What is Government Spending?
Government spending refers to money spent by the public sector on the acquisition of goods and provision of services such as education, healthcare, social protection, and defense.
- In national income accounting, when the government acquires goods and services for current use to directly satisfy the individual or collective needs and requirements of the community, it is classified as government final consumption spending.
- When the government acquires goods and services for future use, it is classified as government investment. This includes public consumption and public investment, and transfer payments consisting of income transfers.
Sources of Government Spending
Government spending is financed primarily through two sources:
1. Tax collections by the government
- Direct taxes
- Indirect taxes
2. Government borrowing
- Borrowing money from its own citizens
- Borrowing money from foreigners
Public spending enables governments to produce goods and services or purchase goods and services that are needed to fulfill the government’s social and economic objectives. Over the years, we’ve seen significant changes in the role and size of governments around the world.
Public spending increased remarkably in the 20th century, when governments all over the world started spending more funds on education, healthcare, and social protection. At present, the governments of developed countries spend more as a percentage of Gross Domestic Product (GDP) than the governments of developing countries.
Also, governments around the world rely upon the private sector to produce and manage a country’s goods and services and utilize public-private partnerships to finance, design, build, and operate infrastructure projects.
In the 2005-10 period alone, the total value of public-private partnerships, designed to increase the spending on public infrastructure projects in low and middle-income countries, more than doubled.
Purposes of Government Spending
- To supply goods and services that are not supplied by the private sector, such as defense, roads, and bridges; merit goods such as hospitals and schools, and welfare payments and benefits including unemployment and disability benefits.
- To achieve improvements in the supply-side of the macro-economy, such as spending on education and training to improve labor productivity.
- To provide subsidies to industries that may need financial support for either their operation or expansion. The private sector is not able to meet such financial requirements and, hence, the public sector plays a crucial part in lending necessary support. For example, transport infrastructure projects do not attract private finance unless the government provides expenditures for the industry.
- To help redistribute income and promote social welfare.
Types of Spending
1. Current spending
They are for the short term and include expenditure on wages and raw materials.
2. Capital spending
They are for the long term and do not need to be renewed each year. Also called “social capital,” they include spending on physical assets like roads, bridges, hospital buildings, and equipment.
The government primarily funds its spending on the economy through tax revenues it earns. However, when revenue is insufficient to pay for expenditures, it resorts to borrowing. Borrowing can be short-term/long-term and involves selling government bonds/bills. Treasury bills are also issued into the money markets to help raise short-term cash.
Thank you for reading CFI’s guide to Government Spending. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below: