Lesson 8 Economic Regulation PDF

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Public Finance I

Marta Ramirez

Topic 3: The budget of the public sector. The Public Sector needs instruments for organizing and planning its activities to achieve two basic objectives: -

Control of activities: submit spending and income policies to the legislature that must approve budget laws. Effectiveness and efficiency: rationalize public management, allowing the achievement of public policy objectives at the minimum cost.

Budget: legal and economic framework to which the expenses and income of the public sector must comply. 1. The Budget: budget concept and process. The public sector budget has been defined in very different ways: -

Government short-term economic plan. Economic quantification of the government's economic policies. Accounting expression of the economic plan of the Public Sector for a given period. Etc.

The most complete definition is the one formulated by Neumark in the 1950s: The budget is a systematic and encrypted summary, drawn up in regular periods, of the expenditure forecasts -in principle mandatory for the executive branch- and of the revenue estimates foreseen for cover such expenses. Its main characteristics are: 

Anticipation: forecast, operations of the Public Sector in a future period.

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Quantification: forecasts encrypted and in accounting language, classified according to different ordering criteria. Budgetary income and expenses are balanced in accounting, since all expenses have planned financing, which does not imply that there is balance in the economic sense, and budget deficits and surpluses may arise.

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Mandatory: obligation to comply. The authorizations for expenditures are limited in nature, and cannot be exceeded except for specific legally foreseen circumstances. Revenues are estimates of potential revenue. They may or may not be exceeded depending on the quality of the projections made.

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Regularity. The budget is drawn up and executed at regular intervals of time. The budget year normally lasts for one year.

Chronological development: 

Preparation: Corresponds to the executive branch. Phase in which economic techniques are used to a greater extent. Variable duration (The most frequent is 6 months). In Spain, it must conclude before October 1, the date on which the government must have approved and sent the General State Budget bill to the Congress of Deputies.

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Discussion and approval: Duration of 3 months. The project can receive amendments and be finally approved or returned to the government. If the budgets are not approved

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Marta Ramirez

before January 1 of the fiscal year to which their figures refer, the budgets of the previous fiscal year will be automatically extended. 

Execution: Starts on January 1 and runs throughout the calendar year. Budget execution may modify the approved figures in some cases. The control of compliance with the budgetary provisions is carried out by bodies of the Public Sector itself. In the case of Spain, the General Comptroller of the State Administration (IGAE) is the body in charge of the control functions.

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Settlement and control: The budget for each fiscal year is settled on December 31, the date that opens the last phase of the budget cycle: external control. Before October 31 of the following year, the IGAE must form the General State Account, a document that will be sent to the Court of Accounts, the body in charge of exercising external control of budget execution by delegation of Parliament. After the examination and verification of the General Account, within a period of 6 months, the plenary session of the Court will raise the appropriate proposal to the Cortes, thus closing the budget process, whose total duration is approximately 3 years.

2. The budgetary principles. “Set of rules that discipline the budget institution and affect the different phases of the budget cycle. They are classified as political, accounting and economic. " I.

II.

III.

Political principles:  Competence: the powers are distributed to achieve a balance between the two powers of the State that intervene in this matter: the legislative and the executive. Legislative: approval and control. Executive: preparation and execution.  Unit: elaboration in a single document.  Universality: collect all income and expenses.  Specialty: the resources must be assigned exactly to the objectives and purposes set in the approved budget and that the established spending limits are not exceeded.  Temporality: approval and execution for a specified period of time.  Advertising: all phases must be public. Accounting principles:  Box unit. Income and expenses must be centralized in a single treasury, which is responsible for management. No allocation of public income to any specific type of public expenditure.  Gross budget: income and expenses must be collected at their gross amount, without any deduction.  Specification: prohibits the transfer of funds from one game to another.  Closed fiscal year: the budget must refer to a specific period of time, so that the planned expenditure for one year is not carried out in another. Economic principles:  Limitation of spending. The budget has to be kept to a minimum. This principle was formulated in the liberal state and had been abandoned with the advent of the welfare state, but it has regained strength with neoliberal economic thinking.

Public Finance I 

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Marta Ramirez

Budget balance. Budgeted expenses must be fully financed by expected ordinary public revenue. Principle of budgetary stability that may require the financial balance of the budget but also the surplus. Neutrality: the economic intervention of the State must not interfere in the economic activity of individuals.

3. Budget content. Organic classification of the allocations consigned in the expenditure programs and of the resources included in the income statement. (on whom is it spent) Economic classification: allows analyzing the impact of public activity on general economic activity (chapters, articles, concepts and sub-concepts). (how it is spent) Classification by programs: only for the state of expenses (According to the nature of the expense), it allows knowing its purpose. Set of budgetary credits that, in order to achieve the objectives that it establishes, are made available to the managing body responsible for their execution (spending areas, spending policies and groups of programs). (where the money is spent).

