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Public Finance focused on how the government and the public

institution is using funds for public goods

The peoples money, managed by the government to deliver
services needed by its constituents
Origins of Public Finance
Finance from the Old French word finer (finir in Modern
French) referred to the notion of paying a fine, paying a
ransom, or settling a debt
The word developed into the Middle English word finaunce
(a fine or to forfeit)
The practice of finance predates the word
How did the practice of finance start?
Invention of agriculture (pagtatanim, animal husbandry)
Invention of effective pottery
Better tools (Neolithic) ; New Stone Age
Mode of Transaction
Coin / metallic money
Paper money (oldest paper money recorded is from China,
800 AD)
Worlds largest banknote : 100,000 peso note created
by the Government of the PH in 1998 to celebrate a
century of independence from Spain
Only 1000 notes were printed
Branches of Finance
Private Finance
Has been the subject of greater study because private flows
have historically been much larger than public flows, with
the exception when the government has been engaged in

Risk in private market is greater ; risks are distributed by

the private market while government securities are deemed
Private finance involves a multitude of firms and entities,
each acting in its own interest (deals with capital budgeting,
internal controls and profitability of the firms and with
external funding concerns such as stocks, bonds, certificate
of deposits)
Public Finance
Deals with revenues and expenditures of government and
related issues concerning the public sector
The government is endowed with certain powers not
possessed by the private sector (taxation)
With some goals other than maximizing profit such as
defense, law and order, education and road construction
The Economic Rational for Government
Mercantilist era it was believed that achieving the best
services to the people was through an active government
Mercantilism : development of a country is based on
accumulated gold
Economic theory that a nations wealth is dependent
on accumulation of its capital
Capital is represented by bullions (gold, silver and
trade value) which is best increased through a
positive balance of trade
Government advances these ideas by increasing
protectionist roles, limiting imports and encouraging
Adam Smiths Critique of Mercantilism :
Demonstrated that freely initiated trade benefits both
Argued that specialization in production allows for
economies of scale, which improves efficiency and growth

Argued that that collusive relationship between

government and industry was harmful to the general
An Insight : Adam Smith
Self-interest : a more powerful characteristic of human
being than doing good ; thus, public good is best served
when the self-interest desires it
If someone values a product but no one is producing it,
then they will be willing to pay for it (what
entrepreneurs always look out for)
Search for profit : makes the producer more efficient in
its own production ; this will eventually undercut his
2 Fundamental Theorems of Welfare Economics
First Theorem : Under certain conditions, competitive market
leads to an allocation of resources with a very special property
No rearrangement of resources such that someone can be
made better off without at the same time making
someone else worse off
What it needs is efficiency in the market
Vilfredo Pareto (1848-1923) : an Italian sociologist
and economist who developed the modern version of
economic efficiency ( a cornerstone of welfare
economics, the dominant school of public finance)
Pareto optimum : discussed in his article Manual
for Political Economy published in 1906 but written in
o English speaking economists learned of his
writings only in 1971, when it was translated from
French (1909)
Pareto optimal : the Pareto optimality / Pareto
maximum is achieved if the production of goods has
reached its maximum efficient potential
o if one more good is made, then another will be
made worse off

Conditions for the First Theorem :

1. Firms maximize profits while consumers maximize
2. All goods are private (only producers and consumers
are affected)
3. All goods are traded
4. Full information on prices and quality of goods
5. Property rights exist and contracts are enforceable
Second Theorem : Every point in the utility possibility curve
can be attained by a competitive economy provided that we
distribute the resources correctly

To say that the economy is Pareto efficient does not say

that the income distribution is good.
We should not abandon the competitive market. We just
need to redistribute the initial wealth.
Pareto optimality assumes the efficiency of the market, and
that there are no failures in the market system.
Market Failures : Free Rider Problem, Public Goods and
The Free Rider Problem
the tendency of people to leave action that would benefit
their groupand eventually themselvesfor others to take,
rather than take the action themselves.
The Tragedy of the Commons reflect the problem of the free
rider problem, where a grassland is overgrazed because of
the lack of regimen to manage it property rights (as
described by Ronald Coase)
Nobel Prize-winning economist Elinor Ostrom revisited the
article and said that the issue is easily solved by the locals,

