government budget

government budget
Forecast of governmental expenditures and revenues for the ensuing fiscal year.

In modern industrial economies, the budget is the key instrument for the execution of government economic policies. Because government budgets may promote or retard economic growth in certain areas of the economy and because views about priorities in government spending differ widely, government budgets are the focus of competing political interests. In the U.S. the federal budget is prepared by the president's Office of Management and Budget. The U.S. Congress has considerable input, influencing the budget's preparation through negotiations with the president and considering it in detail on its official submission to Congress.

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      forecast by a government of its expenditures and revenues for a specific period of time. In national finance, the period covered by a budget is usually a year, known as a financial or fiscal year, which may or may not correspond with the calendar year. The word budget is derived from the Old French bougette (“little bag”). When the British chancellor of the Exchequer makes his annual financial statement, he is said to “open” his budget, or receptacle of documents and accounts.

General considerations

Role of the budget
Traditional functions
      Government budgetary institutions in the West grew up largely as a result of the struggle for power between the legislative and executive branches of government. With the decline of the feudal system, it became necessary for kings and princes to obtain resources for their ventures from taxation rather than dues. With the disappearance of the old feudal bonds, taxpayers demanded to be consulted before they were taxed. In England this was written into Magna Carta (1215), which stated:

No scutage or aid shall be imposed in our kingdom unless by common counsel of our kingdom, except for ransoming our person, for making our eldest son a knight, and for once marrying our eldest daughter, and for these only a reasonable aid shall be levied.

      This related to taxes only, not expenditures. For centuries Parliament seemed content to restrict the amounts that the sovereign levied while letting him spend the money as he pleased. Only after the controversies of the 17th century culminated in the Glorious Revolution (1688–89) and the Bill of Rights did Parliament extend its concern from taxation to the question of expenditure control.

      The histories of many countries have turned on financial crises. In France, for instance, the struggle between the monarchy and the nobility over control of tax revenues was one of the causes of the Revolution of 1789 that led to the overthrow of both the monarchy and the nobility.

      The U.S (United States). budget system also evolved out of controversy. In the early days of the republic there was a dispute between Alexander Hamilton (Hamilton, Alexander) and Thomas Jefferson (Jefferson, Thomas) as to the amount of discretion that the executive branch should exercise in the spending of public funds. Jefferson's victory enabled Congress to assert its authority by making appropriations so highly specific as to hinder executive action. Had Hamilton won, the treasury would have attained extraordinary power in relation both to Congress and to the president.

Modern functions
      In the 20th century a high proportion of economic activity is controlled, directly or indirectly, by various levels of government (federal, or central, state, local, etc.). Thus the budget has taken on a number of other functions as well as the simple monitoring of the overall revenue and expenditure of government. Expenditure programs are now planned in considerable detail, but the sheer scale of public spending raises major control problems, and varying systems of control have been tried in different countries. Taxation is used not only to raise revenue but also to redistribute income and to encourage or discourage certain activities. Government borrowing, in order to finance recurring deficits or wars, is so substantial that budgetary policy has important effects on capital markets and on interest and credit generally. Because the budget is now so important to national economies, a number of different procedures for deciding on the structure of the budget have been developed, and these vary considerably between countries. In some, the United Kingdom, for example, most planning is carried out in secret by ministers and civil servants, and public and parliamentary debate is minimal; while in others, the United States, for example, there is lengthy debate during which the budget can be changed significantly. The different levels of government complicate the budgetary process with differing spheres of influence and control over particular items of expenditure.

      The budget has also come to be used to achieve specific goals of economic policy. It was long recognized that government borrowing could have important effects on the rest of the economy. As the scale of government activity increased, the levels of expenditure and taxation were seen to have substantial direct effects on the total demand for goods and services in the economy. This raised the possibility that by changing these levels the government could use its fiscal policy to achieve full employment and reduce economic fluctuations. This stabilization function has been used by many countries, with varying degrees of success, to expand the economy out of recession and to control inflationary pressures. In the United Kingdom, for example, postwar policy involved a sequence of “stop-go” moves by government for stabilization; unfortunately these often occurred too late and had unintended destabilizing effects.

      As well as affecting the overall economy, the budget may have significant (intended and unintended) effects in specific areas. Taxes affect incentives to work or to consume, while taxes, benefits, and expenditures all affect the distribution of income. In this manner, budgets, particularly those that cause major changes, have considerable political as well as economic impact.

The accounting functions of the budget
      Traditionally the budget is presented to allow scrutiny (by taxpayers, voters, and the legislature) of the resources raised by government and the uses to which these will be put. The publication of a budget thus performs the role of generating accountability for the actions of government at various levels. Historically, the focus of budgets has been to ensure that expenditures and revenues are properly authorized; more recently, the budget has been developed as a framework within which complex decisions on the allocation of resources can be made more effectively.

Alternative approaches to the budget
      In order to deal with the increasing complexity of government's role, most countries have experimented with a variety of forms for the budget and its presentation. Among the more important of these are the administrative budget, the current and capital budget, program and zero-base budgeting, and the full-employment budget. The variety of budgeting methods is extended to the types of efficiency measures used to increase value for money and to the alternative methods of projecting expenditures in cash, volume, and cost terms.

Administrative budget
      The traditional administrative budget contains the executive's recommendations concerning the raising of what Magna Carta referred to as “scutage or aid” and the disposal of it for purposes of government. This kind of budget is designed to control expenditure; accordingly, it emphasizes the salaries and tasks of civil servants rather than the results that they are supposed to achieve. The control objective of the administrative budget naturally gives rise to the doctrine that the budget should be balanced. Deficits imply irresponsibility. Surpluses imply the imposition of unwarranted tax burdens on the public.

      The limitation of the administrative budget is that some important items receive less than adequate attention or are excluded from it entirely. Military procurement is one example. Neither budget offices nor appropriations committees are well equipped to scrutinize the actual procurement of ships or aircraft. Consequently, in most countries large expenditures on military items are often treated perfunctorily while the activities of civil servants receive inordinate amounts of attention. The basic weakness of the administrative budget is that it is principally concerned with whether expenditure has been properly authorized, rather than whether money has been well spent.

      Moreover, the administrative budget often excludes trust funds used to finance contributory old-age and unemployment insurance; taxes are paid directly into the funds and disbursements made out of them. The theory is that the government acts as trustee for the public and that the public is protected by having its social security taxes put in a separate fund. Many countries have adopted this idea of “ social insurance”; it formed the heart of Bismarck's social policy for Germany in the 1870s and of the British welfare state, founded in 1948. In most cases, however, the attempt to generate a distinct fund has failed, and “contributions” have become just another tax with expenditures on, for example, retirement pensions paid irrespective of the resources available to the fund.

      Other items may be included in the budget on a net rather than a gross basis. For instance, the total receipts and expenditures of the post office or other commercial activities of the public sector usually do not appear; only the deficit or surplus does. This is justified by the theory that, first, business management is not well performed by legislative committees and, second, that so long as a business undertaking pays its way, its conduct is not a matter of public concern. The problem is that the distinction between commercial and noncommercial activities is often arbitrarily made.

Current and capital budget
      The administrative budget traditionally deals only with current expenditures; in many countries, some items are regarded as inappropriate for inclusion because they finance capital expenditures or are loans to other public bodies. Such items are then included “below the line,” and the traditional concept of budget balance is not applied to them; instead, it is regarded as permissible to finance them by borrowing (credit).

      Direct public works (public utility) or investment in nationalized industries are regarded by most countries as suitable for loan financing on the ground that they are productive assets that will yield a revenue sufficient to cover their cost. They may do so either directly, as in the case of a toll highway, or indirectly by increasing the general economic welfare, as in the case of a free highway. If, however, there is no market in which the output of a public activity is sold, there can be no objective test of its value. Hence, governments are often tempted to classify expenditure on such assets as capital items that yield a social but no economic return (e.g., free playgrounds) or a lower economic return than any private sector institution would accept (as in government support for declining industries). For this reason, distinctions between current and capital expenditures in public accounts are often viewed with suspicion.

      This suspicion may be increased where, as is often the case, the rules for what is regarded as current or capital are rather indistinct. Moreover, governments have been reluctant to adopt the systematic distinction between current and capital items, or between cash flows and profit and loss accounts, or to construct a balance sheet, even though these mechanisms of monitoring receipts and expenditures are universal in private sector accounting. The federal government of the United States, for example, has resisted the idea of a capital budget, even though there was strong pressure for one in the 1930s when economists and politicians wanted to legitimize the government deficit. Among U.S. state and municipal governments, however, loan financing of public works is the regular practice for two reasons. First, those bodies are usually unable to finance their projects by current taxation; second, they do not want to finance them because the projects are generally of a long-term nature.

      Most national governments have become accustomed to thinking in terms of national economic policies in which the amount of borrowing to be undertaken depends on current requirements for stability and growth. This makes capital budgeting less attractive, particularly if the government wishes to use the budget to supplement the national flow of savings. The more need there is to increase saving, the smaller should be the amount of government borrowing. On the other hand, government borrowing is justified when private savings tend to exceed private capital requirements.

      This lack of explicit monitoring for the capital position of governments can have serious consequences when the government unwittingly takes on large liabilities or uses capital assets to finance current expenditures. Examples are provided by the growing problems in some countries in financing generous state pension schemes and the wasting of assets such as oil reserves.

Cash and unified budgets
      Faced with the increasing complexity of government activities, many countries have fallen back on the idea of the cash budget. This has the merits of simplicity and comprehensiveness. As used in the United States, it presents total payments by the federal government to and from the public (including other levels of government). It is thus similar to the cash flow account of a modern business. Trust fund expenditures and receipts are included, as well as cash payments and receipts involved in loan transactions. Government business undertakings such as the post office, however, are still included on a net basis.

      In the United Kingdom all public expenditure planning is now performed on a cash basis, and many programs are “cash limited,” whatever the level of inflation. This procedure, to which the United Kingdom moved in 1976, is justified on the grounds that such treatment helps to control inflationary pressures and exerts stricter control than, for example, planning in volume terms.

      The cash budget suffers from the defect that it is not directly tied to government decision making. Liabilities incurred do not synchronize completely with payments. This is because government expenditures result from appropriations and other forms of commitments; cash expenditures may follow appropriations and other commitments of money only after a considerable lag, notably in the case of construction and procurement. Appropriations relate to actions in the future. Expenditures result from past decisions. Both kinds of information are needed for a complete appraisal.

      The U.S. government, in an effort to reduce public confusion over the large variety of budgetary concepts, has adopted a so-called unified budget concept that is more logical than the cash budget but differs from it only in some details that do not materially affect the budget aggregates. The unified budget differs from the traditional administrative budget in two main ways: it includes the receipts and outlays of most funds, and it eliminates interagency transfers.