4. Budget formulas. A) Execution budget: before, efficiency was more important than efficiency: Budgetary classification that focuses its interest on those functions that the government performs rather than on those things that the Public Sector acquires (before, effectiveness was more important than efficiency) . Shift the emphasis from the means used to the achievements achieved. 

Phases: Determine the objectives pursued by each administrative unit, through a functional classification, which distinguishes activities or tasks into very broad categories: programs and tasks. Organize an accounting system that allows evaluating the costs of each of the activities carried out by the Administration. (This does not mean that you have to minimize costs, we have already said efficiency before efficiency). Evaluate the execution of tasks or activities. The problem is defining the execution unit.

The consequences are to increase the responsibility of the directors of each administrative unit, and to force a change in the functions of the legislative branch, which must verify the effectiveness of the programs, comparing their realization and the aims that were proposed. The main problem was that there was a relative control to produce at the minimum cost, efficiency is

Public Finance I

Marta Ramirez

not the most important thing. In the US this budget was very important in the Great Depression. A budget like this cannot give everyone an open bar, but must be controlled. B) Budget by programs: It requires the Public Sector to choose between alternative programs, which compete for the resources available, that is, there may be exclusive programs ... if I spend a lot on defense, maybe I don't have that much for health. This technique was used mostly in the last century in the 40-50s, but it was not very successful either. It requires the use of 3 different elements: 1. Structural: it is aimed at determining the purposes that respond to the different functions carried out by the Public Sector, including in the evaluation of such purposes all the costs that require their achievement. 2. I do an analytical analysis: the different programs are evaluated in terms of cost-benefit. The comparison between the different projects is carried out to achieve a certain purpose. Cost-benefit analysis is hardly used today, other types of techniques are used. 3. Informative: provides the information necessary to identify objectives, decide between alternatives and carry out surveillance and control. C) Zero-based budget: This type is a budget where spending control is maximized. It is used especially in moments of great crisis, in 1973 with the oil crisis it was used. In 2008 the PSOE spoke of the base budget 0. Each administrator must justify from the first monetary unit, the level of expenditure proposed. This taken to the limit would mean justifying every last cent that you spend, this causes an administrative overload, it cost more to control the expense than the expense itself. There were a large number of public employees assigned to control public spending in an excessive way. Problem of operability, time and money. It is not enough to explain why you should spend more, but why you spend something. All activities carried out must be identified. Such activities should be evaluated and ranked in order of importance. It does not guarantee that current programs and their level of spending will be consolidated, but rather that both existing expenditures and new projects will be evaluated. This budget caused inefficiencies, although the deficit was controlled very well. This budget was not very successful either.

5. Budget balance concepts. The budget necessarily records a formal or accounting balance. No expenses can be made without having some type of financing. Apart from this formal equilibrium, from an economic point of view it can be affirmed that the budget registers a deficit or surplus when certain expenses are greater or less than certain income. It is important to know the definition and precise meaning of the main concepts of deficit or surplus, since the budget balance is used as a global indicator of the effects of budget activity on the economy. The balance is always computed as the difference between income and public expenditures, but there are different meanings of budget balance depending on various circumstances: Public institutions considered:

Public Finance I -

Marta Ramirez

Operations that are computed for its calculation. Time of recording or accounting of income and expenses. Conjunctural (cyclical) or structural (permanent) nature.

A) Balance depending on the public institutions considered:    

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It is possible to calculate the budget balance of each agent of those that make up the Public Sector. The balance that is available more quickly and reliably is that referred to the State. The balance of Public Administrations is the most used concept, especially in international comparisons. To add the operations of different Administrations, they must be consolidated (bear in mind that there may be transfers between the different Public Administrations), which implies eliminating internal transfers from one to the other. In a hypothetical country, the State Administration has a total unconsolidated budget of CU5,000 and grants transfers to Social Security of CU2,000. Social Security has a total unconsolidated budget of CU4,000 and does not grant transfers. The Autonomous Bodies grant transfers to Social Security amounting to CU1,000 and their total unconsolidated budget is CU2,000. What will be the consolidated budget of the three institutions? Whenever we talk about a budget, the one that interests me is the one that is already consolidated. Therefore we will calculate budget balance always consolidated.

B) Balance based on computed operations. 1. Non-financial balance (non-financial surplus or deficit) (SNF): Capacity or need for financing. It is the balance of non-financial operations, obtained as the difference between income (IPT) and non-financial expenses (GPT). It is the balance of the capital account. SNF = IPT - GPT.  It reflects the surplus or deficit of funds once current and capital expenditures have been met.  It is the most used measure for making comparisons. 2. Primary balance (primary surplus or deficit) (SPr): it is the balance calculated as if the interests of the Public Debt were not to be paid in the current year. It is calculated by adding to the non-financial balance the net interest burden of the Public Debt. SPr = SNF + Interest.  It better reflects the more or less strict orientation of the current year's budget than the non-financial balance. 3. Public balance for the purpose of verifying compliance with the golden rule of public finances (SRO): public investment expenses are not included among the expenses, since according to this rule, it is justified to maintain a deficit if it is due to this type of expenses. SRO = SNF + Investment expenses 4. Debt balance (SE): It is not the same as the SNF (important). Debt capacity or need (gross increase or variation of financial liabilities). It will incorporate the Net variation of Financial Assets and decreases in financial liabilities. So what I am not including in the balance is the increases in financial liabilities. It takes into consideration, in addition 

