Final Consumption Expenditures in current and constant prices, part 2: Government and NPISH 1 Introduction This paper continues the series dedicated to extending the contents of the Handbook Essential SNA: Building the Basics 2. The aim of this paper is to provide some background to understand the compilation of two tables included in the Minimum Requirement Data Set (MRDS), the first data set that a country must have before it can claim to have implemented SNA: GDP by expenditure at current prices; GDP by expenditure at constant prices. To understand how these tables are compiled for final consumption expenditures and what data sources are required to do so, much of the paper is used to outline the expenditure approach to GDP compilation as applied to the case of final consumption expenditures. A previous paper in this series has examined the compilation of the two MRDS tables in general terms 3. In the current paper we will apply these general observations to the particular case of final consumption expenditures. Since the paper will exceed the intended length of papers in the series, we will distribute its content over two parts, of which the current document is the second 4. In the first part we looked at household final consumption expenditures. In this second part we will explore final consumption expenditures for government and for NPISH (Non-Profit Institutions Serving Households). What is Government? The government sector consists of units that carry out the functions of government as their primary activity. Government units have legislative, judicial or executive authority over other institutional units within a given area (SNA 4.9 5 ). They are involved in the production of non-market goods and services and in the redistribution of income and wealth. Non-market production is production free of charge or at prices that are not economically significant. Examples of non-market services by government units are public administration, defense, law enforcement and public health. Government units redistribute income by raising taxes and by allocating social benefits and subsidies. Government units are structured differently than firms. Their output does not have a competitive selling price and most government units are not aiming to make an operating profit. 1 This paper has been prepared with the technical assistance of DevStat Servicios de Consultoría Estadística in consortium with ICON Institute. 2 Henceforth called the Handbook ; references in this paper are to the second (2012) edition; it can be found at the following link: http://epp.eurostat.ec.europa.eu/portal/page/portal/product_details/publication?p_product_code=ks-ra- 12-001 3 Annual GDP by expenditure approach in current and constant prices: main issues 4 The other part is: Final Consumption Expenditures in current and constant prices, part 1: Households 5 References are to SNA 2008 1
How do we determine whether a unit qualifies as government unit? SNA presents a decision tree for this, consisting of three stages (SNA 22.36): It must be an institutional unit, i.e. it must be capable of owning assets, incurring liabilities, and engaging in economic activities and in transactions with other entities; It must be involved in the production of non-market goods and services; in practice, many countries interpret this criterion as meaning that prices cover less than half of the cost of production; It must either be a public sector unit or controlled by one; the public sector is more general than the government as we will see below; the key point here is that the unit carries out the above functions of government as its primary activity. The public sector and the general government are not the same (see figure 1 6 ). The public sector contains both market and non-market producers, whereas the general government contains nonmarket producers only. Examples of public sector market producers are corporations controlled by the government and non-profit institutions (NPI s) controlled by the government. The class of nonmarket producing units that are not controlled by the government is allocated to the NPISH institutional sector in SNA. The general government is the other sector recognized in SNA as a separate institutional sector. Public sector General Government Public corporations Public NPI's Central government Non-financial State government Financial, other than Central Bank Local government Central Bank Social security funds Figure 1 Public sector versus general government 6 See Government Finance Statistics Manual, IMF 2001, chapter 2, section D 2
As is shown in figure 1, The general government consists of central, state and local government and social security funds. The Central government is the single unit of central government that encompasses the fundamental activities of the national executive, legislative and judiciary powers (SNA 22.19). Its revenues and expenditures are controlled by a Ministry of Finance by means of a general budget approved by the legislature. The central government subsector is a large and complex subsector in most countries. It generally consists of many ministries, departments, agencies, boards, commissions, etc. The State government is the government that operates at the level of largest geographical area into which the country as a whole may be divided for administrative purposes, such as state, province, or region. In some countries, individual states and state governments may not exist. In other countries, especially those with federal constitutions, considerable powers may be assigned to state governments. The Local government consists of units operating at the smallest geographic areas distinguished for administrative purposes. Examples are counties, municipalities, cities and towns. A Social security fund is a particular kind of government unit that is devoted to the operation of social security schemes. These include compensations for loss of income as a result of not being able to work due to layoffs, sickness or death; compensations for health expenses; support of spouses, children, the elderly and invalids; housing benefits and allowances to cover education expenses. The public sector outside the general government consists of public corporations and public NPI s. Public corporations are market producers controlled by the general government. Control is defined as the ability to determine the general policy of an institutional unit (see SNA 22.27). In figure 1 we distinguish between non-financial and financial public corporations. Examples of the former are oil, railroad and broadcasting state enterprises. Included in the latter is the Central Bank. Public NPI s will be discussed in the next section. What are NPISH? Non-profit institutions are legal or social entities, created for the purpose of producing goods and services, whose status does not permit them to be a source of income, profit or other financial gain for the units that establish, control or finance them (SNA 4.83). Some NPI s operate as market producers and charge fees that are based on their production costs. These NPI s are classified in the ISIC sections where the production belongs. Examples are schools, universities and hospitals constituted as NPI. Some market NPI s serve a particular class of other market producers. Examples are chambers of commerce, trade associations and employers organizations. But the majority of NPI s in most countries are non-market rather than market producers. Their principal source of finance may be regular subscriptions paid by the members of the association or donations from third parties. NPI s have distinct features that justify treating them as a separate sector 7 : NPI s are not organized for profit and cannot distribute any profits earned to their directors or managers; The governance structures of NPI s differ from those of both corporations and governmental units; non-profit boards are not publicly elected and are rarely paid; 7 See Handbook on Non-Profit Institutions in the System of National Accounts, UN 2003, Series F, No. 91, p. 4 3
The sources of non-profit revenue include voluntary donations of time and money that are not available to for-profit producers; The staffing of non-profit organizations often includes a substantial numbers of volunteers; NPI s are typically exempt from corporate income taxes, and may also be exempt from other taxes, such as sales taxes and property taxes; NPI s lack the defining feature of a governmental entity, i.e., the compulsory power over all those dwelling or carrying on activities within a given area. The NPI sector as a whole is not recognized as a separate institutional sector in SNA. Its units are classified over recognized institutional units as follows (see also figure 2): Non-financial corporations sector: those NPI s, such as universities or hospitals, that receive most of their receipts from sales of non-financial services; Financial corporations sector: those NPI s, such as microcredit financing organizations, that are principally engaged in financial transactions; Government sector: those NPI s that are substantially controlled by the government (the public NPI s in figure 1); Households sector: those NPI s that lack legal status or rely solely on volunteer input; Only those NPI s that receive most of their income from households in the form of contributions and are not substantially financed and controlled by government are assigned to a separate institutional sector, the Non-profit institutions serving households (NPISH) in SNA. Examples are churches and religious societies, sports and other clubs, trade unions and political parties. The activities of many of these NPISH s are classified in ISIC section S. Non-financial corporations All NPIs NPIs classified in other sectors NPISH Financial corporations Government Households Figure 2 NPISH as a special class of NPI s Final Consumption Expenditures in current prices Final consumption is a transaction in the current accounts. As we discussed in a previous paper 8 the current accounts record the transactions from production to saving. Output is created from inputs; 8 See the papers Introduction to the SNA 2008 Accounts part 1, 2 and 3. In a nutshell: the Current Accounts consist of the Production Account, the Distribution of income accounts (consisting of the Primary distribution of income accounts, the Secondary distribution of income account and the Redistribution of income in kind account) and the Use of income account; Accumulation Accounts consist of the Capital Account, the Financial Account and the Other changes in assets accounts. 4
the value added generated is the source of income for labor; this income is redistributed, e.g. to the government in the form of taxes; income from other sources than production is added and redistributed in the form of property income. Ultimately the balance of all these current income flows is recorded as disposable income, which is then used for final consumption in the accounting period. The final balance is net savings, which serves as starting balance for the accumulation accounts. Final consumption is part of the last current account, the Use of disposable income account. Household final consumption is part of the household accounts, government final consumption is part of the government accounts and NPISH final consumption is part of the NPISH accounts. To understand the compilation of final consumption for government and for NPISH we must go back to the first current account, the production account where output, intermediate consumption and value added are recorded. General government output consists of products (goods and services) created during a specified accounting year. SNA distinguishes three types of output: market output, output produced for own final use and other non-market output. Market output is defined as the output that is sold at prices that are economically significant. We already saw before that other nonmarket output consists of goods or services that are supplied free, or at prices that are not economically significant. These services can be individual, i.e. supplied to other institutional units, or collective, i.e. supplied to the community as a whole. An example of output for own final use is software developed in-house by the computer department. The key point is that general government units always have the production of other non-market output as main activity. Market output or output for own final use can exist, but as secondary or ancillary activity only. Since non-market output cannot be valued using observable market prices intended to cover costs, other non-market output is traditionally valued by adding up the costs incurred in production: Intermediate consumption Compensation of employees Consumption of fixed capital Other taxes, less subsidies, on production The final cost component, net operating surplus, is assumed to be zero since general government units (and NPISH units also) operate at a non-profit basis. Since market output in case of general government is always a secondary activity, this type of output is often valued by its costs as well in case no information on the value of sales exists. We now come to the central issue for this paper: the compilation of government final consumption expenditure (GFCE). Actually, final consumption by the general government is an accounting construct. The general government does not in fact consume its non-market output. Households and firms consume that output as public services. However, this consumption cannot be attributed to households or to firms since there are no observable monetary transactions for these receiving units (remember that these services are either free of charge or valued at artificially low prices). Hence, national accountants attribute it to the general government itself. Calculating GFCE therefore amounts to calculating total government output by the cost approach and subtracting from this total the sales of output (at economically insignificant and significant prices) and adding the value of goods 5