Program budgeting and zero-base budgeting
      Traditionally, government expenditures have been considered as inputs rather than outputs. This is because, in the classical 19th-century conception, the well-run government does not produce a marketable output. The program budget derives from this concept; it attempts, however, to classify expenditures in terms of the outputs to which they are devoted. For example, a traditional school budget would categorize expenditures in terms of teachers, books, and buildings; what came out of the process would be left to the reader's intuition or experience. The program budget, in contrast, attempts to assign expenditures to specific outputs, categorizing them according to numbers of children completing various programs.

      In government, budgets have traditionally been constructed according to departments and agencies of government. This may be justified on historical or administrative grounds, but it does not necessarily correspond to the structure of activity. Every country organizes the civilian and military components of its foreign policy in separate departments, but this is frequently a serious obstacle to effective policy-making. Again, the requirements of good administration suggest that there should be a single department of agriculture. But that department's activities impinge on those of others, in both domestic and foreign policy. A budget constructed according to actual programs would cut across departmental boundaries.

      Program budgeting is an attempt to apply the economics of choice to public decision making. Its basic assumption is that explicit choice among alternative courses of action leads to better results than do other methods of decision making. At the highest governmental levels difficult choices must be made that involve the use of a portion of the nation's resources. But the same principles apply to decision making at lower levels. The problem of allocating resources within a specific field, such as health or education, is conceptually similar to that faced in drawing up the national budget.

      Program budgeting also takes account of the time dimension in many government programs. New undertakings often take time to come into operation. A typical new program may have to pass through a research and development phase and an investment or construction phase before it reaches the operating phase. Alternative programs may differ considerably in this respect. The process of choosing among alternatives frequently involves trading the present against the future. One alternative may require 10 years before it yields results; another may yield smaller results but more quickly. The kinds of choices made in government often involve alternatives that cannot be measured in terms of market value. For this reason governmental decisions involve much more uncertainty than do most business decisions.

      A governmental program must therefore be frequently revised in the light of unfolding circumstances. Indeed, every year should be thought of as the first year of a new program. Pervasive uncertainty also requires a high degree of flexibility and a capacity for program revision. A number of options should be held open, particularly in the development phase. Even though this may appear costly, it is less costly than commitment to a design that proves to be inappropriate because of circumstances that could not be foreseen in the early stages.

      In most countries the usual procedure for deciding on government expenditure in a forthcoming year has been to assume that existing expenditure was appropriate and then to decide on incremental expenditure for each program. Such an approach means, however, that the change is likely to increase, rather than decrease, expenditure and that little attention is paid to what the full existing program actually accomplishes.

      In the late 1970s many countries recognized that the steady growth in public expenditure was putting a strain on their economies, and they attempted to curtail the growth. The Jimmy Carter (Carter, Jimmy) administration in the United States, although planning for a steep rise in expenditure as a proportion of gross domestic product (GDP), also attempted to introduce the concept of “zero-base budgeting,” whereby the entire government program, not just its incremental parts, was to be evaluated each year. This idea, which involved considerable changes to existing procedures, was applied to some programs on a selective basis but never had the impact its designers envisaged. A similar attempt was made in the United Kingdom in the introduction of program analysis reviews (PAR), but again attempts to evaluate systematically the whole of government expenditure were unsuccessful. The degree of inertia in the system and the vested interests of existing institutions have proved too entrenched to be overcome by administrative procedure.

Full-employment budget
      Although the idea of budget balance in the administrative budget has been the dominant consideration in the budgetary policy of most countries, it has gradually been realized that such a concept may be inappropriate when external shocks such as exchange rate movements or a world recession occur. Because varying levels of unemployment are a major reason why expenditures may change without comparable change in the public sector output, the concept of a full-employment budget has emerged. This type of budgeting is based on receipts and expenditures that would prevail under conditions of full employment. The approach views the actual expenditures and receipts for the coming year as of secondary importance; it assigns primary importance to the influence of the budget on the national economy. In time of recession a budget deficit may thus be presented as a necessary step toward achieving a balanced budget at full employment. Ideally, the budget should include estimates of expenditures and revenues at full employment, and also estimates of the same items at the anticipated level of employment. These ideas have been extensively used in the United States.

      An analogous procedure could be used with respect to inflation, but this idea is still far from acceptance, because governments are no less reluctant to anticipate inflation than they are to budget for unemployment.

      The U.S. full-employment budget was developed during World War II and has been regularly published in the president's annual Economic Report since 1962. Other countries have adopted similar measures as an aid to policy-making; for example, The Netherlands' “structural budget margin,” developed in the early 1960s, and West Germany's “cyclically neutral budget,” calculated by its German Council of Experts beginning in the late 1960s.

      An analogous procedure could be used to correct for the impact of inflation. When inflation is rapid, interest rates are correspondingly high and a government may appear to run a deficit as a result of high debt servicing costs even if the real value of the debt is declining. The United Kingdom, for example, has seen a government deficit in almost every year in the postwar period, even though its debt has been a diminishing fraction of national income, because growth and inflation have been increasing the level of national income. Although inflation adjustments have been widely advocated and often adopted in private sector accounts, governments have been reluctant to adopt them for public finances because of the element of uncertainty in prediction.

Value for money measurements
      As the emphasis in budgetary policy has shifted away from mere authorization of government spending and toward more public scrutiny of what government accomplishes, the idea of appraising value received for money spent in government finance has grown in importance. This has led to an increasing variety of measurements of public sector efficiency. In general terms, taxpayers need to be satisfied that their money is being used wisely. Because of the wide variety of items within even a single program, however, it is often difficult to identify precisely what is spent on the provision of each service, and the services that are provided rarely have well-developed private sector counterparts to act as a basis for comparison.

      In some programs, governments have developed efficiency measures that relate observable facts, such as the quality of national health or the number of operations performed, to the cost of providing the service. The use of such measures is by no means widespread, however, and their basis is often open to question. The principal difficulty is that there is either no meaningful measure of the output of a public service—defense, for example—or output is complicated and multidimensional—as with education or health. The result is that any method used to measure efficiency is open to debate and challenge.

      Attempts to control public expenditure, particularly since the mid-1970s, have led to some reexamination of which programs should remain in the public sector. In the United Kingdom many services (for example, hospital cleaning) have been transferred from public sector agencies to private contractors, in the search for more cost-efficient purchasing.

Budgetary planning: cash, volume, and cost terms
      There are three principal bases for public expenditure planning: cash, volume, and cost. The cash basis is concerned simply with the projected money expenditure on the services involved. Making such projections is difficult because what the cash expenditure will buy depends on what happens to prices over the planning period. Moreover, many public expenditures cannot be planned in cash terms, because legislation prescribes the output. Most social benefits, for example, must be paid to anyone who is entitled to receive them, and this means that the government cannot control directly the amount of the expenditure.

      The volume basis is concerned with the planned output of public services. The difficulties of measuring output, however, have already been noted. More often the planning process, assuming that changes in inputs are associated with changes in outputs, operates with reference to the cost basis of programs.

      All countries have an annual program of public expenditure allocation, in which those responsible for individual programs argue for greater allocations for their activities and those responsible for raising the money attempt to control the amount allocated. In practice, the results of this process depend as much on the political weight of individuals in charge of a spending program as on an objective assessment of its desirability. The normal practice is to take as a base what each program spent the previous year and then argue about incremental changes, rather than (as under zero-base budgeting) to consider each program in its totality. This creates perverse incentives, in that departmental heads who have saved money in one area in a particular year have an incentive to spend more in other areas in order to protect next year's total budget.

      The basis for most expenditure planning is therefore the number of public employees already in place and the volume of goods and services purchased in the base year. This, multiplied by base year prices, gives the input volume in the base year. In the late 20th century many countries (particularly the United Kingdom) have been abandoning this approach, largely because it gives inadequate control of total expenditure. One reason for a given volume's costing too much to supply is the so-called relative price effect. This arises because goods and services bought by the public sector (labour, medical care, or defense equipment) may rise in price more quickly than commodities generally. Once this has been determined, volume can be expressed in cost terms. The relative price effect is somewhat subjective, however, because of the difficulty of measuring the quality of goods and services. In the case particularly of health care and defense, the relative price effect will often contain the increased price of services and improved equipment, which are actually a volume increase.

      Cost measures, however, merely reflect the cost of a given input; controlling public expenditure in cost terms without taking full account of the relative price effect's change may lead to inappropriate volume responses or, more commonly, spiraling costs as existing input volume is maintained. Hence many countries have moved one stage further, attempting to monitor and control public expenditure in purely cash terms. The United Kingdom's public expenditure programs, for instance, are now “cash limited.”

      Although planning in cash has a superficial simplicity, at times of significant inflation it is not a very appropriate tool, and differential price rises may lead to a balance of expenditure provision somewhat different from the intended plan. In practice, although cash planning is presented as the base on which decisions are taken, those countries that have adopted this approach in fact allow informal flexibility in cash budgets, with volume measures being implicitly, if not explicitly, adopted.

Components of the budget
      In the United States the budget for each fiscal year contains detailed information on the outlays intended by the federal government and the receipts expected, including those from trust funds. The budget also divides authorized expenditure into that which can be carried out without action by Congress (Congress of the United States) and that which requires further authorization. In any year, about half of federal expenditure requires authorization from Congress; by witholding this authorization, Congress is able to force changes in the government's budgetary policy. The budget also summarizes the outstanding debt of the federal government and estimates the size of the surplus or deficit expected on the basis of the revenue and expenditure projected in the budget.

      The U.S. budget is presented as a coherent whole for lengthy consideration by Congress, during which time it is often substantially revised. This joint consideration of revenue and expenditure is also common in most European countries. Practice in the United Kingdom, and in other countries with a British parliamentary tradition, continues to reflect the historical separation of revenue and expenditure. The U.K. (United Kingdom) budget consists of a number of different documents, with only limited attempts being made to relate one to another. A sketchy report of the government's intentions is given in an Autumn Statement, usually published in November, and detailed expenditure plans are provided in February or March in a White Paper. The U.K. budget, usually presented in March, is mainly concerned with taxation and is represented in a separate volume entitled Financial Statement and Budget Report. This gives a general outline of budgetary strategy, details of proposed tax changes, and estimates of likely revenues, as well as details of such items as capital receipts from asset sales and the size of the contingency reserve of unallocated money to cover unforeseen events.

      Partly because of this fragmentation of the U.K. budget, and the difficulty of relating the public expenditure White Paper to the Financial Statement and Budget Report, debate is limited, and it is rare for any detail to be changed after the documents are published. The fragmentation of the budget is exacerbated further by the presentation of details of social security expenditure in yet another document.

Composition of public expenditure
      Expenditures authorized under a national budget are divided into two main categories. The first is the government purchase of goods and services in order to provide services such as education, health care, or defense. The second is the payment of social security and other transfers to individuals and the payment of subsidies to industrial and commercial companies. Both types are usually labeled “public expenditure,” and in many countries attention usually focuses on the aggregate of the two. This obscures important differences in the economic significance of the two items, however. The first represents the public sector's claim on total national resources; the second the scale of its redistribution within the private sector.

