a permanent higher level of public sector allocation.

Peacock and Wiseman derived the key concept of a “tolerable burden of taxation” from this basic tenets. The government needs to pay some attention to unmet needs and needs that have been neglected during the crisis period. They call this the inspection effect. The government thus expands its scope of services to improve social conditions. They noted that this is to be financed by higher levels of taxation and even borrowings.

They further hypothesized that there is an apparent tendency for central government economic activity to become an increasing proportion of total public sector economic activity when a society is experiencing economic growth. They called this the concentration effect.

MUSGRAVE’S HYPOTHESIS

Musgrave et al was concerned with the changing role of the public sector during the developmental process, He suggested that the efficient product mix between private and social goods changes as per capita income increases, and this change involves a rising share of “social goods”, thus the rising ratio of government purchases to GNP. In the course of development, Musgrave et al argued that the demand for social goods could hardly be expected to remain constant or to have an income elasticity of zero. At the same time, there was no particular reason to expect that this elasticity should be just unity.
During the early stages of development, there existed a particular need for the creation of overhead capital such as roads, harbors, and power plants. The benefits from this goods were largely external or they required large amount of capital, the returns on which are spread over a long period, and thus do not lend themselves readily to private provision. The development of industries further created problems of its own such as pollution, urban blight, and congestion. Government expenditures may then be expected to rise and fall depending on the circumstances.

Unlike Wagner, Musgrave et al explicitly measured development using per capita income, which responds positively to increases in productivity. As per capita income increased. He examined its effect on the share of public goods to total output. He categorized the possible influences on this share into three;

1. ECONOMIC 2. CONDITIONING (demographic factors and changes in technology), and 3. CULTURAL, SOCIAL and POLITICAL FACTORS.

Musgrave’s primary interest was to consider effect of changes in (1) given unchanged factors of the (2) and the (3) type.

In exploring the economic factors, he made distinction between government consumption and investment spending and transfers, and how each might change at different stages of development. Public investment was likely to form a large share of total investment at low levels of development but declined thereafter since, in the early development stages, externality-intensive investments were likely to dominate. Subsequent increases in private investment served to reduce the public share as income increases. On the other hand, a tendency for the share of total investment in GNP to rise helped to weaken the decline in the public investment/GNP ratio.

He also hypothesized that there will be some public financing of internal-benefit intensive investment at low level of development. This is due to limited entrepreneurial skills. But he was not clear on whether tendencies towards an increasing or decreasing public investment share in GNP will dominate at relatively late stages of development. An increase in private goods consumption will often require complementary public consumption goods and the growing complexity of an economy during development creates a need for regulatory facilities.

Musgrave concluded that social development processes carry significant implications for public sector intervention and provision. There was every reason to expect a positive association between levels of public outlay and per capita income. At an early stage, government would become heavily involved in the production and/or regulation of major, large-scale industries. Government institutions have to meet the need for increasing law and order services and to oil the wheels of the economy as well as intervene in monetary and banking institutions. As the economy proceeds with industrialization, externality-intensive goods are likely to become more important. Government would have to intervene to ensure efficient production.

OTHER CAUSES OF PUBLIC EXPENDITURE GROWTH

Other authors have worked on determining the causes of expenditure growth. Parkinson for instance, provided a lucid explanation on the rising trend in government expenditures. He developed the Law of Organizational Growth. He based this law on two premises:

1. Psychological desire of individual government officials to have more and more subordinates. This means work specialization and therefore the hiring of more people. 2. The phenomenon that the personnel of an organization perform work for one another. This brings about red tape, duplication of function and complexities within an organization.

Other explanation for the growth of government expenditures include the provision of a variety of entitlement programs to citizens during economic booms to cause the expansion of the government. Such entitlements remain even as the economy has become less bountiful.

