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Chapter Three
Ethiopia is a federal state which comprises of a central government and nine Regional
Governments. There are also two chartered cities. As a federal country, the functions and duties
of the government are divided between central and state governments and they are generally
involves delegating more power to the decentralized divisions of the government. The goal of
this strategy is to speed up government action and to deliver a more suitable package of services
needed by the locality. One component of federalism is fiscal federalism which gives local
governments some taxing power and expenditure responsibility, and allows them to decide on
the level and structure of their expenditure budgets. The main goal of fiscal decentralization is to
move governance closer to the people, and this does require strengthening local government
finances. Fiscal decentralization requires local governments with some autonomy to make
Revenue Assignment
Expenditure Assignment
Borrowing
The division of taxation power is a principal aspect of the Constitution that provides the legal
framework of the Ethiopian federal system. The Constitution divides the taxation power into
three categories, namely ‘the federal power of taxation’, ‘the state power taxation’ and ‘the
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The distribution of revenues between the center and states is followed on the basis of
Revenue between the Central Government and the Regional Self Governments‛. The Articles 96,
97, 98, 99 and 100 of The Constitution of Ethiopia make a clear demarcation of areas where the
Central alone or State alone have authority to impose taxes. It contains a detailed list of the
To enable the central Government and the Regional Governments efficiently carry out
To narrow the existing gap in development and economic growth between regions;
Other factors that are basis for integrated and balanced economy.
Categorization of Revenue:
According to "Constitution of Ethiopia‛ revenues are categorized as Central, Regional and Joint.
Duties, tax and other charges levied on the importation and exportation of goods;
Personal income tax collected from the employees of the central Government and the
international Organizations;
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Profit tax, Personal income tax and sales tax collected from enterprises owned by the
Central Government. (Now sales tax is replaced with VAT and Turnover taxes).
Taxes collected from National Lotteries and other chance winning prizes;
Taxes collected on income from air, train and marine transport activities;
Taxes collected from rent of houses and properties owned by the central Government;
Charges and fees on licenses and services issued or rented by the central Government;
Personal income tax collected from the employees of the Regional Government and
employees other than those covered under the sources of central government.
Taxes collected from rent of houses and properties owned by the Regional Governments;
Profit tax, personal income tax and sales tax collected from enterprises owned by the
Regional Government:
Income tax, royalty and rent of land collected from small scale mining activities.
Charges and fees on licenses and services issued or rented by the Regional Government;
Profit tax, personal income tax and sales tax collected from enterprises jointly owned by
Profit tax, dividend tax and sales tax collected from Organizations;
Profit tax, royalty and rent of land collected from large scale mining, any petroleum and
gas operations;
Forest royalty
Collection and Allocation of Joint Revenues: It is the federal government which collects both the
federal and joint revenues. The joint revenue is shared based on a decision made by a committee
appointed by the prime minister and consisted of representatives of both levels of governments.
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The following table shows how the joint revenue is shared between the federal government and
regional government.
Undesignated Power of Taxation: The power of taxation mentioned in the Constitution is not
exhaustive. To avoid unnecessary dispute between regional governments and the federal
government when a new taxable activity emerges, Article 99 of the constitution states that ‘The
House of Federation and the House of peoples’ Representatives shall, in a joint session,
determine by a two-thirds majority vote on the exercise of powers of taxation which have not
The federal structure of Ethiopia allocates functions and responsibilities, and hence expenditure,
to federal government and regional governments. Art 51 of the Constitution entrusts the federal
services, weights and measures, domestic currency coinage and foreign currency usage, banking,
patents and copyrights, operation of air, rail and water transports and highways linking two or
more states, enacting labor, electoral, procedural, criminal, and commercial codes. Art 52 (2)
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assigns to regional governments such power and functions as enacting and executing the state
constitutions; establishing state police, maintaining public peace and order; administration of
land and other natural resource within the region; and formulating and executing economic,
social and development policies, strategies and plans of the state. The states also have power
over areas of education, health and agriculture. Both regional governments and federal
government are required to cover expenditure to be incurred in connection with their respective
functions and responsibilities. The following table shows the expenditure assignment to the three
levels of government.
