Budget

Advantages of Direct Taxes

üSocial and economic equity Indicates social justice as it is based on the ability to pay. The progressive nature of direct taxation can help reduce income inequalities üCertainty of tax to be paid The taxpayer is certain as to how much tax is to be paid, as the tax rates are decided in advance üEconomical and lower cost mechanism Collection of direct taxes is generally economical. The government does not have to spend much in tax collection as far as personal income tax is concerned. üRelatively Elastic Increase in the income of individuals and companies, leads to increase in the yield from direct taxes also. An increase in tax rates would increase the tax revenues. Thereby, direct taxes are relatively elastic. üControls inflation Direct taxes can help control inflation. When the inflation is on the uptrend, the government may increase the tax rate. With an increase in tax rate, the consumption demand may decline, which in turn may help reduce inflation. ü

Main directions of government expenditures

üSocial programs üGovernance expenses ü üEconomy expenses üInvestment üDefense and security

Social spending

üSocial security üSocial protection üEducation üPublic health üCulture

Why is MTEF Necessary?

üStrengthening pubic finance sustainability; üMore efficient resource allocation; üStimulating more efficient use of resources; üDistribution of resources according to strategic priorities across sectors and within sectors; Medium-term linkages between plan, program and budget;

Subsidy

üSubsidies cover many forms of funding, including direct payments, loan guarantees and special tax breaks, and businesses can use the money to offset operating and management costs üThe main rationale for granting subsidies is to stimulate investment that would otherwise prove too costly for companies to pursue.

Subventions

üSubventions may be granted only on conditions and in accordance with decisions of local governments. Such monetary "feed" can fully cover the costs associated with a particular project, or act as and on the terms of share participation ü üA distinctive feature of the subvention is the fact that, in case of non-use of the funds provided for their intended purpose, they should be returned to the body (budget) that provided them.

Disadvantages of Direct Taxes

üTax Evasion Usually higher tax evasion happens due to high tax rates, poor documentation and corrupt tax administration üImpacts capital formation Can affect savings and investments. Due to tax implications, the net income of individuals reduces, in turn reducing their savings. Reduction in savings results in low investment, affecting the capital formation üArbitrary rate of taxation There is no objective defined for determining the tax rates of direct taxes. Therefore, direct taxes may not always fulfill the requirement of equity. üInconvenient For most people payment of direct tax is a task to convince oneself to pay a part of their income as tax to the state. This is a boost to evade tax further. It is also inconvenient in terms of maintaining accounts in a proper form. üImbalance in Sectoral taxation Certain sectors like the corporate sector is heavily taxed, whereas, the agriculture sector is 100% tax free

Distinction between administrative and economic classifications

üThe economic and administrative classifications provide different kinds of information üThe ec. provides data on types of expenditures (for example, salaries or goods and services), while the adm. provides data on the public sector organizations that incur expenditures or receive revenues üAn administrative classification of expenditure is needed to identify responsibilities for the main blocks of public expenditure and for day-to-day administration of the budget üExpenditures may be divided into separate subcategories for each ministry, department, or public entity.

Fiscal federalism

üThe levels of government can be divided into three broad categories: federal, or central; state; and local; üDivision of taxing and expenditure functions among levels of government; üCentralized and decentralized models; üTaxes and other sources, relevant for each level of the budget.

Tax expenditure

üThe loss of revenue attributable to an exemption, concession, deduction, preference, or other exclusion under a "normal" tax structure that reduces government revenue collection ü üBasically constitutes foregone revenue

National budget

üThe national budget is broken down into budgets for each ministry. Within ministerial budgets, there are program budgets (e.g. for district health services), and within these there are line items and sub-program budgets (e.g. community health services). ü üBudgets may include amounts that are earmarked for specific areas of work or activities, while in others these kinds of decisions may be devolved to lower levels of the system.

Budget deficit impact on macro economy

üThe traditional view of the economic effects of the government budget deficits hypothesizes that, other things being equal, the deficit contributes to higher interest rates; ü Budget deficit can choke off private investment, thereby slowing the real rate of economic growth; üThe market demand for loanable funds is composed of the demand for credit by households, business firms, state and local governments, and the federal government;

The case of Azerbaijan

üTill the May 1 of the current year, relevant executive power body prepares an instruction letter on the preparation of the indicators of the draft state budget of the next year and summary budgets of the following three years and sends to organizations involved in the preparation process of the budget. ü ü Alongside with related data, the instruction includes data on organizations and the highest verge of expenditures of every item, norms approved on the current expenditures, analysis (evaluation) of incomes and expenditures including auxiliary documents for submission of a detailed budget proposal to relevant executive power body.

