Case Study

Case study 5

CaseStudy

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This case was carried out ingovernment of New Brunswick on an imaginary province and its fiscalsituation, main concern being formulating a budget. The casedescribes the process by which the initial fiscal framework wasdeveloped for a particular year and series of options were developedfor students’ consideration. Purpose was to evaluate the options interms of the facts available, to view personal judging concerningdesirable budget objectives and to select one alternative options ordevelop an extra one based on the available reforms.

Preparation of fiscal frameworkinvolves having boundaries within which scarce resources must beallocated. Elements considered include growth rate of the economy,how much borrowing is required within the framework of national andinternational capital market conditions, taxation and whether thelevel of net debt should be allowed and increased. The initial stepin formulating a budget is important as it gives room for thebudgetary expenditure for coming year to be decided. The case usesdifferent variables in arriving at an initial budget strategy andrequires students to elaborate their optimum solutions given theirjudgment of the relevance of these variables. There are a range ofoptions to be considered which represents particular interpretationof the facts and views of governments’ function in the society.

For study purposes, the case isorganized into three sections the introduction part, the fiscalframework and a statement of the actual problem to be solved. Thefirst Step undertaken is the assessment of the future economicoutlook preparation for the development of both short run economicstrategy and accurate revenue forecasting predictions. Second step isforecast of expenditure growth by major program which reveals theextent to which growth exceeds future revenue for three year period.Also this identifies future patterns of spending giving warning toministers. Next is forecast of revenues including federalcontributions to provincial coffers which provide a foundation forthe fiscal framework by setting the limits to future expenditures inconsideration of revenue or deficit policies. Forth step is review ofthe province ability to raise funds in the capital market of theworld, aim being giving decision makers indication of the province’sfuture borrowing capacity. Fifth is the assessment of future behaviorof important financial ratios which seeks to give signs of likelyfuture financial health of provincial governments. Finally, it issuggested that there is need for recognition of the policyenvironment within which a budget must be prepared.

The study had several limitationswhich include less money availability for existing expenditureprograms as well as for new programs. It is pointed out that spendingreductions are likely to be the case than expansion of existingprograms. Development of budget is constrained by limited flexibilitythat government have at any time to alter revenue. Ability of thegovernment to manipulate revenue is limited because such revenues area contribution either in the form of unconditional grants orshare-cost revenues. Finally, budget plan options are seriouslyconstrained by borrowing and thus credit rating agency should becareful on the budget plan to reduce operating deficit.

The findings indicate that economicperformance for the previous year was strongly supported by foreignexports. Pulp, paper and mining were strong but were offset byweakness in the service sector. It is evident that gross domesticproduct grew by 8.8% and real terms by 4.8% which is attributed to anincrease of 35% in corporate. On expenditure side, personalexpenditure on goods and services was the main concern in theprevious year. Gross fixed capital formation increased by 4% due tothe formation of construction industries, utilities and governmentdepartments. Total exports increased by 27% and unemployment raterose from 11.5% to 12.3%. Revenue outlook indicated that the taxeffort of this province relative to others is at average and thatthere is a decreased tendency for the province to rely on federalcontributions. It was observed that shared federal contribution togross revenues increased from 37% in 1977 to 78% but has declinedsince then. Elasticity of own sources revenues to G.P.P has been onaverage of 1.1 over five year period but today is 0.90. Onexpenditure side, its growth rate has exceeded revenue due to thedevelopment of a sizeable deficit which will continue to grow evenwithout extension to existing programs or addition of new ones. Thissizeable growth is as a result of high wage settlements, unemploymentand rise in Medicaid medically needy individuals.

Report from financial constraintsunit indicated that there are two types of ratios ratio between costof servicing the public debt to total budgetary revenue which hasdecline during periods of rapid revenue growth and ratio of net debtto gross budgetary revenue which reflects the changing ability of theprovince to finance its debts. It is reported from borrowing plan andavailability of capital that there will be no shortage of capital inthe next three to five years in capital markets. Province’s creditrating is double A (2AA) and that this has remained so over the lastten years. Fact remains that borrowing as high as 30-40% abovepredictions level can be observed by the market in one or two year’speriod. From economic, fiscal and other policy consideration, it isobserved that western industrialized nations are expected toexperience slow growth over the next two to three years and to followpolicies of monetary and fiscal restraint to mitigate high deficitsof recent times. Report from budget plan options indicates thatgovernment faces financial difficulties which can be solved byincreasing revenue growth rate or decreasing expenditure growth rate.

Some of the questions to be addressedare does the budget plan meet the objectives of the expenditurerestraint? Is this important during the period of high unemploymentand slow growth?, Can the net debt be allowed to rise to a rate thatrequires a substantial increase in the proportion of futureexpenditures to be devoted to debt servicing charges?,Does the budget plan createdifficulties for the province`s credit rating?

From the case, it is recommended thatthe level of provincial assistance be increased as property taxrevenue growth has failed to keep up with the increased cost of localservices. This will also help faltering industries and protectexisting ones. It is also important to provide government services toall sectors and non-budgetary expenditures should be considered inestablishing the total cost requirement of the government during theforecast period. Finally, government should increase pressure torespond to weaknesses in the provincial economy by cost employmentmeasures. There should be tax cuts to the community to stimulateeconomic growth and accelerate the living standards of people.

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