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Primary education
Basic health care
Agricultural extension programs
Veterinary clinics
Land use administration
Woreda Water development, wells construction and maintenance
Local police
Local roads
Shared with regions: small-scale capital projects
Intergovernmental transfers refer to the transfer of money from central government to regional
governments. It has been employed in all federations to achieve a variety of economic objectives.
In Ethiopia the transfer is in the form of subsidy. The main objectives of subsidy in Ethiopia are:
Fiscal Imbalances: An important reason for giving transfers arises from fiscal imbalances or
mismatch between revenues and expenditures of different governmental units. Fiscal imbalances
can be ‚vertical‛ or ‚horizontal‛. ‚Vertical fiscal imbalance‛ refers to the difference between
expenditures and revenues at different levels of government, and ‚horizontal fiscal imbalance‛
refers to the differences between revenue and expenditure levels within a particular level of
government.
Fiscal Equity: The argument for intergovernmental transfers on equity grounds has been made
either in terms of ensuring horizontal equity of individuals across the states, or simply of
ensuring inter-regional equity. Both the approaches build a case for unconditional or general
purpose transfers from the center to the states on a progressive scale so as to offset the fiscal
disabilities arising from low revenue capacity and high expenditure needs.
Correction of spillovers: Intergovernmental transfers are seen as a device to resolve the problem
of mismatch between benefit spans from various hierarchies of public goods and exogenously
given spatial jurisdictional domains. When the benefits of public services provided by a state
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spill over its jurisdiction, the state ignores the benefits accruing to the non-residents while
deciding the amount of the service provided. The jurisdiction equates the marginal benefits from
the public service with the marginal cost of providing it, and as it ignores the part of the benefit
accruing to non-residents the result is non-optimal provision of the public service. Optimal
provision of the service is ensured through central subsidies to offset the spillovers.
As can be evidently observed from the revenue and expenditure assignments addressed in the
Constitution, the lucrative (profitable) sources of revenue in Ethiopia are assigned highly to the
federal government while a wide range of expenditure responsibilities are reserved to the
regions. The subsidy from the federal government to the regional government is made based on a
3.2. Borrowing
Regional governments are not allowed to borrow from abroad. It is the federal government that
has the power to borrow from abroad. They can, however, borrow internally from banks to meet
the cash flow timing problem. Borrowing internally from banks requires the permission of
MOFED. When regional governments experience budget shortfall in any fiscal year the federal
government may give them loan in the form of advance to be charged to their budgetary subsidy
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Public revenue refers to different sources of government’s income. The Ethiopian government
revenue is broadly divided into three: tax revenue, non-tax revenue, and capital revenue. The tax
revenue includes income taxes, VAT, TOT, excise tax, custom duty, and stamp duty. The non-tax
revenue includes
Administrative fees and charges: passports & visas, registration of foreigners, work permits,
court fines, court fees, forfeits, business and professionals registration fee, license fees,
warehouse fees, television license fees, coffee inspection & other fees, standards charges, other
Sales of public goods & services: sales of government newspapers, magazines & publications,
media, advertising revenue, health services, sales of medicines &medical supplies, medical
aviation services road transport services; science &technology services; national examination
services; farm products; forest products; and other goods and service
Government investment income: residual surplus; dividend income from government assets;
government employees; interest on government bank accounts; capital charges; lease of land
Capital revenue: sales of moveable and immovable properties; privatization proceeds; collection
The government receives grants from foreign governments and other developmental
organizations. The grant may be in cash or in-kind. The grant and assistance may be obtained
from multilateral institutions (such as African Development Fund, European Union, Food and
Development Program, United Nations Fund for Population Activity, World Health
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Since the modern government represents a welfare state, the responsibility of the government is
to bring about maximum social welfare. In addition to this, it has to perform various other
functions, which require heavy expenditures. Public expenditure refers to the expenses, which
the government incurs for its own maintenance as also for the society and the economy as a
framework for both policy decision making and accountability. The best-known classification
systems are the functional ‚Classification of the Functions of the Government (COFOG),‛
developed by the United Nations, and the Government Financial Statistics (GFS) classification,
developed by the IMF. Expenditures are classified for different purposes, such as: the
preparation of reports that fit the needs of report users (policy decision makers, the public, and
the budget manager); the administration of the budget and budgetary accounting; and the
According to the different needs for policy formulation, reporting and budget management
to their purposes (e.g., education, defense, health, social security, housing, etc.). It is independent
allocation of resources among sectors. It also allows producing historical surveys of government
Line-item classification: For budget management purposes, the budgets include an object
classification (also called ‚line-item classification‛). This line-item classification lists expenditures
along categories used for budgetary control and monitoring, such as different categories of
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organization. Expenditures are classified into separate sections for each ministry, department, or
Economic classification: Public expenditures are classified into recurrent expenditure, capital
expenditure, interest payment, and repayment of loan. Recurrent expenditure covers all items to
be funded during the current fiscal year like salaries, materials, and services necessary for the
ongoing activities. Capital expenditure refer to the cost of acquiring buildings, roads, dams,
equipment and other items that will have a life-span of more than 1 year.