Public Finance I

Marta Ramirez

to non-financial operations, the income and expenses derived from decreases (▼ AF) and increases (▲ AF) of financial assets, respectively, and the expenses caused by the decrease in financial liabilities (▼ PF) : SE = (IPT + ▼ AF) - (GPT + ▲ AF + ▼ PF) It is calculated by subtracting from the non-financial balance, the net change in financial assets (VNAF = ▲ AF - ▼ AF) and the decrease in financial liabilities: SE = SNF - VNAF - ▼ PF (this is always true, it is an accounting identity). This balance is calculated and can have a negative or positive sign (need or capacity), if I have a need for debt, it means that I have to get into debt (the basic instrument is issuing public debt). SNF = AFN = VNAF - VNPF (using this and the notable identity above, I get): SE = - ▲ P (this means that the SE = the increase in financial liabilities, but in negative. I generally express the SE in absolute value, the higher it is, the more indebted I am, the issuance of public debt increases the debt balance). But I must use counting identity from above to calculate it. As I pay my debt, I will decrease my SE. C) Balance at the time of recording income and expenses: 1. Management balance (accrual): variation in non-financial transactions attributed on an accrual basis. Moment in which rights and obligations are recognized, regardless of when they are made effective at the cash register. If you use this criterion for the payment of a tax, I have to make a provision in the treasury to be able to pay something if I have not yet collected it, this generated many bankruptcies in companies, especially in the period of the economic crisis. In the end, a door was opened to the option of allowing those taxes to be paid when they have actually been collected, using a cash criterion. From the point of view of the Public Administration, they are lending me money (I obtain financing) at a zero interest rate, it is good for them but bad for the economy. 2. Cash balance measures the difference between income and cash payments caused by operations carried out in the year, regardless of the year in which the rights accrued or the obligations were recognized. It explains the variations in the balance of the current account of the Treasury at the Bank of Spain. These income and non-financial expenses must be accounted for at the time they are collected. I prefer this criterion when paying taxes. The use of this balance or the other, affects the domestic finances.

6. The budget and economic activity: the budget balance adjusted to the cycle. D) Adjusted balance of cycle or structural balance: aims to correct public balances for the effects of cyclical variations. Indeed, the total budget balance observed (S, in terms of GDP I know this value). It can be understood as the sum of: a discretionary component, called the structural or cycle-adjusted balance (SAC, is a more medium-long / term balance, it is quite difficult to reduce) and an automatic component that depends on the economic cycle, called the balance cyclical or conjunctural (SC, has much more variability, much more ac / p, responds very quickly to the economic cycle we are in, has a higher standard deviation).

Public Finance I

Marta Ramirez S = SAC + SC.

SAC: Result of the decisions intentionally adopted by the authorities in matters of public income and expenditures. SC: As a result of the impact that the economic cycle has on the variables and ultimately on the magnitude of the observed balance. This incidence occurs through automatic stabilizers (progressive taxes on income and benefits or unemployment subsidies, mainly). If it is desired to know the expansionary or contractionary orientation of current budgetary policy, it is preferable to separate both components, since only the structural balance can provide a measure of the orientation of budgetary policy. In addition, since the payment of interest on the debt is not directly related to the budgetary policy of the current year, it is recommended not to include these in the calculation of the balance, with which what would be calculated would be the primary balance adjusted to the cycle or structural (SPAC). The structural balance is calculated in a residual way, by a procedure that consists of three stages. 1. The cyclical position of the economy is estimated through the gap or production gap, I am interested in that the gap is as small as possible, because it is an error that I make in terms of GDP, I am interested that the estimate is not fulfilled but because we have grown more than expected, if I am wrong for overestimating, instead of underestimating, it is worse for me. Understood as the quotient of the difference between observed production (GDP) and an estimate of potential production or, alternatively, of the trend (GDP *), over the latter: (GDP - GDP *) / GDP * = (GDP / GDP *) - 1 = Production Gap 2. I calculate the elasticity of that gap, how my economic level varies depending on my gap. The cyclical balance is calculated as the impact of the cyclical position of the economy on the budget balance, making use of the elasticities either of the total balance or of different categories of public income and expenditures, previously estimated. The simplest form of calculation is as follows: (SC / GDP) = f (GDP / GDP *), f> 0 (SC / GDP) = εs ((GDP / GDP *) - 1) εs = elasticity of the total balance or of the various categories of income and expenses with respect to production or its macroeconomic base. 3. Finally, as I already know SC and S, I know SAC. The structural or cycle-adjusted balance is therefore the result of subtracting the previously estimated cyclical component from the observed public balance: (SAC / GDP) = ((S / GDP) - (SC / GDP))....