Loans

üTransfers for which repayment is required by the government ü üLoans obtained by the government to finance expenditure over and above available resources from tax and non-tax revenues (deficit). •

Grant

üTransfers made in cash, goods, or services for which no repayment is required by the government üUnlike loans, grants are funds that the recipient does not have to pay back üSuch assistance is most commonly associated with people furthering their education, in the form of fellowships, funding for special research or scholarships from foundations and nonprofit organizations üGrants are sometimes available to for-profit businesses, though it is usually for a specific purpose. (business working with special needs children).

Inter budgetary transfers

üTransfers of funds from one level of the government (usually the central government) to lower levels üThere are significant source of revenue for subnational governments ü The design of these transfers is critical for the efficiency and equity of local service provision & fiscal health of subnational governments

functional classification

üfor what purpose is the money spent

Progressive

üif effective tax rates are higher for higher-income taxpayers than for lower-income taxpayers;

Structural budget deficit

•: Long-term measure of the government fiscal positions, with short-term factors removed

Cyclically adjusted budget deficit

•A measure of the government's fiscal position if the economy were operating at full potential GDP

Cash Accounting

•A method of measuring the government's fiscal position as the difference between current spending and current revenues

Capital accounting

•A method of measuring the government's fiscal position that accounts for changes in the value of the government's net asset holdings

Tax Rate

•Average tax rate (ATR) ATR= (Total Taxes Paid)/(Value of The Tax Base) • Marginal tax rate (MTR)MTR=(Δ Total Taxes Paid)/(Δ Value of The Tax Base)

Types of Budget Classifications

•Program — indicates a set of specific policy objectives to be achieved with the provided resources • •Source of fund (on-budget, extra-budgetary, counterpart funds) • •Geographical location (administrative units, taxpayers, recipients of government transfers) etc.

What you can spend on subvention?

•The most popular are subventions for social needs: ütemporary or one-time payment to low-income, disabled children üpayment of state aid to orphans and parents deprived of their care ümajor repairs of interior doors üproviding hospitals and ambulances with medical equipment and consumables ürepair in pre-school establishments, purchase of sports equipment ümany other programs.

Subsidies

•gratis resources provided from the State Budget to the budget of the Nakhchivan Autonomous Republic, local budgets and legal entities;

üThe principle of comprehensiveness:

-requires that the budget cover all government entities and institutions undertaking government operations, and present a consolidated and complete view of these operations

A broad range of activities of central banks, public financial institutions and public enterprises that are fiscal in character

A broad range of activities of central banks, public financial institutions and public enterprises that are fiscal in character • •Examples; üInterest rate subsidies üPayment of government debt ü Building infrastructures, ambulance, etc

Revenue

A government's total annual amount of available resources, such as income collected taxes on salaries, company profits, sales, etc., as well from loans and foreign aid

Vertical equity

Progressive, regressive, proportional

Discretionary Spending

Public expenditure that is governed by annual or other periodic appropriations, rather than by formulas or criteria set forth in authorizing legislation

Subvention

Subvention refers to a grant of money in aid or support, mostly by the government Example: The government sometimes asks financial institutions to provide loans to farmers at below market rates The loss is usually made good through subventions.

Indirect taxes

Taxes are applied on the manufacture or sale of goods and services üThe value-added taxes (VAT), a tax on the amount by which the value of an article has been increased at each stage of its production or distribution üConsumption tax, a tax paid on individual or household consumption of goods (and sometimes services). üPayroll tax, a tax levied on income earned on one's job ü üSales tax, a tax paid by consumers to vendors at the point of sale üExcise tax, a tax paid on the sales of particular goods, for example cigarettes or gasoline.

Prime reason for levy of taxes

Taxes are the basic source of revenue to the government, which can be utilized by the government for its expenses like defence, healthcare, education, different infrastructure facilities like roads, dams, highways etc.

Direct taxes

Taxes that are directly paid to the government by the taxpayer: ü üIncome taxes, tax levied directly on personal income; ü Corporate taxes, tax on all the income or gains generated by corporations, which is generally levied on the profits earned üWealth taxes, taxes paid on the value of the assets, such as real estate or stocks, held by a person or family. üProperty taxes, a form of wealth tax based on the value of real estate, including the value of the land and any structures built on the land ü üEstate taxes, a form of wealth tax based on the value of the estate left behind when one dies.

Taxable Income

The amount of income left after subtracting exemptions and deductions from adjusted gross income

Economic Classification

The classification of expenditures and assets according to the economic transactions involved or in ways that emphasis the economic nature of the transactions (salaries, interest, transfers, etc.)