Even if the government expenditure is broadly classified into recurrent and capital expenditure,
expenditures are also classified based on functions. The major classification is into general
services, economic services, social services, pension payments, interest & charges, subsidies, and
external assistance. The following table shows what is included under the major functions.
It is obvious that when any government's expenditure exceeds its revenue, then this deficit will
be financed either by internal or external borrowing. The external debt of the government is
divided into three: multilateral, bilateral, and private creditors. Multilateral creditors are
institutions such as the IMF, the World Bank, African Development Bank, and Fund for
include governments and their agencies (including Central Bank), autonomous public bodies or
official export credit agencies. Private creditors include foreign commercial banks and suppliers.
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The government borrows internally through issue of bonds, sale of treasury bills and direct
advances from National Bank of Ethiopia. Treasury bills are issued by government to raise
money for short-term. A government may need money to cover salary expenses, operating and
project expenditures before its regular revenue is collected on time. Or it may issue treasury bills
to adjust the amount of money in circulation with its actual demand whenever there is
imbalance. Three kinds of treasury bills, different with respect to their maturity, are issued– a
monthly (28 days), a three-month (91 days), and six-month (182 days) bills. Bonds, in general, are
long-term written promissory agreements by which a borrower promises to pay a stated sum of
principal and interest amount on specific dates to the holder of the bond. Government bonds are
those bonds issued by the government for the purpose of financing, mainly, its recurrent
One of the main responsibilities of the government is to ensure an efficient and effective
utilization of public resources. Proper utilization of public resources calls for a systematic
with its amendments govern the financial administration of the government. The public financial
Budgeting cycle consists of four roles which are budget preparation, legislative approval, budget
A. Executive Preparation
This includes preparation of the annual budget by public bodies according to directives of the
MoFED. Executive preparation can be divided into some stages as described below.
The preparation stage has three tasks. All the three tasks would be carried out by the public
bodies who prepare their budget request. The First task is to determine the unit cost of goods and
services of developing cost build-up in the request stage. Unit cost will be determined for each
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The Second task in the budget preparation will be the mid-year program review. The review
involves assessment of the performance of on-going projects. As indicated earlier, since on-going
projects require resource for their completion, the amount of resource to be spent on them needs
to be examined.
The Third task in the budget preparation will be development of work plans for on-going and
new projects for the upcoming fiscal year. Once the budget preparation stage is completed, the
next step in budgeting is for public bodies to receive their budget ceiling and reduce their work
MoFED will prepare a proposal and present it to the Federation Council for the formula to be
used in allocating the regional subsidy. The federation council will then amend the formula for
the regional subsidy if it is commonly felt that the formula does not permit allocation of
MoFED releases to regions and administrative councils of their estimated subsidies for the
coming fiscal year. Notification of the subsidy enables regional governments to incorporate the
subsidy in their annual budget which is presented to the regional council. The notification is
issued by the MoFED to regions and administrative councils between January 9 and January 16.