      In most Western countries, the share of the public sector in total economic activity averages between 20 and 30 percent. This reflects the proportion of workers who are employed in the public sector or in publicly financed activities, the proportion of national output generated there, and the proportion of incomes derived for productive services that is earned by public sector employees.

      Some of these activities yield commercial revenues—the postal service, for example. Most have to be financed by taxation. In addition, the government raises taxation in order to redistribute income within the private sector of the economy. It taxes some activities and subsidizes others—through investment credits, for example. On a larger scale, it uses the benefit and social security system to make payments to needy individuals and raises taxes in order to subsidize those who warrant it. With this redistributive activity, plus the direct government productive activity financed from legislation, the total share of incomes taken in taxation is higher than the share of government in total production. It averages around 40 percent in Western economies.

      In addition to direct expenditures, attention has been drawn to “tax expenditures.” If the government favours a particular activity—such as investment—grants or tax concessions may be awarded to that activity. The two procedures have much the same effect on investment and on government revenues, but one appears to raise public expenditure and the other to reduce taxation. It has been suggested that these tax expenditures—tax reductions motivated by an economic or social objective—should be the subject of a tax expenditure budget similar to the public expenditure budget, and several countries have now moved in that direction.

      For all private and public purposes within the economy, the scale of public activity is best measured as a proportion of national income: the total of incomes generated or (equivalently) of expenditures on goods and services.

      The overall proportion of national income that is collected in taxes, raised from profits on government activities, or borrowed varies widely in the developed nations. This variation reflects different national decisions concerning the proportion of a nation's activity deemed most appropriate to have carried out by the various levels of government or by government agencies. Much of the variation occurs because of choices over the provision of health care (mostly public in the United Kingdom, mostly private in the United States) and over the level and importance of transfer payments.

      By the late 20th century the share of national income devoted to public expenditure varied from almost 60 percent in countries such as Denmark, Sweden, and The Netherlands to about 30 percent in Australia, the United States, Japan, and Greece. The United Kingdom, Italy, France, and Germany all devote between 40 and 50 percent of their national incomes to public spending.

      Expenditures on transfers also vary widely, depending partly on how redistributive the government wishes to be, partly on how much of this redistribution is carried out through the tax system, and partly on factors such as the number of old people and the level of unemployment. The dominant payment in every country is for old-age pensions, and the amount depends on how well-developed private sector pensions are. Another factor is the extent to which the government chooses to use direct subsidies rather than tax concessions to stimulate the economy.

      In the United States in the late 20th century, between 25 and 30 percent of the federal budget was being spent on defense and a similar amount on social security and Medicare payments. Only a fairly small proportion of the federal budget was spent on other items, with about 10 percent of the overall budget being devoted to the salaries and other remuneration of federal civilian employees. Most other provision of public services—education, roads, welfare, public health, hospitals, police, sanitation—were provided by state and local governments, which spent about three times as much as the federal government on the provision of civilian services. Both levels of government in the United States raise taxes from a variety of sources. The relative importance of state, local, and federal expenditure on civil functions has varied considerably, with the role of the federal government being greatest before World War II and declining after the war.

      In Europe public expenditure was both larger (as a share of national income) and more centralized during this same time. The United Kingdom, for example, devoted about 12 percent of national income to centrally funded social security programs; 5 percent each to defense, the health service, and education; and smaller amounts to industrial support, law and order, and subsidies of various kinds. Although most revenue is raised centrally in the United Kingdom, administration of many programs is carried out at local levels, partly financed by a local property tax (taxation) and partly through grants from the central government. Local authorities are usually regarded as separate decision-making units, but the role of central government as a provider of finance that sets rules and imposes penalties has become dominant.

John Anderson Kay Ed.

Growth of public expenditure
      The proportion of national income devoted to public spending rose considerably during the 19th and 20th centuries. Much of this historical rise, however, cannot be taken as a direct measure of either the relative importance of government as a whole in economic decision making or of the comparative roles of central and lower levels of government. Inflation aside, in most countries the major reasons for the persistent rise in public spending since the middle of the 19th century have been war and the preparation for war, the rise in the cost of pensions for veterans, the great increase of the administrative role of government in response to expanded and urbanized populations, and the marked rise in the demand for a varied list of public services as the vote was gradually extended to the lower income classes.

      Writing in 1890, the Irish economist Charles Bastable observed that “in nearly all modern States outlay is steadily increasing,” and “the older doctrines of economy and frugality have disappeared.” He was referring to doctrines that had developed in the latter part of the 18th century, particularly in connection with the Industrial Revolution. He did not mean that there had been a “golden age” in which governments entirely refrained from interfering in the private sector. As Bastable himself pointed out, even the strictures of Anne-Robert-Jacques Turgot and Adam Smith on “excessive” government intervention did not preclude the encouragement of new industries.

      In western Europe there was a long tradition of government influence on private economic decisions. The interventionist policies in the England of Henry VIII, Elizabeth I, and Oliver Cromwell, the France of Louis XIV and Colbert, and the Russia of Peter the Great are examples of such influence. But the sense of confidence conferred on the industrial class through the industrial and transportation revolutions of the 19th century, especially in Britain and the United States, produced an atmosphere that was unfavourable to government intervention. This did not, however, prevent rising pressure for government spending on economic resources, together with a secular rise in the magnitude and variety of the output of public goods that is still in evidence.

      In the post-World War II period, government expenditures rose sharply. In the United States, overall public expenditure rose from 20 percent of gross domestic product to around 30 percent by the mid-1980s. Over this period, transfer payments as a proportion of national income nearly doubled. Other countries have seen an even steeper rise, both in expenditure on goods and services and in transfer payments. In Denmark public expenditure rose from about 18 percent of national income in 1950 to nearly 60 percent in the 1980s. The Netherlands experienced similar growth.

John Anderson Kay Kenyon Edwards Poole

Problems of public expenditure control
      The problems of controlling public expenditure vary across programs. Some are “demand led.” Transfer payments, and particularly social security payments, are largely dependent on the number of old or unemployed people. Apart from reducing benefits (which may in turn be prevented by past commitments), or through macroeconomic policies designed to reduce unemployment, for example, there is little that can be done to limit these payments. Most countries have seen a steady rise in transfer payments as the longevity of the population and the benefits of pension schemes increase.

      Public expenditure also depends on the price of the goods and services that the public sector buys and on the efficiency with which they are used. Public sector workers are often highly organized and may be well placed to demand pay increases from an employer who is able to recoup the costs from taxation. Public sector purchasing may be inefficient—civil servants may find it easier to enjoy a comfortable relationship with their suppliers, and, in fields such as health and military expenditures, administrators may demand the latest technologies with little regard for their cost-effectiveness.

      At the same time, much of the public sector lacks the incentives to increase efficiency that apply to private firms in competitive markets. It is easier to resist innovation, and bureaucracies often have a conservative culture in which it is more important to avoid mistakes than to experiment with new techniques and procedures. With few external indicators of performance, managers in the public sector may feel inclined simply to promote the growth of their organization and the staff numbers and budgets that they control.

      As the level and complexity of governmental involvement in the economy has risen, so public expenditure has become increasingly difficult to control. The only people with enough information to monitor their program needs are those actually engaged on the program. Coupled with technological change, the general tendency has been for expenditures to rise without any clear evidence of increased levels of service being provided. Indeed, in many key areas, such as health and education, expenditures have risen steadily at the same time that the public perceived a deterioration of service.

      Governments in most countries have responded to this problem by occasional severe contraction of particular programs or of public expenditure in general. Numerous countries have adopted cost-cutting exercises with some limited success. But attempts at cost reduction can provoke inappropriate reactions. If politicians discover expenditure can be reduced without reducing the value of the services provided, they may insist on further cuts. If, on the other hand, popular or politically sensitive activities are restricted, there will be pressure to restore expenditures. Managers of public sector programs therefore often have incentives to respond to cuts in ways that maximize, rather than minimize, the effects on the services provided.

      Governments acquire the resources to finance their expenditures through a number of different methods. In many cases, the most important of these by far is taxation. Governments, however, also have recourse to raising funds through the sale of their goods and services, and, because government budgets seldom balance, through borrowing. The subject of borrowing, because of the intricacies of deficit spending, is covered in a separate section of this article.

      Most countries raise resources through a variety of taxes, including direct taxes on wage and property income (personal income tax), contributions to trust funds, and a variety of indirect taxes on goods, either at the final point of sale or on the inputs used to make them. A smaller amount of revenue is raised from taxes on property, on capital gains, and on capital transfers, particularly at death. Most countries have a separate corporate income tax.

The composition of tax revenues
      The balance between these different taxes has varied considerably over time and between countries. In the United States, sales taxes are relatively unimportant, accruing mainly to state and local governments. Federal government revenue is principally derived from taxes on personal and corporate income; until the 1980s the corporate share was diminishing, but changes in tax law tended to increase it. This dominant reliance on income taxes in the United States is a post-World War II phenomenon; at the beginning of the 20th century about half of all tax revenue came from taxes on property and half from sales taxes. Income tax was introduced on a regular basis only in 1913.

      The tradition in Europe is somewhat different, with indirect taxes being relatively more important. All the countries in the European Communities impose a tax (at varying rates) on value added, charging tax on output from industry and rebating it on inputs. In the United Kingdom, value-added tax (VAT) raises about half as much as the personal income tax, and together excise duties and VAT raise about one-third of total tax revenue. U.K. corporation taxes on non-oil activities are relatively light, although oil revenues have become very important, despite fluctuations, contributing increasingly to all tax revenue.

      Australia, New Zealand, and the Scandinavian countries all rely heavily on income and profits taxes, which account for about half of all revenue raised from taxation. In contrast, France, Greece, Portugal, and Spain raise only about one-fifth of their revenue from such taxes. Social security taxes are important throughout Europe, raising about 30 percent of all revenue in Austria, Belgium, France, Greece, and Italy and rather more in Germany and The Netherlands. The Scandinavian countries, Ireland, and the United Kingdom rely less on these taxes, which are not used at all in Australia and New Zealand. Japan, like the United States, raises about 30 percent of total tax revenue from social security taxes.

      Payroll taxes are relatively unimportant, raising significant amounts only in Australia, Austria, France, Ireland, and Sweden but rarely exceeding 5 percent of total revenue. Property taxes (property tax) rarely account for more than another 5 percent, with the United Kingdom being the exception in this case. Sales taxes, excise duties, and VAT account for nearly one-half of all revenue in Greece, Ireland, and Portugal, compared with less than one-fifth in Japan.

The relationship between tax rates and revenues
      In deciding how to raise enough money to finance its expenditure program, a government faces a large number of different considerations. First, the tax system is complex, containing many different taxes, each often having a complex structure. Perhaps the major consideration is the effects on behaviour that particular tax rates will cause.