Tax base

The item or economic activity on which the tax is levied Can be grouped into three broad categories: üIncome; üConsumption; üWealth.

Budget Cycle

The period of time in which a country's budget is formulated, approved, executed, and audited

Budget expenditures

The spending of money by the government or the amount of the money spent

Administrative Classification

This classification system indicates which government entity (ministry, department, or agency) will have responsibility for spending funds and ultimately be held accountable for their use

Why budget classification system is important?

üA budget classification system provides a normative framework for both policy decision making and accountability. üClassifying expenditures and revenues correctly is important for: - policy formulation and performance analysis; - allocating resources efficiently among sectors; - ensuring compliance with the budgetary resources approved by the legislature; - day-to-day administration of the budget. üA stable classification facilitates both the analysis of trends in fiscal policy over time and intercountry comparisons.

Functional classification

üA classification system that organizes government expenditure according to its various activities and policy objectives in different sectors, e.g. health, education, agriculture ü üThis system is independent of the administrative units (i.e., ministry, department, or agency) that carry out the transactions ü üMore than one ministry can contribute to a sector

The use of the functional classification

üA functional classification organizes government activities according to their broad objectives or purposes (e.g., education, social security, housing, etc.) üIt is independent of the government's administrative or organizational structure. Such a classification is especially useful in analyzing the allocation of resources among sectors üIt may also be used for tracking poverty-reducing expenditures üA sound and stable functional classification is required to generate the data that are necessary to produce historical surveys.

Principles of taxation

üAbility to pay, a taxpayer who can afford to pay more should pay more ü üHorizontal equity, the principle that similar individuals who make different economic choices should be treated similarly by the tax system ü üVertical equity, the principle that groups with more resources should pay higher taxes than groups with fewer resources.

Budgets as Preferences

üAllocation resources among different agencies, group of people, etc.; üCollective preferences; üConsensus; üPolitical preferences; üLobby

The case of Azerbaijan

üBodies ensuring the execution of incomes of the state budget and organizations financed from the state budget of the Republic of Azerbaijan submit the prepared draft budget to relevant executive power body till July 1 of the current year ü Relevant executive power body specifies economic and social development forecasts and state investment program of the next year and following three years by August 1

What is a budget?

üBudget is a document that sets out how much money (income or revenue) is coming in, where it is coming from, and what it will be spent on; üBudget is a statement of a government's planned receipts and expenditure for some future period, normally a year; üThe budget sets out how the government will raise funds (revenues) and distribute them to the various ministries, states and local structures responsible for delivering basic services, such as health and education, as well as other sectors, such as defense, infrastructure and energy.

Components of budget

üBudget revenues (e.g. taxes, debts) ü üBudget expenditure (e.g. functional, programs) ü üBudget deficit (the excess of a government's total expenditure over its income) ü üBudget surplus (the excess of a government's total income over its expenditure) ü üBudget constraint (the limit to expenditure - for any economic agent including government, expenditure must stay within limits set by the ability to finance it)

Budget System and Budget Policy

üBudget system encompasses the process as well as the content, the structures and institutions that enable it to be implemented. üBudget policy is this process of prioritization. Many different factors can influence how a government decides to allocate its resources, including historical legacies. üThe government needs to undertake adequate planning at different levels of the social-economic system in order to identify the required inputs for each policy or program, as the budget requirements are worked out based on these inputs.

Budgets as an explanations

üCasual relationship üResource consumption üMeasurement difficulties

Functional Classification (GFSM 2001)

üCategorizes government activities based on their broad objectives üFacilitates the analysis of resource allocation among sectors and the impact of fiscal policies üDistinct from the administrative structure of the government üFully consistent with COFOG and comprises 10 major government functions, further divided into groups and subgroups üCOFOG system often adapted to a country's particular policy needs (mapping tables between COFOG and classification used)

International Classification Standards

üClassification of the Functions of Government (COFOG) üDeveloped by OECD and published by the UN Statistical Division üClassification has 3 levels; 1) divisions; 2) groups; 3) classes üDivisions define the broad objectives of governments üGroups and classes define the means by which these broad objectives are achieved. üExamples; division 01- General Public Services group 01.1- Executive and legislative organs, financial and fiscal affairs, external affairs class 01.1.1 - Executive and legislative organs

Haig-Simons comprehensive income

üDefines taxable resources as the change in an individual's power to consume during the year ü üWhich types of income should be subject to taxation and which should not üEconomists have historically embraced a very broad definition of income, called the Haig-Simons definition, which defines income as any increase in an individual's potential ability to consume

Responsible government

üDemocracy üElection üCheck and balances üSeparation of power üRepresentativeness üLegislative power üExecutive power üMonitoring

Economic Classification (GFSM 2001)

üDetermined by the type of expenditure incurred ü"Expense" replaces "expenditure" because of accrual basis üAll line items are equally applicable to accrual-basis GFS 2001 and cash-basis GFS 1986, with one exception—consumption of capital üIncludes current expenditure and capital transfers but excludes capital expenditure as in GFS 1986 üAcquisition of fixed capital assets, purchases of stocks, land and, intangible assets are recorded as transactions in nonfinancial assets üCapital transfer when ownership of a capital asset is given up without any compensation üO&M spending is an expense, while major improvements are acquisitions and added to the existing value of an asset üIndependent of the administrative classification, but can be incorporated for each government organization and its subdivisions

Medium Term Expenditure Framework (MTEF)

üEstimates of revenues and expenditures for multi-year periods ü üA three-year period horizon for budgeting and planning ü üThese estimates might be revised as circumstances change ü üNewly adopted MTEF in Azerbaijan

Recurrent expenditure

üExpenditure that does not result in the acquisition of long-term assets; It consists mainly of expenditure on salaries, goods, and services, etc

Budget expenditures classification

üFunctional classification ü üAdministrative classification ü üEconomic classification ü üProgram-level expenditures

Capital expenditure

üFunds spent for the acquisition of a long term asset; ü üThe total spending on such asset would be divided over several years; ü üThis includes expenditures on equipment, land, building, legal expenses, and other transfer costs, associated with property.

Centralized versus Decentralized Government

üGeographical factor ü üSize of the government ü üHistory and tradition ü üPolitical equilibrium ü üThe character of the services (pure national public goods)

Differences between grant and subsidy

üGrants are sums that usually do not have to be repaid but are to be used for defined purposes üSubsidies, on the other hand, refer to direct contributions, tax breaks and other special assistance that governments provide businesses to offset operating costs over a lengthy time period üThe practice is controversial since large corporations - not small businesses - tend to receive most subsidies.

Program Classification

üGroups expenditure by common policy objective üKey purposes: (1) establish specific goals for budgetary spending and (2) improve operational performance by adopting performance measures üBasic information tool for many performance budgeting systems üThus serves not only for budgetary planning and reporting but mainly for promoting budgetary decision-making - better aligning government activities with policy priorities üEconomic classification still needed in programmatic structure: Capture cost information to link economic inputs to program results; Incorporate current and capital inputs of a particular program.

Key stages and elements of the MTEF

üMacroeconomic framework - analysis of sources; ü üDetermination of Ministry's goals, activities and interim results; ü üDiscussion of sectoral programs and sub-programs; ü üPreparation of a 3-year budget estimates for compromise programs; ü üAchieve discussions and agreements on goals, objectives and programs; ü üDetailed expenditure frameworks, 3-year ministry-sectorial cost ceilings; ü üFormation of the latest version of the ministries' 3-year budgetary expenditures in line with the government-approved framework and cost ceilings; ü üReview of the latest budget estimates by the Ministry of Finance, final clarifications, presentation to the government and parliament.

Preparation

üMost difficult üChief executive responsibility üCountry institutional system üBudget calendar

Contingent liabilities

üObligations that have been entered into, but the timing and amount of which are contingent on the occurrence of come uncertain future event (that may or may not take place) ü They are therefore not yet liabilities may never be if the specific contingent event does not happen

Budgets as a descriptions

üOrganizational activity üOrganizational accomplishments üQuantitative information (amount) üQualitative information (ex. number of employers)

The case of Azerbaijan

üPreparation process of the draft state budget starts 11 months from the beginning of the budget year till the day of submission of the draft budget to the Milli Majlis (Parliament) of the Republic of Azerbaijan. üAccording to the specified medium-term forecasts of the economic and social development, relevant executive power body issues initial medium-term forecast (incomes, expenditures, deficit and financing) of the state and summary budgets of the next year and following three years till the March 31 of the current year

Budget system

üProcess (formulation, enactment, executing, auditing) ü üInstitutions (Ministry of Finance, Treasury, Parliament) ü üStructure (central budget, local budgets, extra-budgetary funds, off-budget operations) ü üPeriod (budget year - the fiscal year used by governments) ü üContent (8 key budget documents and reports)

