Nuggets of Public Finance

The Government Budget is a complex document that represents in a detailed way the financial and economic condition of a country. In addition, through an accurate analysis of the public expenses, it is possible to find out important information about the culture and the social structure of the State.

 

<<The Government Budget is the mirror of all the political and social problems of a country>>.  

                                                    Joseph Schumpeter

 

Depending on the information searched and the goals pursued, we can distinguish several types of budget statements.

In this article, I will briefly refer to the final budget and the provisional budget to give an idea about the essential content of a public budget statement and about the role of Gross Domestic Production (GDP) in the evaluation of the total wealth produced, of the national income and of the welfare level inside a society.

(The correlation between welfare, national income and wealth, even though it might seem intuitive, it is a cornerstone of the Classic Welfare Economics’ thought. This topic deserves a specific deepening; we will go further on the following article).

 

The final budget statement contains data about public revenues and expenditures referred to the current year. These pieces of information are useful to check the activity and the efficiency of central and local public offices about social security institutions and programmes. Another fundamental function is the control of the information previously planned with the past balance statement.

The budget act is the legislative act, which yearly permits to the parliament of a country to check the government financial and economic activity.
There the parliament votes the government’s economic targets and approves the financial budget, the expenses plan, if correctly covered with taxation or other revenues and more generally, the allocation given to the public resources.
The parliament activity of control should follow the direction previously decided with the provisional budget for that year and, regarding to EU countries, also the suggestions and the advices received from the European institutions.

The provisional budget is an accurate estimate of expenses and revenues, which are combined with the macroeconomic forecasts and the financial commitments for the following year, sometimes even for longer periods. The structure of this statement is, like the final budget, made of expenses and revenues items, but here the amounts reported are, often, forecasts.

 

If we look at the government budget, normally at the income statement, we can obtain a lot of information about the public finances of the State, for example:

Tax revenues, a sum made of the income tax for people or enterprises, the housing tax and other kind of taxes.

Public deficit, sum given by the computation between the State’s expenses and its revenues during a year, whether the State made a positive result we register a surplus.

Public debt, value that consists of the sum of all the debt not paid, by the State, in the past.

The fundamental difference between debt and deficit is that, the first one is a stock value made of the sum of all the past deficit realized and which still have to be paid, the second is a flow value which represents the growth of the debt from a date to another, usually during one year.

Interests on debt, which is the cost sustained by the State to find the financial resources on the market or from a bank. It changes when the financial, political and economic condition of the country improves or get worse.

Tax burden, index of weight of taxes upon the country’s economy.

Each one of the indicators mentioned, when considered as an absolute value, is just a raw date with a weak meaning for analysis and comprehension of phenomena.

 

USA Income Statement 2015

 

Public Administrations Income Statement of Italy, 2015

 

 

In 2015 Italian Public Deficit was around 43.1[1] billions of euro, should we consider it as a high or moderate level?

Is it useful to compare this value with the equivalent value for USA in the same year, which was equal to 438 [2]billions of dollars?

A direct comparison between two absolute values like these does not give us any relevant information, we have to find a common denominator to weight the variables and establish the real dimension of the datum.

The typical common denominator used in Public Economics is the GDP, the aggregate value of the overall production in a country during a year.

Using this filter to weight the deficit data, we discover that Italy had a Deficit/GDP equal to 2.6%, while Usa had a 2.5%; proportionally the values have not a so different value compared to the respective national economy.

 

The ratio Deficit/GDP shows the indebtedness accumulated by the State during a year weighted with the aggregate production in the country during the year. The ratio makes easier to understand the real impact of the debt on the State’s finances and economy.

Whether the economic growth is large, a State can easily receive great amount of loans, (even if for this kind of analysis we must consider the debt collected in previous years), because GDP is a guarantee of solvency and economic power of the State.

Thus, one of the most significant roles of Gross Domestic Product is that it is the measure of the relevance of each macroeconomic variable of the State and a tool to compare different values belonging to different countries. GDP, sum of all the value of goods and services produced during a year in a country, is a reference value also to measure the welfare of a population. Its size and its variation over time, usually a year, is an indicator of the State’s economic health and growth, representing the wealth produced by national and foreign enterprises, obviously also the State itself.

Its value is the sum of the consumption level, the investments, the public expenses, the taxation and the difference between import and export volumes.

 

The combination of these elements makes GDP so important for the economy of a country, even to evaluate the social condition of a population.

Dividing GDP for the number of inhabitants we obtain the datum about GDP per capita, another significant indicator, useful to notice the dispersion of GDP.

How many people benefits of its value?

Indirectly it represents the wealth of a country, but can it also be considered as representative of the citizens’ wealth?

 

As a mean value, GDP per capita has to be carefully handled, its value might be influenced by the extreme values, for example a high level could be demonstration of a rich country or a strong inequality with very rich people and poor people too.
Historically, the welfare analysis has often been limited to GDP and national accounting data reported in the State’s statements, this fact without considering that the very significant datum is the distribution of this wealth such as GDP or national income.

 

What is more, we must not forget that a low level of income, even though most of times it represents a difficult economic and social situation, might be misleading when there is a wide and deep furniture of public services which allows the citizens to live well.

 

Despite the criticisms, GDP has still its key role as indicator of wealth and welfare of a State, but recently something has changed.

Many alternative theories and interesting innovations are spreading throughout the economic world.

New systems of welfare and wellbeing evaluations have been proposed, tested and in some cases implemented too.

The purpose of these new ideas is to deepen the comprehension and the analysis about social condition, welfare and wellbeing of a country, but this topic will be soon further described in another article…

Michele Corio

References:

[1] http://www.ilsole24ore.com/art/notizie/2016-03-01/l-istat-rivede-rialzo-pil-2015-08percento-primo-aumento-tre-anni-calo-rapporto-deficit-pil-26percento-piu-basso-2007-110114.shtml?uuid=ACZgf2eC

[2] https://en.wikipedia.org/wiki/2015_United_States_federal_budget

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