      Income tax has a graduated structure whereby no tax is paid on the first segment of income and then each subsequent segment is taxed at a higher rate than the previous one. In the United Kingdom most taxpayers pay tax at a uniform marginal rate, while other countries have more steeply rising rate schedules. Higher marginal tax rates make work less rewarding, which tends to reduce work effort. High marginal rates, however, may have less impact in some areas than others, a factor that needs to be considered when deciding who should bear the tax burden. Such considerations presumably have influenced the trend in many countries to tax the wealthiest groups.

      Whatever the structure of the tax, the general proposition that increasing tax rates will reduce work effort usually holds; and this, in turn, tends to reduce tax revenue again. A vigorous debate has persisted over the “Laffer curve,” which postulates that at some level of tax the disincentive effects will be so great as to mean that an increase in tax rates actually reduces revenue. This idea has been influential in leading governments to attempt to curtail the share of public expenditure in national income. The administration of Ronald W. Reagan in the United States cut taxes in 1981 in the hope of increasing revenue by stimulating the economy, and, while this succeeded to some extent, expenditures grew even more, causing a substantial increase in the budget deficit.

      Tax rates affect the pattern and level of consumption. Excise duties, value-added tax, and sales taxes all change the relative prices of goods and the attractiveness of consumption relative to saving. Once again, an increase in tax rates will generate responses that tend to cause a reduction in revenue, and, again, governments must balance the strength of these effects when deciding on which rates to increase. Other considerations, such as the protection of domestic industries, also affect such decisions.

      Tax rates also affect commercial decisions, and the balance between individual and corporate taxes must reflect this. Accordingly, many countries have sought to attract new manufacturing industry with tax concessions. Finally, as rates rise, taxpayers seek more ways to avoid taxes. They employ tax advisers to find more tax-efficient routes, which, in particular, can involve a search for capital rather than income-yielding assets and the movement of activities overseas to less heavily taxed countries.

The balance between taxes
      As the share of public expenditure in overall national income has risen, so has the strain on traditional sources of tax revenue. The original stalwarts, property and capital taxes, have shrunk in importance and been replaced by increasing reliance on income taxes, on social security contributions, and on sales taxes of various kinds. The balance between these taxes varies considerably among countries, which make differing decisions about the appropriate balance between taxes.

      Each of the main types of tax is perceived by taxpayers in different ways. Social security taxes have everywhere risen in importance, partly as a result of the growth of social security expenditures but also because their association with the benefits received, however loose, reduces the unpopularity of increases. Income taxes tended to increase in many countries until the mid-1970s—even longer in the United States—because the exemptions and rate schedules were not fully indexed to inflation. This was later reversed, however, by indexation or explicit tax cuts.

      Sales taxes (sales tax) are less obvious, as they change the price of goods a consumer buys rather than his income. At times of high inflation, it is often hard for taxpayers to identify what proportion of the price rise is actually caused by increased taxation, which has led to increasing reliance on this kind of tax. But sales taxes too have their limits; when the proportion of tax on a good is sufficiently high, consumption declines, and there is political pressure from consumers and industry to reduce the tax increases. Governments have been reluctant to increase indirect taxes significantly as the control of inflation has become a major policy goal.

Sale of goods and services
      Taxation is not the only means by which a government can raise revenue. It can charge for the services it provides, or it can undertake profitable commercial activities. This is done to some degree by all Western governments, although the revenue raised is much less than that raised by taxation.

      Charging for public services faces a number of difficulties. Perhaps the most important is collection costs. Public services such as roads and parks are difficult to charge for, because they are closely integrated with the community. Some countries have tolls on major highways, and a few parks have admission charges, but in the main these are supplied free of charge. Other goods, such as museums and art galleries, are easier to charge for, but attempts at charging often generate more political opposition than can be justified by the limited revenue that could be raised.

      A second consideration in deciding on charges is that it is rarely economically efficient to charge for public goods. Parks and roads, for example, have high initial costs but relatively low costs per user. Imposing a charge will mean that fewer people use them, and unless congestion is sufficiently severe to reduce others' enjoyment, less overall welfare will be generated.

      In many countries, particularly the United Kingdom, many industries are publicly owned, and these include highly profitable industries such as those supplying gas or electricity. The profits from these industries provide revenue. It is an open question, however, whether they provide as much revenue as would the assets employed if these were invested in private sector companies. Other publicly owned undertakings make substantial losses, and this reduces the net value of any surplus. Few countries rely heavily on public sector industries for revenue, the nationalization of specific industries being usually justified on other grounds.

John Anderson Kay

Government borrowing (deficit financing)
      Although most of the resources required for public spending are raised each year through taxation, it is rare for any modern budget to balance in any one year. For a variety of reasons, ranging from a desire to accelerate capital spending to a policy of economic stabilization, governments may choose to raise some of their resources by borrowing (credit) rather than taxation. Most countries today run an annual budget deficit, and the deficits have tended to increase in size. For some countries—such as the United States and many developing countries—this means that the burden of the debt has been steadily increasing. Most European countries have a substantial accumulation of liabilities from wars and reconstruction, not shared by the United States. Even though they also run a current deficit and their total debt may be increasing in size, the rate of increase is often much smaller than that of the United States and often below the rate of growth of national income. Thus, the burden of the debt is increasing less rapidly and, in some countries, may even fall. In times of inflation it may be possible for a government to run a deficit without actually increasing the real burden of debt, as inflation erodes the real value of its existing debt.

      Although most countries ran a deficit budget in the late 20th century in response to a world recession and high rates of inflation, only a minority did so in the 1960s; in the European Communities, on average over the period 1960–73, only Belgium, Ireland, Italy, The Netherlands, and the United Kingdom ran a deficit.

Forms of public debt
      The necessity for governments to borrow in order to finance a deficit budget has led to the development of various forms of public debt, which are now a central feature of all capital markets. Governments may owe public debt in the form of bonds, notes, bills, and the like, which require specified payments to the holders at designated times. For the most part, public debt differs from private debt only in that it is an obligation of government rather than of private individuals or corporations.

      Public debt may be classified according to various criteria.

External and internal debt
      If the debt is held outside of the issuing jurisdiction, it is called external; if it is held within the jurisdiction, it is called internal. The U.S. national debt is almost entirely internal, while the debts of many developing countries and of local governments in the United States are largely external.

Maturity period
      Public debt ranges in maturity downward from infinity to periods of a month or even a few days. Debt instruments without a maturity date, requiring merely the payment of interest, are often called consols. The name originated in Great Britain, where the first important indeterminate-period debt issue happened to be one that consolidated a number of separate issues.

      A large portion of government debt consists of bonds (bond) with specific maturities of five years to 99 years or more. Twenty- and 30-year periods are common. These are often known as long-term or funded debt.

      Debt of maturity less than five years is often called short-term or floating debt and may take several forms: notes, with maturities from one to five years; treasury bills, with maturities from one month to a year and often sold at auction; and certificates of indebtedness, with similar maturity periods but available at a fixed interest rate.

      The length of the maturity period affects what is known as the liquidity of the debt—i.e., how quickly it can be converted into money. Securities with very short maturity periods are constantly repayable in money and thus have maximum liquidity. As the period of maturity increases, the liquidity falls, unless a capital loss is to be incurred, and the pure debt characteristic increases.

Type of issuer
      Government debt may be directly issued by a government or by semiautonomous governmental organizations. Examples of the latter would include the railways and provincial power authorities in Canada and various federal lending agencies in the United States. Their issues may be guaranteed by the government (general obligation bonds) or may rest solely upon the enterprises themselves, to be paid out of their revenues. In the United States the latter type of obligation is known as a revenue bond.

      The great bulk of all government debt consists of marketable securities. These securities are negotiable and are sold freely on the market. They are usually issued in relatively large denominations, $1,000 or higher, and interest is paid by check or coupon on a periodic basis. Since they are salable, their price fluctuates from time to time, going above maturity value when the current market interest rate falls below the interest rate that they bear and falling below the maturity value when the current rate rises or when fear about the ability of the government to pay interest develops.

      Other bonds bought by the public are not marketable but can be redeemed, at least after a specified period, for their principle plus accrued interest. Various savings bonds, including those of the United States, are of this kind.

Other characteristics
      Bondholders may receive current interest either by redemption of coupons attached to the bonds or by check from the government. Alternatively, interest may be receivable only upon maturity or redemption of the bond, as in the case of savings bonds. Interest and principal are usually payable in fixed monetary units, but they may be payable in amounts with fixed purchasing power based on changes in price levels.

Economics of government borrowing
      Government borrowing is likely to have effects upon the economy substantially different from those of other methods of financing, and the existence of a sizable debt may likewise have important consequences. The effects of retiring (or repaying) the debt may also be significant. National government borrowing has the greatest impact, but that of subordinate units may have some influence as well.

Effects of borrowing
      Government borrowing in the strict sense includes only borrowing from the private sector of the economy—from individuals, corporations, and various financial institutions, including banks. When the government obtains its funds from the central bank (the Bank of England, the Bank of Italy, the Bank of Japan, or the Federal Reserve System in the United States), it is really creating money rather than borrowing it, since the purchasing power is made by the central bank and no obligations to the public are created.

      When a government borrows, funds are transferred from the lender to the government, the lender exchanging his money for government securities. The effect is to reduce the liquidity of the lender—his command over cash—to an extent dependent upon the nature of the securities. The reduction in liquidity is small with short-term securities and greatest with nonsalable, nonredeemable securities—a type seldom issued except in time of war or other crises that create financial emergencies.

      Funds loaned to the government almost certainly come from savings (saving), unlike, for example, funds paid in higher taxes, which are more likely to come out of consumption. In many countries the major holders of public debt are, in fact, pension funds, which invest in government debt on behalf of the individual members of their pension schemes. To pay higher taxes, many individuals are forced to reduce their consumption since they have no margin of savings and are unable or unwilling to go into debt; others do so as a matter of choice, in an effort to keep their savings intact. Lending, on the other hand, is entirely voluntary. The person who buys government securities is not likely to increase his rate of saving or to decrease his consumption. If government borrowing raises the market rate of interest, this may in turn encourage the diversion of additional money to saving, as may government securities that offer additional attractions—such as small denominations or redeemability—not possessed by other securities. But both effects in total are not likely to be of any particular significance.

      The net effect of government borrowing on total spending and thus on employment and national income depends upon its influence on real investment—the purchase of new capital goods. In a period of unemployment, when savings are available in greater quantity than is required for investment, government borrowing does not compete with private investment nor make it more costly. In effect, the government absorbs funds that would otherwise be idle.

      In periods of full employment the situation is substantially different. With banks loaned up to the limit of their reserves and real investment absorbing all of savings, government borrowing will restrict private spending as much as an increase in taxation will under the same conditions.