Types of Subsidy

üProduction subsidy üConsumer/consumption subsidy food, water, electricity and education üExport subsidy üImport subsidy üEmployment subsidy üTax subsidy (reimburses 15% of all health expenditures to a group that is paying 15% income tax. (Tax subsidies are also known as tax expenditures)) üTransport subsidies üOil subsidies üHousing subsidies

Program Classification Combined with Functional and Economic

üProgram classification inherently disconnected from government's organizational structure üContemporary approach: to place each program under a single ministry and align it with the functional classification •Ensures clear assignment of responsibility for a program and accountability for results

Mandatory spending

üPublic expenditure that is governed by formula or criteria set forth in authorizing legislation, rather than by periodic appropriations ü üThis type of spending contributes to the rigidity of the budget

Program-level expenditure

üReferring to any level of detail below an administrative unit, as a ministry or department ü üFor example, the Ministry of Health's budget could be broken down into a number of programs, such as "primary health care" , "hospitals", etc. ü üBudget line items for such programs show program-level expenditure

Protected expense items (case of Azerbaijan)

üSalary; üSalary supplements; üPension, other social allowances and payments; ü Expenditures of internal and foreign government liabilities; üExpenditures of other provisions to be justified in accordance with the law on the state budget of every year.

Budget sequestration

üSequestration entails the permanent cancellation of budgetary resources by a uniform percentage üMoreover, this uniform percentage reduction is applied to all programs, projects, and activities within a budget account üHowever, the current sequestration procedures, as in previous iterations of such procedures, provide for exemptions and special rules üThat is, certain programs and activities are exempt from sequestration, and certain other programs are governed by special rules regarding the application of a sequester. ü üArticle 23. Review of the state budget and application of curtailment to expenditures

Fiscal Capacity

A measure of the ability of a jurisdiction to finance government provided services • üThe fiscal capacities of local governing units are likely to vary with the values of local tax bases and with the ability to "export" taxes; üAssets; üRevenues; üDemographic characteristics.

COFOG

Classification of the function of the government

Non-tax revenue

Government revenue not generated from taxes, such as aid, revenue from state owned enterprises, rents (concessions, royalties, fees, etc.)

Tax revenue

Money collected from direct and indirect taxation of individuals and companies

Budget loans

allocations provided from the State Budget to the budget of the Nakhchivan Autonomous Republic, local budgets and organizations and from the local budgets to the municipality organizations for a certain period of time and subject to repayment;

üThe principle of internal consistency:

between different components of the budget requires, in particular, that the current expenditure needed for the operations and maintenance of past investment projects be fully reflected in the budget

Grants

donated special purpose financial resources from domestic and external sources; The Law on Budget System (1.1.15.)

Donation

gratis financial resources provided from the State Budget to the budget of the Nakhchivan Autonomous Republic and local budgets in order to balance their revenues and expenditures; The Budget System (1.1.14. )

Proportional

if effective tax rates are essentially the same across different income categories

Regressive

if lower-income taxpayers experience higher effective tax rates than higher-income taxpayers

Special purpose budget funds

in-cash resources formed and to be utilized for conducting specific events from the State Budget, the budget of the Nakhchivan Autonomous Republic and local budgets;

a political doc

it allocates scarce resources of a society among multiple, conflicting and competing interests

an accounting doc

it provides a ceiling on government spending and makes it binding for it to live within the allocated funds

As an economic (fiscal) doc

it redistributes an income, stimulations its economic growth and development, promoting full employment, combating inflation and maintaining economic stability

an administrative doc

it specifies the ways and means by which public services are provided and to be monitored, measured and evaluated

Budget outputs

refers to how inputs are used (for example, to train health workers, to build hospitals, or to purchase medicines and supplies)

Budget inputs

refers to the allocation of funds for a specific use in the budget

Budget outcomes

refers to the impact or result of budget inputs and outputs (for example, improved child health, and fewer maternal and child deaths

The principle of unity

requires that the budget include all revenues and expenditures of all government entities undertaking government operations. This principle is important to ensure that the budget is effective in constraining total and sectoral government expenditure, and in promoting greater efficiency in the allocation of resources

SUbvention

resources provided from the State Budget to the budgets of the Nakhchivan Autonomous Republic and local budgets for financing special purpose events, which are to be retrieved if not spent for these purposes or within determined period of time;

Main future of budget classification

unity, comprehensiveness, internal consistency

Economic classification-

what is the money spent on

Administrative

who spends the money

Budget phases

ü. Preparation and submission, when the executive branch puts together the budget proposal; üII. Approval, when the legislatures debate, alter an approve the budget; üIII. Execution, when the government implements the budget; üIV. Audit & evaluation, when the supreme audit institution accounts for and assess the expenditures made under the budget.