only through the intervention of outsiders that problems

are not solved.
Patriotism is probably the strongest non-economic motive
for organizational allegiance. But despite the force of
patriotism, the appeal of national ideology, the bond of a
common culture and the indispensability of the system of
law and order, no major state in modern history has been
able to support itself through voluntary dues or
contributionTaxes, compulsory payments by definition, are
needed Marcus Olson, The Logic of Collection Action :
Public Goods and the Theory of Groups
Market Failure :Public Good
Public Good non rivalrous and non- excludable
With the Free Rider problem, financing the lighthouse would
falter. Even if there are good meaning individuals willing to
finance the maintenance of the project the free rider
problem may also exist.
An institutional arrangement to compensate for the use of
the good is for the Govt to fund this.
A classic example of public good are Adam Smiths three
duties of the sovereign: national defense, the administration
of justice, and the maintenance of certain public works and
Education as a social service should be provided by the
government; primary and secondary education shall be
free for all, as prescribed by the 1948 Universal
Declaration of Human Rights and the 1987 Philippine
Higher education shall be made generally available
and accessible to all, with the state ensuring greater
access to the underprivileged.
Market Failure : Externality

Another manifestation of market failure where a private

activity affects a party / parties not part of the
Arthur Pigou (English economist) : externalities may be
corrected by the government through taxation (polluters
pay principle)
Other economists not convinced by the hype caused by
A.H. Barnett & Bruce Yandle in an article The
End of the Externality Revolution (2009) :
externalities are overrated and that simply put,
markets seldom fail because of externalities
More to the point, a great deal of public policy is
inappropriately based on the externality rationale.
Neoclassical welfare economists let this genie out of
the conceptual bottle. It is time to do what we can to
put it back.
1. Competitive Breakdown
Three sources of barriers to entry :
o Ownership of a key resource
o The government gives a single firm the exclusive
right to produce some good
o Costs of production make a single producer more
efficient than a large number of producers
Progressive economists : discusses monopoly capitalism
Imperialism : highest stage of capitalism (Lenin)
o Not limited to economic expansion but has a social,
cultural, and political dimension
Mark Twain : part of the Anti-Imperialist League
2. Incomplete Market
Financing or coordination of large and complex projects (e.g.
Manila Bay Reclamation Project)
3. Information Failure
Rise of Modern Banking
Medieval English Monarchy

Limit kings powers to impose taxes

Limit standing army beyond times of war
1689 Bill of Rights : established principle that only
Parliament could authorize taxation
levying money for or to the use of the Crown by
pretence of prerogative, without grant of the
Parliament, is illegal.
Parliament did not volunteer money to the Crown.
Resolved in 1706 that this House will receive no petition for
any sum of money relative to public service, but what is
recommended from the Crown.
Limitation is considered an essential constitutional principle
Budgeting for Policy Outcomes (Performance
Done during the Roosevelt administration where an activist
government is needed to get out of the economic situation
they are in.
Government budget is appropriated with government
formulating a desired outcome.
Incremental Budgeting
Provided additional budget from last years budget ; used by
the GMA admin.
First implemented by DND
Competing expenditure options are evaluated for their
marginal benefit to the program.
Uses cost benefit analysis and systems theory
Management by Objective
used by Nixon who was more concerned in implementing his
objectives (than theories of budgeting)
all budgets from below must be aligned with Nixons
objectives which is a response to the public perception that
the government was being mismanaged

Zero Based Budgeting

Effort was placed on justification of the budget (where the
budget was decreased and increased by certain
Used by Carter
Questions assumptions behind expenditure (theoretically
Both a bottoms-up and a top-down approach in budgeting
Cutback Budgeting
Govt is not the solution, govt is the problem.
Reagan used this to identify mandatory and discretionary
Fostered private intervention for public consumption (e.g.
road, transport, health, education, etc.)
Became the worldwide dominant theory of the era, affecting
the PH performance budgeting
Performance Budgeting
Clinton used this to spur govt to be better (unlike Reagans
no intervention view)
The govt was spurred to be a more responsive and resultdriven organization
But it is not wary of cutting back the govts bloated
Some Principles of Good Budgeting
Comprehensiveness : covers all fiscal operations
Predictability : certainty by agencies about spending
allocations in medium term to plan ahead
Contestability : no item should have an automatic claim to
Transparency : accurate, timely, reliable and comprehensive