      Government borrowing is of economic significance in several other respects. First, the buying and selling of government securities provides the central bank with a means of influencing the money supply, essential for effective monetary policy. Second, borrowing avoids the adverse effects that taxes may have on incentives, particularly if the taxes are raised sharply above levels to which persons have become accustomed. Third, borrowing permits government expenditures to be higher than would otherwise be feasible. Finally, the foreign borrowing of some governments gives them access to a greater quantity of foreign exchange, which enables them to finance the import of capital goods essential for economic growth. This consideration is not of concern to highly developed countries.

Effects of debt
      The existence of a government debt is of economic significance in itself, as distinct from the effects of the borrowing. In the first place, individuals who hold government securities regard them as a portion of their personal wealth. This is true even though the only way the government will ever pay the interest on the debt or repay the principal is by levying taxes on the community, which holds the debt. In this sense “we owe it to ourselves.” But since these links are not immediately apparent, the existence of a debt may make individuals spend more on consumption and save less than they otherwise would. The additional consumption may reduce the rate of capital formation and economic growth; it may also increase the level of employment over what it would otherwise be.

      Second, because government securities are more liquid than most other investments, their holders are able to increase consumption out of accumulated savings more easily than they could otherwise. This may contribute to inflationary pressures.

      Third, if investors, and particularly the business community, regard the national debt as a source of potential economic instability, their willingness to undertake real investment will be lessened. At times, particularly in the 1930s, there has been widespread fear of government debt even though there was, in reality, little basis for the fear. A similar phenomenon sometimes arises in the case of subordinate units of government. A large debt may discourage expansion of economic activity because of the fear of high taxes in the future and the realization that the large debt may prevent borrowing for urgently needed local improvements.

      When governments borrow they must meet interest obligations, and these are usually paid out of taxes. The payment of interest on government debt thus involves a transfer of wealth from taxpayers to bondholders. The taxes may have adverse effects upon incentives, while receipt of the interest will provide no offset to these adverse effects. The tax-and-interest-payment program is also likely to redistribute wealth in favour of higher income groups, since government bonds are likely to be held to a greater extent by those groups. The effect may be to increase saving and reduce consumption.

      Finally, large interest obligations lessen the ability of the government to finance other governmental activities. This effect is particularly obvious at the local level, where there are limited tax potentials.

Retiring the debt
      The retirement of government debt arising from a budget surplus has effects opposite from those of borrowing. Bondholders receive money in exchange for their bonds; though they could increase their consumption, they are more likely to put the funds into other securities and, as a consequence, security prices rise and money capital becomes more readily available for business investment. Whether it is used for that purpose depends, of course, on factors within the existing general economic situation.

      Money for retirement must be obtained from some source. If it is simply created, there is no repressive effect on consumption or investment, and total spending in the economy rises—although by an amount relatively small compared to the total retirement. If, as is more common, the debt is retired from tax revenues, consumption is reduced in substantial measure; the remainder of the tax is absorbed from savings, and real investment may be reduced. The net curtailment in spending from the program of debt retirement is likely to reduce total spending in the economy. Elimination of the debt has one other effect: while current taxes will be increased, future taxes required to meet interest and principal obligations will be reduced.

      It is commonly thought that borrowing shifts the burden of governmental activities to future generations, since those generations will be assessed higher taxes to pay the interest and principal. Some economists have disputed the idea, noting that future generations will inherit both the bonds and the obligations to pay them and collectively will be neither richer nor poorer than if the debt had not been incurred, except as a result of the difficulties incident to the debt and its retirement noted in preceding sections. Regardless of the methods of financing, the real cost of any governmental activity, war or otherwise, is borne in the form of reduced private consumption and investment and harder work or the like during the period in which it is carried on. The only burden on the future is that arising from the depletion of natural resources, and this is not affected by methods of financing. Nevertheless, the method of financing may affect the way in which the burden of public expenditure is shared among different groups, including age groups.

Limitations on public sector debt
 Although borrowing can often seem an attractive alternative to raising money from taxation or indeed to spending less, there are limits to how far a government can allow itself to become in debt either to its own citizens or to overseas investors (including intergovernmental agencies, such as the International Monetary Fund). In many countries, particularly in Latin America and in Africa, these limits have been exceeded in the late 20th century, with serious results for the stability of the country concerned. When debt rises to unacceptable levels, so that investors cease to believe in the ability of the country's tax base to support it, then drastic measures are forced upon the country, including severe contraction of the economy.

Problems of borrowing
      The desirability of government borrowing has been debated for centuries. The traditional argument against borrowing is, of course, the interest burden to which it gives rise, an argument applicable equally to private and governmental borrowing. These interest obligations require either higher levels of taxes, with possibly adverse effects on the economy, or reduced expenditures for other purposes. The payment of interest may easily result in a transfer of purchasing power to higher income groups, contrary to accepted standards of equity.

      As well as causing more and more of the government's resources to be used to pay interest on its debt, a large public debt can push interest rates up for other borrowers. If the government is persuading a high proportion of available funds to be spent on public debt, the amount remaining for investment in other places, for example, investment in industry, is correspondingly small, with the result that a higher price (or higher interest rate) needs to be paid to attract such investment. This has been seen as a serious constraint in recent years, and most Western governments have tried to reduce their borrowing in order to keep interest rates down. There is some debate over just how important public borrowing is for interest rates, with monetarists believing it to be extremely important. Other types of economists are more skeptical, contending that factors such as inflation and the availability of private sector investment opportunities are more significant.

      The financing of expenditures by borrowing instead of taxation and the debt itself, once incurred, increase total spending and so tend to produce higher prices and other inflationary effects in periods of full employment. During periods of full employment, any increase in government expenditures not offset by an equivalent decline in private spending for consumption or business expansion will be inflationary. This is the usual argument made against the use of borrowing instead of taxation from the standpoint of the goal of economic stability. It is primarily relevant to national government borrowing because the national government must assume the primary responsibility for lessening economic instability. But state and local borrowing is, of course, equally inflationary.

      Borrowing, if freely employed, can easily lead to increases in government expenditures beyond levels regarded by society as the optimum and may reduce the pressures for efficiency and elimination of waste. As governments consider expenditure levels, the adverse reaction to taxation serves as an offset against the favourable response to increased services that will have to be paid for by taxation and thus facilitates the attainment of a balance between government-produced services and privately produced services. But if borrowing replaces taxation and is generally accepted as a suitable routine method of financing, the pendulum will swing in the direction of increased governmental activity, and appropriate balancing will be lost. The best evidence of this danger is to be found in the history of state and local government finance in the early 19th century in the United States, when large sums of money were borrowed for purposes of limited usefulness to society. Borrowing appears to be a less painful method of financing government, but, as has been noted, the costs of public expenditure still have to be met from current consumption or investment.

Restrictions on borrowing
      Efforts have been made in some countries to set restrictions on government borrowing through legislative acts. In the United States, fear of excessive borrowing has resulted in restrictions on the amounts the executive, and even the legislative branches of government, can borrow. When many states found themselves in financial difficulties after borrowing heavily to provide funds for canals and railroads in the middle of the 19th century, public debt provisions were written into the constitutions of all but seven states. The provisions limiting borrowing differ widely. In most jurisdictions a maximum, usually expressed as an absolute dollar sum and one relatively low in terms of present-day expenditure levels, is set. Either this figure cannot be exceeded at all (except by amending the constitution) or it can be exceeded only with the approval of the voters at an election. In some places all bond issues require approval by popular vote and in some instances by more than a bare majority. The purposes for which funds may be borrowed and the duration of the issue are also frequently restricted. These constitutional restrictions have unquestionably lessened state borrowing; in so doing they have, perhaps, reduced waste, but they have also sometimes prevented urgently sought improvements. The limits have likewise greatly increased the use of revenue bonds, which are normally not subject to the restrictions. Unfortunately, the interest rate on these bonds is higher than the rate on other bonds.

      Restrictions on municipal borrowing in the United States are almost universal. The restrictions, established either in the state constitutions or by state legislation, limit the total sum to be borrowed by any particular unit to a certain percentage (from 2 percent to more than 20 percent) of the total assessed value of its property. The limits vary for different types of local units (city, county, school district, etc.). They usually do not apply to debts incurred for self-liquidating enterprises. In many states every bond issue must be approved by popular vote, in some instances by a two-thirds majority. In other states the limits established may be exceeded by popular vote, often with a requirement beyond a mere majority. Legislative controls also include maximum interest rates that may be paid, the duration of the issues, the purposes of the borrowing, and the establishment of means of retiring the bonds. Several states exercise review over local bond issues. Like the states, the local governments have found means of escaping the restrictions. Special taxing districts with their own debt limits are often formed when a city has reached its limit. Revenue bonds are also employed. In some states, such as Pennsylvania, there has been widespread creation of special authorities, school building authorities, for example, that have been established with the power to finance the building of schools by issuing revenue bonds. In turn, the authority pays interest and principal on the bonds from rentals obtained from the school districts using the buildings.

      While there are no constitutional limits on federal borrowing powers in the United States, Congress for many years has restricted borrowing by the Treasury Department. Before 1917 borrowing was permitted only upon specific authorization by Congress. After 1917 maximum figures were set at first for each type of loan and then, after 1938, as an overall total. The 1938 figure of $45,000,000,000 was gradually increased to a high of $300,000,000,000 in 1945 and reduced to $275,000,000,000 in 1946. Buttressed by a strong belief prevailing in Congress that refusal to raise the limit would check growth in government spending, the limit remained at the 1946 level until 1954. Eventually, pressure on the limit became so great that various government bodies such as lending agencies were forced to borrow on their own at higher interest rates. A series of increases was made in the 1960s and 1970s, and by the early 1980s the limit exceeded $1,000,000,000,000. Experts differ in their estimates of the usefulness of the federal limit. Some believe that it curtails government waste and unjustified increases in expenditures, while others argue that it reduces flexibility in meeting emergencies, checks needed increases in various activities, could prevent quick action to stave off a depression, and leads to uneconomical forms of borrowing.

      By the mid-1980s, the U.S. deficit approached an annual figure of $200,000,000,000 and was seen as a central economic problem. A movement grew for a constitutional amendment to prescribe a balanced federal budget. Such a constitutional provision would not, however, specify how such an outcome was to be achieved. Nor, given the many budgetary concepts described, would balance easily be defined. Congress instead passed the Gramm-Rudman-Hollings Act in 1985, which required arbitrary reductions in spending in all programs if the overall deficit failed to fall within certain limits that were set for the purpose of eliminating the deficit by the end of the decade.

      In Canada, neither the dominion nor provincial governments are subject to debt limitations. Local government limits are comparable to those in the United States, and in several provinces bond issues must receive the approval of a provincial agency. In the United Kingdom borrowing by local governments is subject to control, and limits are usually established in terms of a ratio of debt to total ratable value (assessed value of property). After World War II much local borrowing was channeled through the Public Works Loan Board, and thus was subject to additional control. There are no arbitrary limitations on the amount the U.K. central government may borrow; effective limits are set by the reaction of capital markets and of interest rates to borrowing.