The budget call provides public bodies with their budget ceiling for recurrent and capital
expenditure for the coming fiscal year and the deadline for submitting their budget requests. It
also includes a review of the policies that affect the expenditures of public bodies, the guidelines
on treating external loan and assistance. The general guidelines for the preparation of the
recurrent and capital budget submission and detailed instruction and formats for preparing the
request for the recurrent and capital budgets is also part of the budget call. In general, the budget
call allows public bodies to start the task of formulating the budget by taking into view resource
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In brief, the budget call informs public bodies what their ceilings are and when to prepare their
budget requests. It is issued by MoFED to promote a common budget calendar and better
The budget request begins when public bodies receive the budget call. The central task of the
public bodies during the request stage is to fit their request within the budget ceiling issued in
the budget call. To ‚fit‛ the requests two tasks have to be done by the public bodies. First, they
have to adjust their planning and programming based on resource envelope and work plans to
the budget ceiling. The original request they prepare before the ceiling has to be reviewed and
hence a change in the plan and programs for the next fiscal year is necessary. Second, they have
to prepare a justification of the cost build-up of the work plans of their projects and sub-agencies.
Public bodies are responsible for preparing their budget requests and seven weeks (February 8-
It is at this stage that budget requests that exceed the ceilings are reviewed and necessary
adjustments are made in the total ceilings of public expenditure and the ceilings of public bodies.
The MoFED prepares a recommended budget, consolidates it, and forwards it to the Office of the
Prime Minister for approval. The recommended budget will have the following four parts: an
estimate of resources; subsidies to the regions and administrative council; a recurrent budget,
This is a stage where the budget gets approval from the office of prime minister and the council
of ministers. The approval will be finalized within two weeks because most of the comments
have already been communicated during review of capital expenditure. The four tasks involved
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2. To review the total of the subsidies to regions and administrative councils and the split
3. To ensure that priorities established have been reflected in the budget &
4. To ensure that recurrent budgets are budgeted according to the government policy.
Any change or revision at this stage is referred to Ministry of Finance and Economic
Development and adjustments are made accordingly. Finally, the revised budget will be
approved by the Council of ministers and wait for the approval of the parliament.
B. Legislative Approval
The stages stated from stage 1 to stage 7 constitute the first part of budgeting referred as budget
preparation. Next stage of budgeting deals with legislative approval and executive
implementation.
The recommended budget is draft approved budget subject to review, revision, and approval of
the parliament. It has been stated draft approved budget because it has got the approval of
At this stage, the parliament, based on the approved budget, authorizes funds for appropriations.
Approved budget is appropriated by budget type (capital and recurrent expenditure for federal
government), and by subsidy (by region and administrative council). The approved budget and
its annual appropriation become proclaimed budget and it is published in Negarit gazeta.
Whenever, there is need to have additional fund above the approved and appropriated budget,
executive agencies must submit a supplementary budget to the parliament and get approval.
C. Executive Implementation
This is an initial implementation stage of the budget cycle. Public bodies are notified by Ministry
of Finance and Economic Development of their proclaimed budget in detail to the extent of line
items of expenditure.
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In the implementation stage, the proclaimed budget is managed in terms of requests for
adjustments and monitored through financial and physical reports. The adjustments are
Transfers:
These are the transfers of funds between public bodies, which increase one public body’s budget
and decrease another public body’s budget. It also includes transfer of budget between capital
and recurrent items of the same public body. The transfer can be done in two different ways. The
first type is reallocation between the capital and recurrent budgets within the same public body.