Heavy reliance on indirect taxes and social insurance contributions, electoral exercises and its frequency, and the rising exposure of economies to the world economy are likely to increase the scope of the public sector in order to control external economic pressures. Furthermore, the growth of the public sector maybe explained in terms of the demand for more services by the citizens, more often expressed through pressure groups and through their access to bureaucracy. Demographic factors such as rising population, urbanization, industrialization, advances in technology, and calamities would partly explain government growth.

ECONOMIC, SOCIAL, POLITICAL and ADMINISTRATIVEFACTORS

ECONOMICS FACTORS Countries, which are deeply dependent on the export of a few agricultural resources for foreign exchange, on foreign borrowings and grants to beef up the balance of payments, and at the same time, pursue huge capital investment projects tends to expand the scope of the government. The degree of exposure of economies to the world economy is likely to set scope of the government in order to put up a concerted effort in controlling external economic pressure.

SOCIAL FACTORS Rising population, urbanization and rising incomes put pressure on the government for more and better services. More roads have to be built, more schools have to be put up and more hospitals have to be constructed. The bottom line is that public expenditures must address the social development objectives of a country. The components of developments invariably reflect the concepts of human and sustainable development. At the same time, government expenditures must be subjected to the test of prudence, transparency, fiscal responsibility and accountability.

POLITICAL FACTORS We can include here such factors as the conduct of elections and the government reorganization that follows. After election, political supporters expect their winning candidates to give them some accommodation in one form or another. This could mean employment in the government, award of contracts and other kinds of favors. Those already in the government are expected to oppose any move to reduce public employment.

ADMINISTRATIVE FACTORS The size of the government also tends to be influenced by the tendency of some people to perpetuate themselves in power. The need for self-preservation and protection of office turf put internal pressure on those in power on to their positions and surround themselves with loyal supporters.

PHILIPPINE EXPENDITURE POLICY and PERFORMANCE

Government expenditures in 1970 rose to unprecedented levels, indicative of a larger government and the growing role of the public sector in the economy. The increase in government spending was justified in the name of development. In the 1970s the Philippines and many other developing countries embraced, the western concept of development propagated by the likes of Rostow, Harold and Domar, and Keynes, and integrated it into policy framework of the industrialized country-dominated World Bank and the IMF. Development meant following footsteps of the now developed countries and infusing heavy doses of foreign capital on domestic economic infrastructure and everything else will follow. Unfortunately, growth and development are just too expensive for developing countries. Debt and more debts have piled up. Revenues did not cope with the government’s heavy spending.

The fiscal character of the Philippine public sector has markedly changed since the 1970s. Its size has expanded in terms of the number of government departments, the number of government-owned or controlled corporations, the number of employees, the size of borrowings, and the size of the budget as a whole. The trend and direction of government expenditures received much attention particularly during the turbulent years of Martial Law, the post Martial Law, and the pre and post-EDSA people power revolution.

DEFINITION and CLASSIFICATION OF GOVERNMENT EXPENDITURES

GOVERNMENT EXPENDITURES Refer to the actual disbursement during a stated fiscal or accounting period, including expenses in current operating expenditures, capital outlays and the retirement of debt. It is the equivalent in money terms of all activities performed by the government in serving the common and joint needs of the populace.

CLASSIFICATION OF GOVERNMENT EXPENDITURES

BY OBJECT Under this classification are two (2) expenditure types: CURRENT OPERATING EXPENDITURES (COE) and CAPITAL OUTLAYS (CO). COE are further disaggregated into personal services and maintenance expenses.

a. CURRENT OPERATING EXPENDITURE (COE)

COE comprises the PS and MOOE. These refers to expenses or purchases of goods and services for the conduct of normal government operations within a budget year.

Personal Services (PS) Refers to provision for the payment of salaries, wages and other compensation (merit, salary increases, allowances, honoraria, GSIS life and retirement benefits, contractual services, overtime pay, other personnel benefits) of permanent, temporary, contractual and casual employees of the NG.