Wartime finance (war finance)
      The use of borrowing is regarded as inevitable in periods of major war. If taxes were increased sufficiently to finance all war costs, they could seriously impede the war effort by impairing incentives to work and by reducing the overall morale of the people. The limits of economically and politically tolerable taxation may well be below the maximum feasible allocation of resources to the war effort. Adequate tax increases would also aggravate the inequities of the tax structure; an overall level that would reduce total consumer spending to a level equal to the rate of output of consumer goods might well push some persons below subsistence levels and make it impossible for others to meet fixed commitments. While the use of borrowing as a method of war finance makes the control of inflation more difficult, there appears to be no escape from the necessity.

Evolution of government borrowing
      The evolution of government borrowing was very slow. The extensive use of loans by governments became possible only after the ruler had become differentiated from the state and after the fact of the continuity of the state had been separated from the persons of the rulers. Other factors were also required: the development of a regular revenue source to provide funds for repayment of loans, a monetary system, and an organized money market. The earliest loans of medieval times were either forced loans or personal borrowing by the sovereign. Government borrowing in its modern form first occurred in medieval Genoa and Venice when the city governments borrowed on a commercial basis from the newly developed banks.

      Throughout much of French history public borrowing has been of major dimensions. Ministers of finance in the 17th and 18th centuries found the problem of managing the debt almost insuperable. During the Revolution that began in 1789, about two-thirds of the accumulated debt was repudiated, and the remainder was refunded in new securities in 1800 at a total of 926,000,000 francs. The sum increased by only 340,000,000 francs during the Napoleonic period because Napoleon's military expenditures were financed mainly by foreign levies. A large increase occurred during the Second Empire, when the debt rose from 5,516,000,000 francs in 1852 to 12,310,000,000 francs in 1870. The Franco-German War, which ended in defeat for France, and the consequent imposition of an indemnity of 5,000,000,000 francs by the victorious Germans raised the French public debt to more than 21,000,000,000 francs in 1873. Most of the increase was financed by four bond issues. After 1878 the debt increased further as a result of public works expenditures and France's colonial expansion until it stood at 34,204,000,000 francs at the outbreak of World War I. The war and its effects multiplied the debt, although at the same time inflation reduced the value of the franc by half. The inflationary trend continued throughout the interwar years, and by 1960 the franc had lost more than 99 percent of its 1914 value. The increase of the public debt in this period to 8,404,000,000,000 francs has to be seen, therefore, in the context of the continuing inflation. The issuance in 1960 of a new franc equaling 100 old francs automatically reduced the nominal value of the public debt to 1 percent of its previous figure. Following the introduction of the new franc, the national debt continued to rise.

      Government borrowing in the United Kingdom dates to the end of the 17th century. In 1692 legislation pledged the receipts from beer and liquor taxes as security for a loan of £1,000,000. The trend of the debt was upward throughout the next 150 years largely because of wars; by 1802 it had reached £523,000,000 and by 1840, £827,000,000. The second half of the 19th century saw gradual reduction of the debt to £610,000,000 in 1900, while the amount of debt still remaining became less significant because of the growth of the economy in the same period. World War I brought a tremendous increase, the 1920 figure being £7,828,000,000. The 1920s showed little reduction, and the figure rose slightly during the Depression years. World War II brought the level to £21,366,000,000 in 1945, and the figure rose in the postwar period—partly as a result of nationalization of industry. During the 1980s it surpassed £140,000,000,000.

      In the United States, when the federal government was formed, it assumed the debts of the states and various other obligations incurred during the American Revolution, all of which were funded into a single debt issue of $75,000,000 in 1790. The government was highly successful in avoiding additional borrowing in the early years, except for the War of 1812, and during 1835 all federal debt was eliminated. The years 1835 and 1836 were the only ones in the history of the country during which there was no federal debt at all. The American Civil War, only 25 percent of which was financed by taxation, pushed the debt to a total of $2,678,000,000 in 1865. Most of this debt was retired by budget surpluses during the following decades; debt reduction proceeded so far that bonds available for security behind national bank notes became inadequate. The debt remained relatively constant in the 1890s and during the early 1900s. World War I brought an increase to $26,000,000,000, consisting in part of short-term and intermediate-term securities and in part of Liberty Loan bonds. In the 1920s the government was able to reduce the debt; the low point reached was $16,185,000,000 in 1930, primarily by budget surpluses.

      The 1930s brought budget deficits because of the Depression and the efforts to stimulate recovery. Despite extensive borrowing, which raised the total debt to $42,968,000,000 by 1940, interest rates fell sharply as a result of the surplus of money capital and federal reserve action. A substantial part of the borrowing was on a short-term basis, partly because the interest on such loans was extremely low. With the outbreak of World War II, borrowing rose sharply and by 1946 the debt had reached $269,000,000,000.

      In the postwar period the debt fell to a low of $252,000,000,000 in 1948, then gradually rose. This increase was caused by budget deficits arising primarily from a high level of defense spending and the unwillingness of Congress to hold taxes to rates high enough to meet the expense and in some years from a desire to stimulate economic activity. During the 1970s the debt increased each fiscal year; by the mid-1980s it had passed $1,400,000,000,000, and it continued to grow, although some factions sought legislation that would put a ceiling on the national debt.

      The states incurred substantial debts in the early part of the 19th century, largely for public improvements, and some found themselves in financial difficulties. As a result, borrowing came nearly to an end until after 1900; after that date there was further borrowing, particularly for highways. After 1945 the state debt increased sharply and had passed $167,000,000,000 by the mid-1980s. Much of this additional borrowing was for highway purposes. The local governments have traditionally borrowed more than the states, largely because of the nature of their functions. Local debt in the 20th century increased steadily and had passed $287,000,000,000 by the mid-1980s.

      Canada's debt began with $75,000,000 (Canadian) at the time of confederation in 1867, when certain obligations were taken over from the provinces. The figure grew slowly until 1915, largely because of government railroad financing. World War I pushed the figure to $3,042,000,000 by 1920; the total rose as the Canadian National Railway was developed, fell slightly in the late 1920s, rose to $5,000,000,000 with Depression borrowing, and reached $15,713,000,000 at the end of World War II. Some debt fluctuation then took place and the figure reached about $17,000,000,000 by 1950. By April 1969 it had risen to $35,800,000,000 as a result of deficits. Canadian debt continued to rise until 1976, when it briefly decreased by about 5 percent from the previous year. By the mid-1980s the country's debt had surpassed $160,000,000,000. The path of provincial and local borrowing in Canada was similar to that in the United States, though with a slower rate of growth.

      The German Reich, founded in 1871, began as a confederation of sovereign states. Most financial powers remained with the individual states until the Weimar Republic was established in 1919. A French war indemnity of 1871 was used largely to reduce the public debts of the states. As late as 1913 the debt of the Reich (4,900,000,000 marks) was less than half that of Prussia (9,900,000,000 marks) and substantially less than the aggregate debt of all the other federal states (6,300,000,000 marks). The country's defeat in World War I led to financial chaos. In 1925, after the stabilization of the new Reichsmark, the public debt was 2,413,000,000 marks. In the 1930s the public debt rose, going to 52,060,000,000 marks by 1940. World War II was financed mainly by borrowing, from both the private sector and the central bank; by 1945 the debt stood at more than 300,000,000,000 marks. Most of this was wiped out by the postwar currency reform of 1948. Following this currency reform, West German public debt increased nearly fourfold in the 1950s, twofold in the 1960s, and fivefold in the 1970s; by the mid-1980s it had surpassed 360,000,000,000 marks.

      The rise of the modern Japanese state began in the latter part of the 19th century. The government began to issue bonds in 1870. The cost of financing the war with China in 1894–95 and a subsequent buildup of its army and navy raised Japan's public debt from 255,000,000 yen in 1890 to 506,000,000 in 1900. The war with Russia in 1904–05 cost about 1,500,000,000 yen, which was mainly raised by foreign borrowing. The financial burden of the growing empire was henceforth largely covered by taxation, so that public debt did not increase substantially from 1907 until the end of World War I. Between 1918 and 1930, however, the debt doubled. In these years a large proportion of the debt was in foreign-owned bonds. In the 1930s the government adopted heavy spending policies, mainly for military purposes, and in 1940 the debt was more than three times what it had been in 1930. Between World War II and the mid-1980s the debt had risen from 150,795,000,000 yen to more than 111,000,000,000,000.

      Local governments in Japan have always been heavy borrowers. This has continued to be true in the postwar years, when prefectures, cities, towns, and villages issued bonds on a scale approaching that of the national debt. Much of the local indebtedness was used to finance large public works programs.

Debt and national income
      The absolute figures of growth in government debt exaggerate the actual growth in the debt relative to the economy as a whole. In the first place, the general price level has increased significantly over recent decades; since debt obligations are stated in fixed monetary terms, the relative magnitude goes down as the price level goes up. The general rise in prices over a period thus reduces the problems created by the debt for the government and the magnitude of the adverse effects of the interest payments on the economy. The gain occurs at the expense of the bondholders, whose real economic position is worsened by the change.

      Second, the rise in national income reflecting an increase in output reduces the real significance of a fixed sum of debt for the economy. The combined effects of the real and monetary influences can be illustrated by expressing the size of the debt as a ratio to gross national product (GNP) over a period of years. In the United States the ratio fell from 129 percent in 1946 to 35 percent in 1980. It had risen again slightly by the mid-1980s. The ratio of interest payments to national income likewise fell until 1968, when it began to increase, reaching 3.8 percent in 1980. In the United Kingdom the ratio of national debt to GNP fell from 221 percent in 1952 to 136 percent in 1958. The ratio continued declining to less than 100 percent in the mid-1960s and less than 50 percent in the mid-1970s, although the size of the debt increased slightly over the period. By the early 1980s the ratio of national debt to GNP was about 43 percent.

Comparing debt in various countries
      An adequate comparison of debt burdens in various countries is difficult to make. The reported figures are by no means entirely comparable because they vary in their treatment of debt incurred for various commercial enterprises, loans from foreign countries, special issues, and the like. The relative importance of the national debt and the debt of subordinate units of government also varies, and figures for the latter are not available for many countries. Any comparison of absolute figures of debt in monetary terms is of limited value and may be very misleading because of problems of conversion to a common monetary unit. The only meaningful figure is the ratio of national debt to national income, and the significance of these figures is greatly lessened by the inaccuracy of national income data for many countries.