Periodicity : should cover a fixed time and follow a clear

Objectives of Budgeting
Fiscal discipline : budget totals should be the result of
explicit, enforced, decisions ; they should not merely
accommodate spending demands
Allocative Efficiency : expenditures should be based on
govt priorities and on effectiveness on public programs
Operational Efficiency : agencies should produce goods
and services at a cost that achieves ongoing efficiency gains
Budget the sum total of aspirations, values, social and
economic policies, and services of the government
Budget Process procedure during which the national govt
budget is planned and prepared, evolves into a law, and is
implemented and accounted for.
Budget Decision Makings Major Functions
1. Allocating resources to achieve government priorities, goals
and policies
2. Raising funds through taxes and loans to finance the budget
3. Stabilizing the economy through fiscal policy (mix of
expenditures, revenues and debt financing) in tandem with
monetary policy
4. Holding operating agencies accountable for the efficient and
effective use of resources provided in the budget
5. Controlling expenditures to make certain they are legal
6. Providing a mechanism for transferring funds from a level of
government to another
Phases of the Budget Cycle

Budget Preparation
Phase involves : budget planning, preparation of agency
budget proposals, budget review, submittal to Congress
Macroeconomic assumptions : NEDA, BSP
Revenue Program : DOF, DBM
Expenditure Program : DBM
Financing Program : DOF
DBCC approves fiscal targets
Formulation of macroeconomic assumptions
o GNP growth rate
o Inflation rate
o Domestic interest rate
o Foreign interest rate
o Oil prices
o Growth in imports
o Growth in exports
Formulation of revenue program
o Estimates of total NG collection
o Non-tax : NGAs
Setting of national governments obligational ceilings
Formulation of Financing Program
DBM issues the Budget Call
Budget call instructs NGAs and GOCCs to prepare budget
proposals in line with approved over-all budget ceilings and
Budget Authorization

Sec. 22, Article VII : The President shall submit to the

Congress within 30 days from the opening of every regular
session, as the basis of the General Appropriations Bill, a
budget of receipts and expenditures and sources of
financing, including receipts from existing and proposed
revenue measures.
First reading
Budget hearings by the committee on the appropriations and
its sub-committees
Committee report / second reading
Plenary deliberation / budget debate
o Sponsorship speeches
o Plenary discussion
o Tumo en contra
General Appropriations Bill
Third Reading
Presidents approval
o President may approve the GAB as presented by the
Congress and signs it into law called the General
Appropriations Act (GAA)
o President may exercise his / her veto power partially or
totally. Partial veto shall not affect the items in the GAB
to which he does not object to. (Sec. 27(2), Article
o If Congress, during its reconsideration period, is not
able to pass the GAB into law, the preceding budget
years GAA is considered re-enacted and shall remain in
forced until the passage of the new GAA
Budget Execution
Budget implementation is budget in action
Agency Budget Matrix
Obligating Authority
o General Allotment Release Order
o Special Allotment Release Order
Disbursement Authority
o Notice of cash allocation

Disbursements are made for the payment of

expenditures for the regular operations of the
agency, which includes payment for personal services
(PS) and maintenance and other operating expenses
o the purchase of equipment and construction of
government building would also require disbursements
to contractors, suppliers etc.
Most govt expenditures are paid through checks prepared
based on duly approved Disbursement Vouchers together
with valid supporting documents
However, cash consisting of bills and coins, may also be
disbursed for cash advances and petty cash expenses
Payroll expenses are paid through transfers from the
agencys bank account to the automated teller machine
(ATM) accounts of the employees
Budget Accountability
Submission of budget execution documents and
budgetary accountability reports by the agencies
Conduct of the agency performance review (APR) by DBM
A Basic Budget Analysis Toolkit

Issues in the Budget Process

% share = share of agency / national budget

Declining pupil per spending
o Education budget increasing only by 2% per year while
enrolment rate has been growing at 2.5% per year.
o Education spending must grow faster than the combined
effect of inflation and population growth.
Budget Preparation
Government prioritization
Limited access to information, thereby leading to lack of
Budget Authorization
Consensus building in the legislature in order to get a
bigger share of the pie
Prioritization of expenditure items is disregarded
Efficiency takes a backseat
Budget Execution
Late release of funds
Funds diverted to other uses (there are creative ways of
diverting funds)
Budget Accountability
Reports are never submitted in time for timely scrutiny
Lack of transparency