Maintenance and Other Operating Expenses (MOOE) Refers to expenditures to support the operations of government offices such as those for supplies and materials, traveling expenses, communication services, repairs and maintenance of government vehicles, water, illumination and power services, discretionary expenses, representation and emergency expenses, others.

b. CAPITAL OUTLAY OR CAPITAL EXPENDITURES (CO)

Refers to purchases of goods and services, the benefits of which extend beyond the budget year and which add to the assets of the government. It includes land and land improvement, building and structure outlay, furniture and equipment outlay, investment outlay, loans outlay, livestock, work animals outlay, and equity investment in capital stock of GOCCs.

BY SECTOR

a. ECONOMIC SERVICES

Include agricultural, agrarian reform and natural resources; industry, trade, labor and tourism; utilities and infrastructure; other economic services.

b. SOCIAL SECTOR

Include education; housing and community amenities; health; social security and welfare; housing and community development; other social services.

c. DEFENSE

Domestic security; peace and order.

d. GENERAL GOVERNMENT

General administration; public order and safety; subsidy to LGUs; other general public services.

e. TRANSFER PAYMENTS

This refers to grants, subsidies and contributions, awards, indemnities, SSS benefits and other claims.

f. NET LENDING

This refers to the advances by the national government for the servicing of government-guaranteed corporate debt, net of repayments on such advances, during the year. It includes loans outlays or proceeds from national government program loans re-lent to GOCCs.

g. DEBT SERVICING

Refers only to interest payments.

h. DEBT AMORTIZATION

This refers to the sum of principal repayments for loans payable by regular installments, and annual contributions to the debt sinking fund for debts payable upon maturity.

EXPENDITURE POLICIES and PROGRAMS from 1972 to 1986

The Medium Term Philippine Development Plan (MTPDP) of President Marcos emphasized the pursuit of economic development and social justice. Its strategy for the development involved:

➢ the attainment of a dynamic and balanced economy through increased agricultural and industrial production, trade diversification and rationalization, transformation of the energy structure, application of science and technology, and proper management of natural resources and the environment; and

➢ more equitable access to social development opportunities and the utilization of human resources in nation building.

The economic sector was the focus of government expenditures in line with the strategy of development finance.

The Marcos government assumed a very aggressive role in economic activities during the period. It created a number of government-owned or controlled corporations (GOCCs), and at the same time, gave priority to the economic services sector, particularly infrastructure and agriculture. The Marcos strategy of development, however, was heavily dependent on foreign capital.

The 1935 Constitution did not envision foreign borrowing as a powerful fiscal tool nor did it set limitations on foreign loans. It was RA 4860 dated September 8, 1966, as amended which first provided the legal basis for public foreign borrowing.

When Marcos declared Martial Law in 1972, he abolished Congress and exercised executive and legislative powers. The fiscal policies of Marcos took a radical shift from principle of balanced budget to one of deficit financing, wherein borrowing plays a crucial role in the financing of development programs. Eventually, deficit financing developed into a well-ingrained policy and easily became the major source of government financing. This policy shift was institutionalized in PD No. 1177, dated July 30, 1977, which also mandated in section 31 the automatic appropriation in the annual budgets of debt service payments to government-incurred loans.

The fiscal policies of the government also took the form of rapid expansion of public investments at a time when government revenue performance was deteriorating and resulted in massive fiscal deficits largely financed by foreign borrowing. The fascination of the Marcos government for borrowing particularly from foreign sources eventually led the country to ominous debt crisis of 1983. In absolute amounts, Philippine external debt outstanding based on central Bank estimates, soared from US$2.732 billion in 1972 to US$24.816 billion in 1983.

By the end of 1985, public external debt has reached US$26.252 billion. Unfortunately, for the Filipinos, poverty degenerated into absolute poverty. More people become poorer while the rich became richer, unemployment swelled; and the quality and quantity of public services deteriorated further.