Under this type, surplus funds from recurrent budget can be transferred to the capital budget
with the approval of council of Ministers. However, transfer from capital budget to recurrent
budget is strongly prohibited. The second type of reallocation is between public bodies within
the same type of budget (e.g. capital or recurrent). The second type of reallocation requires the
Virement: This is the reallocation of funds within a public body’s budget between items of
expenditures. This occurs when the amount of resource allocated to a particular activity is
relatively higher than the one allocated to another activity. It is made within a public body to
transfer within a project between items of expenditure or transfer between projects. For this type
of re-allocation, the MoFED has to approve transfers in the recurrent budget and the capital
Allotment: Once the legislature approves appropriation, the treasury does not automatically
channel the funds to the spending agencies. In nearly all governments the central budget office
operating agencies submit plans to the central budget office as to how appropriated funds will be
used; the plans often indicate proposed expenditures for each month or quarter of the fiscal year.
The budget office may require modification of agency proposals and virtually approve
apportionment for each agency. The allotment may be a lump sum subject to restrictions
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imposed by the central budget office. Conversely, if the appropriation consists of numerous line
items, the allotment follows the same classification. Presumably, a lump sum allotment gives the
spending agencies maximum flexibility and discretion in the use of funds. Conversely, allotment
Apportionment: Following the approval of allotment by the budget office, apportionments are
made within the department. This process grants expenditure authority to subunits of operating
agencies. The nature of the apportionments varies with the structure of the appropriation. The
primary purpose of apportionment is to ensure that units of operating agencies spend at a rate
that will keep them within limits imposed by the annual appropriation of the operating agency.
Supplementary: These are additional funds to a public body, which increase the total
Supplementary appropriations are made after checking for the possibility of both transfers and
virement.
Mid-year Changes: As the year progresses, the budget office conducts reviews of agency
operations. One problem that often emerges is that resources in some agencies are insufficient to
meet the demand for services. In this case, one alternative for the budget office is to approve
Mid-session review of the budget discusses economic trends and how these trends affect receipts,
spending patterns, the activities of credit programs, and whatever requests and other procedures
are in place to attempt to limit the budget deficit. In any event, what is actually spent will be
Mid-year crises may emerge because of unfavorable revenue situation. Government budgets that
depend heavily on a single commodity export may experience severe fluctuation during the year
as the world price of the commodity fluctuates. Since personnel costs are the largest single item
in operating budgets, these costs must be curtailed when revenue receipts are below projected
Some governments have expected all employees to share in the problem by working, and being
paid for, a four-day week rather than a five-day week, thereby creating a 20% saving.
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End-of-Year Spending: As the fiscal year approaches its end, agencies will attempt to exhaust
their budgets; an agency having unexpended funds at the end of the fiscal year may be
considered a prime candidate for cuts in the upcoming budget. In addition, unexpended funds
often lapse at the end of the budget year. From the agency’s perspective, it is a now-or-never
situation for spending the available money. Another factor is that an agency might have delayed
some expenditure, saving a portion of its budget for contingencies. This delay results in hasty
spending of expenditures at the end of the year, with some spending being highly appropriate
In most government organizations, spending level attains its peak towards the end of the fiscal
year. This is explained partly due to inability of the central finance and planning agency to make
other reason is absence of putting activities in the order of priority and accomplishing them in
If the budgets are to be funded in gross, then the disbursement would include the retained
revenue. Retained revenue are defined as ‚own funds‛ of public bodies. The total amount to be
disbursed to a public body would be the sum of both treasury and retained revenue.
D. Budgetary Control
Internal control (i.e., the compliance of the rules and regulations, procedures, etc.) is an essential
function for every public body to ensure effective and efficient use of budget resources. The
budgetary control examines records, facilities, systems, and other evidence to discover or verify
organization being audited. External audits/controls are performed by outside professionals who
are independent from the organization being audited. It can also be classified as financial
Financial statement audit involves examination of accounting reports of an entity to vouch for
their accuracy and being free from any material misstatement of facts. Performance audit, on the
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other hand, focuses mainly on checking that units of an enterprise are operating in line with pre-
Compliance audit is concerned more with ensuring that operating units of an organization are
discharging their respective responsibilities in accordance with the rules and regulations in the
organization.