Sovereign debt
      The oil crisis of 1973–74 and its aftermath created a new instability in world capital markets. Some countries, particularly Middle East producers with few economic activities not based on oil, gained revenues much in excess of their capacity to spend. Others, particularly in the less developed world, faced balance-of-payments problems that they found difficult to cover. Some other oil producers, such as Mexico, borrowed heavily in anticipation of rapidly increasing revenues. Those countries with surpluses of revenues over expenditures wanted to retain the liquidity of the financial assets that they acquired, and Western banks increasingly took on the role of intermediaries between the surplus and deficit countries. This led to the growth of sovereign lending—bank lending either to governments or to agencies of governments with government guarantees. While a bank lending to a private individual or company normally requires examination of the relationship of the loan to the borrower's assets, and of the interest to income or cash flow, banks felt able to apply more relaxed criteria to sovereign loans.

      By the early 1980s, however, it was apparent that for many countries sovereign debt had grown to levels at which even the interest on these loans would be met only by further borrowings. Moreover, these countries' limited capacity to repay might be undermined by political or economic instability. The problem was particularly acute in Latin America, where U.S. banks had lent aggressively. Argentina, Brazil, and Mexico had very large external debts; smaller countries such as Bolivia, Ecuador, and Peru had debt burdens that were even larger in relation to their capacity to service them. Similar difficulties were encountered in Africa and in parts of eastern Europe, particularly Poland.

      The debtor countries were reluctant to repudiate their debts, which would have deprived them of access to the world capital markets and even perhaps to the world trading and payments system for a considerable time. At the same time, the lending banks were reluctant to demand repayment of their loans, which would have led to default and losses that would have wiped out a substantial portion of their reserves. Thus, there was a mutual interest in using the financial system to continue to support the indebted governments, and, paradoxically, the negotiating position of the borrowers was stronger than that of the lenders.

      These were highly unstable arrangements, arousing fears that major defaults would occur. Such defaults might well set off a cumulative process of demands for repayment and defaults that would undermine not only the economies of the debtor countries but also the banking and financial systems of the countries in which the lending (credit) institutions were located. Avoiding such a crisis has demanded continued sensitive responses on the part of international financial agencies, such as the International Monetary Fund and national regulatory institutions.

John F. Due John Anderson Kay

The budgetary process
      The budgetary process is the means by which the executive and legislative branches together formulate a coherent set of taxing and spending proposals. The mechanics of this process, and the relative roles of the two parts of government, differ considerably among countries.

Government versus private sector budgeting
      Although the process of preparing and discussing a national budget has progressed considerably during the 20th century, it is in a number of senses still inferior to the way budgeting is carried out by private sector companies or indeed by individuals. Commercial practice is governed by a series of well-defined rules, and firms are required to produce a balance sheet, a profit and loss account, and to monitor their cash flow carefully. The total indebtedness of a company is monitored closely by its shareholders, who are also critical of future forecasts of profits and growth. Individuals who fail to budget adequately are equally closely monitored by bank managers and credit agencies, and those with complicated affairs can draw upon skilled professional help.

      The accountability of government, even in a well-developed democracy, is in reality considerably less acute, or certainly less clear, than that of companies to their shareholders or individuals to their various creditors. As a result, governmental budgeting is frequently of lower quality than is the norm in the private sector. Forecasts of receipts and expenditures are often wildly at variance with reality; changes to accounting practices are sometimes made for cosmetic political purposes; and certain distinctions, such as those between capital and current expenditures, are frequently blurred deliberately.

      These criticisms of the national budgetary process are more valid in some countries than in others. The extent of scrutiny of the national budget varies widely, and governments vary in how ready they are to provide relevant information and to what degree they try to obscure features of the budget by complicated and disjointed presentation. The United States has a relatively open budget, which is presented as a whole and subjected to congressional scrutiny. In contrast, the government of the United Kingdom presents the budget in different documents at different times, and, although subject to parliamentary scrutiny, it is rarely changed.

Selected national budgetary procedures
      Since 1921 the budget of the United States has been the responsibility of the president. It is prepared under his direct authority by the Office of Management and Budget (OMB). The process begins when the various departments and agencies prepare their appropriation requests, based on expenditures required under existing law and those estimated under new legislation to be proposed by the president. These requests are carefully scrutinized by the OMB. In case of disagreement, Cabinet officers negotiate directly with the president, who is ultimately responsible.

      Unlike the budgets of many countries, that of the United States deals mainly with expenditures. Revenue is covered in much less detail. Great significance is ascribed to the size of the expected deficit or surplus, even though there is no legal requirement that the budget be in balance.

      The budget is submitted in January and normally applies to appropriations for the fiscal year beginning July 1. These must normally be spent in the following two years. For some items, such as construction or procurement of military hardware, appropriations are made to cover expenditures for the whole construction period.

      When the budget reaches the House of Representatives (Representatives, House of), it is distributed among the subcommittees of the Appropriations Committee. Each subcommittee is concerned with a particular organizational unit. There is virtually no consideration of the budget as a whole by the committee as a whole. Revenues fall under the jurisdiction of the Ways and Means Committee of the House and are considered separately and possibly even at a different time from appropriations. The upper house of Congress, the Senate, plays a secondary role with respect to the budget. Its Appropriations Committee acts as a kind of court of appeal from the House Appropriations Committee. These procedures allow more coordination than appearance would suggest. The committee chairmen are among the most influential members of Congress, and the committee staffs are experienced and skillful.

Economic impact
      The president sends three documents to Congress in January: the State of the Union Message, the Budget, and the Economic Report. The first is addressed to broad national policy, whereas the Economic Report is concerned with economic policy alone. In particular, it seeks to assess the economic impact of the budget and its effect on employment and prices. It is therefore mainly concerned with the stabilization rather than the administrative aspects of the budget.

      Budget makers in the United States must also consider the international balance of payments. This is a relatively new problem for the United States, which enjoyed a balance-of-payments surplus until the 1960s. Since that time, declining trade balance, coupled with heavy military commitments abroad, has required that budgetary and other economic measures be designed with international as well as national economic balance in mind.

Effect on resource allocation
      There is no formal machinery for ensuring that the budget strikes a satisfactory balance among the different programs contained in it. But the alternatives receive a good deal of scrutiny. Cabinet officers have their clienteles in the public and in Congress and through them can bring political power to bear in the competition for funds. Similarly, the congressional committees are able to exert some influence on the budget during its preparation. The president for his part is not passive; he has a political position of his own that permits him to assert his conception of the national interest. Other pressures come from the taxpayers, who are able to express their stand on expenditures both to Congress and to the president.

      A satisfactory outcome for the allocative process depends on the evenness with which these competing forces are balanced. Opinions differ. It can be said that the process of decision making is at least an open one, even though vested interests have entrenched themselves in particular areas. Although amendments to the budget are usually minor, the influence of Congress is not negligible. The prospect of facing Congress is a sobering one to the officers of government; congressional committees often strongly influence departmental budget recommendations. The secretary of agriculture, for example, may have a relationship with the agricultural committees of Congress that is closer than his relationship with the president.

      The U.K. budget is submitted to Parliament by the chancellor of the Exchequer, who is responsible for its preparation. The emphasis of the chancellor's budget speech is on taxation and the state of the economy, rather than on the detail of expenditures; public discussion is devoted mainly to the chancellor's tax proposals. The estimates of expenditures are sent to Parliament with less fanfare and are reviewed by the departmental select committees on estimates of the House of Commons. The reviews hardly touch matters of policy. While the committees do not amend the budget, they are influential through their criticism and advice.

      In the preparation of the budget, the Treasury appears to have virtually complete authority over the government departments on matters of detail. Major issues are settled in Cabinet discussions, the records of which are not available. The British system thus vests extensive controls in the Treasury bureaucracy.

      A major part of the budget speech by the chancellor of the Exchequer is addressed to forecasts of employment, prices, and the balance of payments, together with a discussion of fiscal and monetary policies. Economic analysis is a continuing preoccupation of the Treasury. Forecasts are prepared three times a year, although only published once a year with little detail; a budget committee composed of important financial and economic officials meets continuously to discuss policy matters. Their attention, however, is focused on tax, borrowing, and monetary policies rather than on the details of government spending.

      In the 1960s an attempt was made to plan government expenditures on a long-term basis. Emphasis was placed on the predetermination of expenditures, over a five-year period, in accordance with the expected (or desired) rate of growth of the economy. Planned expenditures are broken down by major functional categories such as defense, education, health and welfare, housing, and so forth, which are to serve as guides in the preparation of annual budgets. The functional breakdown is also intended to assist legislative discussion.

      More recently, the elaborate systems of planning and control developed in the 1960s have been abandoned. There is less, and less detailed, forward planning of public expenditure. Forecasts are presented in cash terms, and the levels of inflation or cost increases contained within them are only partly disclosed. The primary disadvantages of the old system were that it allowed expenditures to be driven excessively by the burden of past commitments and to be blown off course by rises in the cost of public sector inputs. The new system has almost the opposite weaknesses: it induces short-term planning, in which capital expenditure is squeezed in favour of current spending, and allows the volume of outputs and inputs to be governed by optimistic assumptions about price increases. This development, intended to assist in public expenditure control by providing simple-to-understand criteria, has, according to some critics, reduced public understanding of the public expenditure process and therefore the accountability of government for its actions.

      Germany differs somewhat from other countries in that there are unusual constraints on government borrowing and unusual reliance on countercyclical taxes and reserves. This is a direct result of Germany's history of extreme inflations. Detailed rules of budgetary behaviour apply to particular circumstances to determine whether deficits of borrowing are permitted.

      After a steep expansion in government expenditure in the 1950s and early 1960s, new legislation was passed in 1967 to restructure the budgetary process. This provides for a five-year Federal Finance Plan that covers expenditures and receipts of the federal government, the Länder (states), and the local authorities for each year of the plan. The plan includes the budget for the present year, the draft budget for the next year, and estimates for each of the next three years. These financial plans are linked to a macroeconomic projection based on published target values for various economic indicators. The system ensures that expenditure and taxation are planned together for a five-year period and that countercyclical measures are also considered in such a medium-term framework rather than as panic responses.

      Under Japan's 1947 constitution the Cabinet has the responsibility of preparing the national budget, which must then be submitted to the lower house of the Diet. Taxes can be imposed or modified only as prescribed by laws enacted by the Diet.

      The budget is prepared on a fiscal-year basis by the budget division of the Ministry of Finance. The centre of the budget system is the general account, which theoretically includes all revenue and expenditure directly applicable to the overall fiscal operation of the government. There is also a system of special accounts for the operation of government enterprises and other special aspects of government finance. Theoretically, each special account is self-balancing. In actual practice, however, there have at times been substantial deficits in the special accounts that have had to be covered by direct government appropriations, borrowings, and transfers of funds from one account to another.

      Under the Public Finance Law of 1947, the general account of the national budget must be either balanced or in surplus. The government cannot increase its net long-term debt without special legislation, and then the increase must be tied to some specific investment use.

