Best Practice in Government Budget Management

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Governments, just like households or companies, need to plan annual budgets, based on their revenue and expense projections.

A Government budget will lead to a deficit or a surplus, which is the difference between government receipts and government spending in a single year.

Just like households, if a government spends more money than it brings in, it has a deficit (indicated by a negative number). If it spends less than it brings in, it’s a budget surplus (indicated by a positive figure).

Unlike households, there is no universal best practice pertaining to government budget management; worse, best practice recommendations vary.

A deficit occurs when the expenses of a government exceed the revenues collected by the government; on the contrary a surplus is when revenues exceed spending.

It is usually presented as a percent of gross domestic product (GDP).

Government deficits or surpluses are measured using the net borrowing (or net lending) figures of the general government sector in the national accounts. Put another way, it is the difference between total revenue and total expenditure, including capital expenditure (in particular, gross fixed capital formation).

Revenue is mainly in the form of taxes, social contributions, dividends and other property income.

Expenditures are chiefly compensation of government employees, social benefits, interest on the public debt, subsidies and gross fixed capital formation.

A government that has a recurring yearly deficit increases its debt.

Governments have 3 ways to raise debt: they can print money (banknotes etc…), sell off assets, or borrow.

  1. Printing money can run a risk of “runaway” inflation.
  2. Selling assets can be a short-term, partial fix and in some cases necessary – but, as in a household, it is not a substitute for learning to live within one’s means.
  3. Borrowing is the most common way to finance debt, but it comes with interest payments, which can also hamper long-term growth and, in some cases, add to the deficit. Borrowing can be from residents of the country (internal debt) or from foreigners (external debt). Economists generally believe that internal debt is more manageable than external debt.

Throughout history there have always been different opinions and fierce debates on  what is the best practice in budget deficit. The schools of the ”pros” and “cons”  of budget deficit best practice have alternatively prevailed.

Many economists, the most influential of them being John Maynard Keynes, believe that governments should run deficits during recessions and periods of high unemployment to compensate for low private demand, while governments should work to balance the budget only during times of full employment and strong growth. The underlying assumption is that more government debt during a recession can stimulate the economy, whereas during times of prosperity, deficits can lead to high inflation rates. They state that the 2008-2010 stimulus packages around the world have softened the threat of a potential new “Great Depression” into a “Great Recession.”

In contrast some Economists argue that the most important issue is to reduce the deficit by cutting government spending and/or increasing taxes. While at the start of the subprime crisis in the late 2000’s world leaders massively embraced the Keynesian economic theories – with huge stimulus packages in many countries-, the political decision makers have then focused on the growing debt levels and called for sharp cuts in public expenditures, as market turmoil was sparked by government deficits of countries in the euro area, particularly Greece in 2001.

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