Actual expenditures were greatly influenced by the domestic political and social developments as well as by the developments in the global economy. In 1981, the national government felt obligated to rehabilitate private companies on the brink of collapse due to the fall in commodity prices and the softening of the world market. The program continued until 1984 when the government could no longer afford such drain on resources. The already critical situation intensified when the leading standard-bearer of the opposition was assassinated, causing capital flight and forcing the government to impose strict foreign exchange controls, devalue the currency and raise domestic interest rates to unprecedented levels.

By 1984, the crisis necessitated a refocusing of government expenditures away from long-term projects to ore short-term concerns, including debt servicing and the grant of wage increases to somewhat cushion the purchasing power of government workers from high inflation rates.

Under Marcos, the emphasis of the budget was on the provision of economic services, particularly basic infrastructure for power and energy development, transport and water supply as well as industrial development. Towards the end of his rule, the sectoral distribution of government expenditures necessarily took a different twist as the debts incurred in 1970s became due for payment. The amortization of debt servicing was to continue in the succeeding years. Budget priorities were changed from economic services to debt servicing. The economic services sector, which used to account as much as 40.7% of the budget in 1980 had much smaller budget share of 26.3% in 1985.

By object personal services (PS) expenses grew consistently during the period. The increases were intended to finance the 10% salary adjustment granted to government personnel pursuant to the National Compensation Circular No. 27 and to additional cost-of-living-allowances, additional government shares to life and insurance premiums, and contributions to the PAG-IBIG fund. The government policy on MOOE was moderate increases on less essential activities. Thus, increases in the MOOE were primarily intended for loan and interest repayments. Table 30 give us the object of distribution of national government expenditures from 1960-1985.

Table 30. Percentage Distribution of National Government (NG) Expenditures
By Object, 1960 - 1985 [pic]irisiIRIS • share to total national government expenditures • sources: Briones Leonor M. Public Fiscal Administration, 1996; Commission on Audit, National Government Financial Reports; The GNP and Population data were taken from the Philippine Statistical Yearbook.
Table 31. Percentage Distribution of National Government Expenditures
By Sector 1960-1985

[pic]sources: Briones, 1996: Statistical yearbook, various years

With respect to capital outlay, investment outlays were the largest accruing to GOCCs. This was consistent with the policy of Marcos of ensuring adequate funding support to public corporations as the primary implementers of the development program of government. This was also reflective of the growth in the role played by government in the economy. However, during the crisis years, expenditures for this item were also drastically reduced.

EXPENDITURE POLICIES and PROGRAMS from 1986 to 1992

From 1980 to 1990, as in previous years, the general pattern of government spending was prescribed by the MTPDP. Three successive five-year development plans – 1978 – 1982, 1983 – 1987, and 1988 – 1992 – invariably called for the following expenditure policies.

➢ Expansion of capital investments to build up the productive base of the economy; ➢ Provision of adequate funds to maintain infrastructure and other service facilities; ➢ Encouragement of greater financial independence and efficiency among state-owned enterprises; ➢ Streamlining of government’s administrative machinery; and ➢ Delegation of greater authority and responsibility to LGUs in project implementation. The period 1986 to 1992 was a period of adjustment and reconciliation. We had a new government installed in February1986 via people power revolution. The economy was in worst state than in 1972. The real GNP growth rate was negative and the budget deficit had reached Php. 11.141 billion. Inheriting a domestic debt of Php. 116 billion and a foreign debt of US$ 28 million. Aquino responded to the economic crisis by assigning a major role to fiscal policy. Fiscal policy focused on the effective management of the huge debt and financing of the fiscal deficit, restructuring of the tax system, and realignment of government expenditures. She reprioritized the budget to stress short-gestating, employment-generating projects for rural communities. Early during her term, the government assumed the non-performing assets of government financing institutions (GFIs) and absorbed liabilities, mostly foreign loans, associated with such assets. This accounted for the sizable increase in government spending since 1986.