Since financial statement audit has a very little significance to budgetary systems, emphasis is
made here on performance audit and compliance audit. Hence, subsequent discussions on
auditing will center on these two types of audits. In budgetary systems classification of audits
into pre-audit and post-audit received greater acceptance. Let us see them in turn.
their completion. It occurs before the government commits itself to a purchase and is used to
verify whether an agency has sufficient funds to purchase given equipment and that agency is
authorized to have that equipment. In this audit, not only the budget office but also the
Determination that obligations were properly incurred, goods were received, amounts
Post-audit: is an examination of records and activities after they have already been completed. In
programs and projects. A post-audit includes verification of legality of transactions and accuracy
Verification of documents and ascertainment that receipts and expenditures have been
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whether the allocated resources are used economically and for the purpose approved in the
legislation.
Deficit, in finance, refers to the excessive public expenditure over public revenue. Deficit is
income due to several reasons such as expansion of government activities in a budgeted period,
decline in source of revenue, inflation, over and under estimations, etc. The gap between the
shortfall of public revenue and excessive public expenditure must be filled. The means by which
governments fill this gap is deficit financing. Deficit financing is occurred due to imbalance of
Deficit is financed through different mechanism. In a wider context, countries shift their excess of
current account or capital account to finance wherever deficit exists. Since deficit financing is a
wider conceptualization that affects the overall economy of a nation, macroeconomic alternatives
such as taxation, printing money and borrowing financing sources are key factors to make
decisions of filling the gap in the fiscal policy. Internationally, money financing is proved as
inflationary.
Deficit financing through taxation and borrowing from the public and commercial banks is
Deficit financing has been recognized as an important role in fiscal policy on account of increases
in public expenditure on various accounts while public revenues remain insufficient to cover
government spending.
There are several reasons why deficit financing is important including the following ones.
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i) To finance wars: many countries are want to be equipped with modern weapons and build up
their military. They also engaged in very expensive wars. This demands huge resource and
hence, deficit financing has been found to be the simplest and quickest method to finance
ii) To reduce unemployment: during bad economic times like deflation, unemployment rate
increases as the economy unable to create jobs. Thus, public expenditure increases to stimulate
the economy and create more jobs for jobless citizens. Hence, deficit financing is advocated as
iii) To promote economic development: in developing countries, one of the vital roles of public
mobilization due to huge spending. Public investments in infrastructure are essential to attract
more foreign investors for huge capital accumulation. Thereby, deficit financing can go a long
iv)To finance strategic plans: in developing countries like Ethiopia where several development
plans are adopted at several times to ensure overarching development, deficit is obvious. We
can cite the Growth and Transformation Plan (GTP) which requires huge resource
v) To serve as an alternative tool: underdeveloped countries suffer from low taxable capacity
and low savings. Hence government's ability to raise resources gets constrained. Therefore
Deficit financing has both positive and negative effects in the economy as under:
1. Inflationary rise in prices: The most serious disadvantage of deficit finance is the
inflationary rise of prices. Deficit financing increases the total volume of money supply.
Unless there is proportional increase in production this can lead to inflation. When deficit
financing goes too far it becomes self-defeating. There was inflationary pressure during the
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2. Effects on distribution of wealth and income: The real income of wage earners gets reduced
of business class
3. Faster growth: Country is able to implement the developmental plans through deficit
certain fields like construction, luxury consumption inventory holding and speculation. This
5. Credit creation in banks: Inflationary forces created by deficit financing are reinforced by
Among various fiscal measures, deficit financing has been assigned an important place in
financing developmental plan and various developing countries including Ethiopia resort to
Deficit financing in Ethiopia was mainly resorted to enable the Government of Ethiopia to obtain
necessary resources for the plans. The levels of outlay laid down were of an order, which could
not be met only by taxation or through a revenue surplus. The gap in resources is made up
partly through external assistance. But when external assistance is not enough to fill the gap,
deficit financing has to be undertaken. The targets of production and employment in the plans
are fixed primarily with reference to what is considered as the desirable rate of growth for the
economy. When these targets cannot be achieved through resources obtained from taxation and
external borrowing, additional resources have to be found. Deficit financing is the easier option.
It is important to emphasis the fact that deficit financing cannot create real resources which do
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