Communist countries
      In countries having Communist governments, economic activity either is carried on by state enterprises or is subject to central control. The national budgets therefore have a much broader scope than in countries where most economic activity is in the private sphere. For example, in the now-defunct Soviet Union (Union of Soviet Socialist Republics) more than 90 percent of capital investment was financed by the government; in the United States the corresponding figure was less than 25 percent, and in the United Kingdom it was less than 50 percent.

      The two main sources of revenue are the profits of state-owned enterprises and the turnover tax on sales of goods from these enterprises. The relative proportions of the funds drawn from enterprises under these two headings vary; there has been a long-term tendency for the share of the turnover tax to decline and for profit transfers to increase.

      The budget is essentially a part of the national economic plan. It is drawn up every calendar year. Revenues and expenditures are usually in close balance. The budget is implemented by the ministry of finance, which scrutinizes the operations of the state enterprises in accordance with the economic plan.

Budgets of other levels of government
      Although the major budgetary decisions that affect the performance of the economy and the national debt are usually made by the central government, most countries have local or state governments that are responsible for the provision of various services and have the authority to raise revenues through taxation or to borrow on their own account. This devolution of authority is greatest in the United States, where the majority of provision of civilian services is carried out at state or local levels and where states have a tradition of being individual decision-making units. In the United Kingdom, by contrast, local-authority spending is constrained by rules set by the central government. Local authorities are also limited in their ability to borrow and to raise taxes, which are set by the central government. The budget of the European Community is an example where authority for major spending, particularly for agricultural support, has devolved to a transnational body.

State and local budgets in the United States
      Expenditures by state and local governments grew rapidly in the United States after World War II, particularly in the areas of education, health, and welfare services. Rising expenditures have been coupled with an expansion of the number of taxes used at this level and a widening of the traditional tax base from property. Although some local activity is financed by federal grants or by taxes that are shared between the federal and state level, the majority of expenditure at state and local levels is raised by locally determined taxes. Most federal grants are specific, for particular and limited purposes. The majority of such grants concern education, income security (e.g., public aid, housing assistance), and health programs such as Medicaid. The appropriate balance both of public provision and of revenue sources between federal, state, and local levels is the subject of continuing and vigorous debate.

      The individual states pioneered the use of income taxation (personal income tax) before World War I, but today the federal government is the major user of this form of revenue, with only limited scope for state income taxes. The decline of income taxes as a source of local finance at the state level was also hastened by problems with the definition of income and rising collection and compliance costs.

      Diminishing taxation of income, coupled with congressional rejection of a general sales tax in the 1930s, led to a growth in the use of the retail sales tax; in the late 20th century most states have adopted this as their major source of finance. Taxation of business income at the state level has also run into problems, not least because of its damaging effects on interstate trade; accordingly, although most states have tried such taxes, their importance remains limited. Property taxes (property tax), which once were the major source of state revenue, have, during the 20th century become largely a local tax.

      The 20th century has witnessed a large shift in expenditures on civil functions. In 1902 more than 70 percent of such functions were supported by local governments out of revenue raised predominantly from property taxes. But through the following decades, the proportion provided by local governments shrank to less than one-half, with the states taking on a larger share of the funding and the federal provision also increasing. During the period since World War II, the balance of state and local expenditure has shifted somewhat, with education increasing in importance (today it accounts for more than one-third of the state and local budget), while highways have increasingly become a federal function, carried out with either direct federal funding or grants-in-aid to state and local governments.

      Relations between the federal and state governments have been through a number of cycles in the postwar period. In 1948 grants to state and local governments were small, but they increased so dramatically during the 1960s that only the most dynamic local administrations could keep up. The allocation of resources came to depend more on the efficiency and wit of local administrators than on any particular need. A backlash to this situation took place during the 1970s, with a strong movement toward grants allocated by formula (loosely based on need) rather than application from the states. In 1972 Congress passed the State and Local Fiscal Assistance Act, which over a five-year period allocated some $30,000,000,000, one-third to state governments and two-thirds to local governments. This act, called general revenue sharing, continued into the 1980s although the amounts it allocated generally diminished after 1980. Only a fraction of the total amount of federal aid to state and local governments, estimated to exceed $100,000,000,000 per year by the mid-1980s, was provided by the act.

Local government finance in the United Kingdom
      The United Kingdom has a number of different levels of government, ranging from local parishes to the central government and including districts (town, borough, or city), counties, and metropolitan counties. All these levels have different traditional roles and are responsible for the provision of particular services. Historically, apart from direct contributions to finance the activities of parish councils and charges for local services, the only source of local revenue was a property tax called rates.

      Rates are levied, at levels determined by county and district authorities, on both households and businesses in proportion to the ratable value of the property they occupy. This ratable value, in principle revised periodically, is supposed to reflect the rental value of the property in a base year; increases in revenue are caused not by changes in ratable values but by steady increases in rate poundage (tax rate).

      The domestic rates system of collecting revenue for local government was replaced in Scotland in 1989 and in England and Wales in 1990 by a community charge, or poll tax, determined by each community and payable by nearly every adult resident. (The rates system remains in use in Northern Ireland.) The flat-rate poll tax proved highly unpopular, leading to large-scale demonstrations and the worst riot in the city of London in the 20th century. In April 1993 the controversial poll tax was replaced with a council tax, under which each household pays a single bill based on the market value of its property and on the number of adults living in it. Rebates and discounts are available for low-income households.

      Local taxes do not raise sufficient funds to cover expenditure, so that local authorities are very dependent on grants from the central government. These are determined according to complex formulas that relate them to needs and resources in each local area. The central government now tries to limit local expenditure by imposing penalties on high-spending authorities through the grant system.

Budget of the European Economic (European Community) Community (EEC)
      Each year, European countries that are part of the European Economic Community agree on a budget for the EEC. This covers expenditure on agricultural support, on regional and social development, and on the financing of various transnational agencies. The budget is presented in a series of drafts that are substantially revised following discussion among ministers from the various countries.

      Finance for the budget of the EEC is provided by the common external tariff levied on all imports from outside the EEC, by levies raised on agricultural imports, and by a national contribution that is set, in most cases, as a fixed percentage of the “value-added base” (roughly the national income) of each member state. This is subject to a limit set at 1 percent by the Treaty of Rome but which was subsequently raised to 1.4 percent.

      The EEC budget is mostly devoted to financing the Common Agricultural Policy (CAP), which endeavours to protect farmers by guaranteeing them high prices for their output, often at as much as double the world price. This has led to overproduction of many goods and the accumulation of various surpluses, which are stored at community expense or sold at cheap prices. The costs of this policy have been difficult to control, and the budget of the EEC, as a consequence, has lurched from crisis to crisis as the limits on agricultural expenditure have been steadily exceeded.

John Anderson Kay Ed.

Additional Reading
Studies of the governmental budget include Jesse Burkhead, Government Budgeting (1956); E.S. Kirschen et al., Economic Policy in Our Time, 3 vol. (1964); J.R. Hicks, The Social Framework: An Introduction to Economics, 4th ed. (1971); United States. Congress, Planning, Programming, Budgeting: Inquiry (1970); David J. Ott and Attiat F. Ott, Federal Budget Policy, 3rd ed. (1977); Peter C. Sarant, Zero-Based Budgeting in the Public Sector: A Pragmatic Approach (1978); and Wilfred Beckerman, An Introduction to National Income Analysis, 3rd ed. (1980). Survey of Current Business (monthy), published by the Bureau of Economic Analysis of the United States Department of Commerce, together with its supplement, The National Income and Product Accounts of the United States: Statistical Tables (irregular), provides practical analyses. The Brookings Institution annual Setting National Priorities explores U.S. budgetary developments; and the London Institute for Fiscal Studies does the same for the United Kingdom in its IFS Report Series.Components of the budget and their interrelation are explored in Richard A. Musgrave, Fiscal Systems (1969, reprinted 1981); Hugh Heclo and Aaron Wildavsky, The Private Government of Public Money, 2nd ed. (1981); Alan T. Peacock and Jack Wiseman, The Growth of Public Expenditure in the United Kingdom, 2nd rev. ed. (1967); Leo Pliatzky, Getting and Spending: Public Expenditure, Employment, and Inflation, rev. ed. (1984); Carl S. Shoup, Public Finance (1969); Harold F. Williamson (ed.), The Growth of the American Economy, 2nd ed. (1951); Alan S. Blinder et al., The Economics of Public Finance (1974); Charles L. Schultze, The Politics and Economics of Public Spending (1968); J.A. Kay and M.A. King, The British Tax System, 3rd ed. (1983); Carolyn Webber and Aaron Wildavsky, A History of Taxation and Expenditure in the Western World (1986); Mervyn A. King and Don Fullerton (eds.), The Taxation of Income from Capital: A Comparative Study in the United States, the United Kingdom, Sweden, and West Germany (1984); John F. Due and John L. Mikesell, Sales Taxation: State and Local Structure and Administration (1983); Charles E. Walker and Mark A. Bloomfield (eds.), New Directions in Federal Tax Policy for the 1980s (1983); Mark Ashworth, John Hills, and Nick Morris, Public Finances in Perspective (1984); Henry C. Adams, Public Debts: An Essay in the Science of Finance (1887, reprinted 1975); John Maynard Keynes, How to Pay for the War (1940); Tilford C. Gaines, Techniques of Treasury Debt Management (1962); Warren L. Smith, Debt Management in the United States (1960); Edward Nevin, The Problem of the National Debt (1954); Henry C. Murphy, The National Debt in War and Transition (1950); A. James Heins, Constitutional Restrictions Against State Debt (1963); James M. Buchanan, Public Principles of Public Debt (1958); and James M. Ferguson (ed.), Public Debt and Future Generations (1964, reprinted 1982).The budgetary process at both national and local levels is discussed in Richard A. Musgrave and Peggy B. Musgrave, Public Finance in Theory and Practice, 4th ed. (1984); Arthur Smithies, The Budgetary Process in the United States (1955); Aaron Wildavsky, The Politics of the Budgetary Process, 4th ed. (1984); Sir Herbert Brittain, The British Budgetary System (1959); Samuel Brittan, Steering the Economy: The British Experiment (1971); R.W. Davies, The Development of the Soviet Budgetary System (1958, reprinted 1979); David Novick (ed.), Program Budgeting: Program Analysis and the Federal Budget, 2nd ed. (1969); Richard A. Musgrave (ed.), Essays in Fiscal Federalism (1965, reprinted 1977); Wallace E. Oates, Fiscal Federalism (1972); C.D. Foster, R.A. Jackman, and M. Perlman, Local Government Finance in a Unitary State (1980); and J. Richard Aronson and John Hilley, Financing State and Local Governments, 4th ed. (1986).Kenyon Edwards Poole John F. Due Assar Lindbeck Charles Nicholas Morris Ed.

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  • government — governmental /guv euhrn men tl, euhr men /, adj. governmentally, adv. /guv euhrn meuhnt, euhr meuhnt/, n. 1. the political direction and control exercised over the actions of the members, citizens, or inhabitants of communities, societies, and… …   Universalium

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