and services purchased from market producers for delivery to households free or at economically insignificant prices. The remainder is by convention equal to GFCE 9. GFCE is itself split into individual consumption expenditure and collective consumption expenditure. The former includes expenditure by general government that benefits individual households such as expenditures on education, health, social security, operation of transport, provision of housing, sports, culture and collection of household refuse. The latter covers all other expenditure for which it cannot be said with certainty who the consumers are, households or enterprises. All members of the community can benefit from such services. These are collective expenditure items such as public administration, law enforcement and infrastructure maintenance. Classifying expenditures as individual and collective is not always easy in practice. An example given in SNA (9.98) relates to overhead expenses connected with the functioning of a public-health hospital, which are to be included in individual expenditures, since this would be the case for a similar private hospital where the costs of common services such as laboratories, ambulances or other facilities, would be taken into account in the prices charged to patients. As we saw in the previous paper on households, adding together individual consumption expenditure, provided as social transfers in kind, and household final consumption, we obtain households actual final consumption. Similarly, actual final consumption of general government is equal to the value of its total final consumption expenditure less its expenditure on individual goods or services provided as social transfers in kind to households. The value of this actual final consumption is therefore equal to the value of the government expenditures on collective services. The treatment of consumption expenditures incurred by NPISH s is very similar to that for general government (SNA 9.105). The services provided by NPISH s are often confined to the members of the associations that own them. These services are therefore essentially individual rather than collective. For many NPISH s, the value of their consumption expenditure will exactly match the value of their non-market output 10. In this case the whole of individual consumption of NPISH s is treated as social transfers in kind. Basic data and classifications As we noted earlier, the calculation of government output and GFCE is usually achieved as part of the compilation of the government accounts. The general government accounts are typically the most accurate of the national accounts. For this sector national accountants often have at their disposal complete micro-data in government financial accounting databases to compile the accounts of the institutional units making up the sector and not just a statistical sample as is frequently the case for households and for firms. When setting up a full system of integrated economic accounts, countries often start with the compilation of the government accounts. The compilation of the government accounts are also the central part of the macro-economic data to support the fiscal or government finance statistics (GFS). The Government Finance Statistics Manual 2001 (GFSM 2001) is the internationally accepted methodology for compiling GFS and provides a 9 Output for own account capital formation is subtracted as well (SNA 9.90) 10 Although for NPISH s, as for government, it is possible that they purchase goods from market producers for distribution to households and it is also possible that they may have some receipts from sales either of non-market output at prices that are not economically significant or from sales of secondary market production at economically significant prices (SNA 9.109). 6
framework for the compilation, recording, and presentation of revenues, expenditures, stocks of assets and stocks of liabilities 11. Government expenditures are classified by a functional classification of expense known as the Classification of Functions of Government (COFOG) 12. This classification has three levels of detail: divisions, groups and classes. The ten divisions are presented in table 1. 01 General public services 02 Defense 03 Public order and safety 04 Economic affairs 05 Environmental protection 06 Housing and community amenities 07 Health 08 Recreation, culture and religion 09 Education 10 Social protection Table 1 COFOG divisions COFOG codes should be assigned to each purchase, wage payment, transfer, loan disbursement or other outlay according to the function the transaction serves. A major use of COFOG is to identify consumption expenditures that benefit individual households and which are transferred to division 14 of COICOP. Similarly, NPISH expenditures are classified according to the Classification of the Purposes of Non- Profit Institutions (COPNI), also divided into divisions, groups and classes (see table 2) 13. 01 Housing 02 Health 03 Recreation and culture 04 Education 05 Social protection 06 Religion 07 Political parties, labour and professional organizations 08 Environmental protection 09 Services not elsewhere classified Table 2 COPNI divisions Consumption expenditures by NPISH always benefit individual households and are transferred to division 13 of COICOP. Public deficit and public debt Government final consumption in the Use of disposable income account is the last major transaction of the government current accounts. The resulting balance in this account is net saving. The next account, the capital account, records the various capital transactions (such as gross fixed capital formation) that are paid by these savings. The balancing item for the capital account is net lending / net borrowing (B9). A negative B9 shows the existence of net borrowing. In this case the country 11 See Handbook, p. 109; table V.6 gives an example of a simplified bridge table for reclassifying some income and expense budget items into SNA transactions 12 See Handbook, p. 88 13 See Handbook, p. 88 7
faces a public deficit. Net borrowing leads to an increase in public debt 14. A positive B9 means the existence of net lending, or a surplus, enabling the government to reduce its debt. Note that B9 can become negative as a result of current operations, current expenditures exceeding current revenues, and as a result of large investments by government. To exclude the effect of investments some countries prefer to use net saving as a measure for the public deficit. Final Consumption Expenditures in constant prices Constant price estimates of general government final consumption expenditure are usually prepared in a similar way as the current price estimates 15. Following the explanation given earlier for current price compilation, they are calculated as non-market output less sales plus transfers in kind of market products via market producers directly to households as final consumers, all at constant prices. As we have seen in a previous paper 16, non-market output at constant prices can be estimated by the input approach as a sum of value added and intermediate consumption, both at constant prices. The value added components are compensation of employees, other taxes on production and consumption of fixed capital (operating surplus being zero). These need to be compiled in constant prices, as must be intermediate consumption. Compensation of employees consists of gross wages and salaries, employers social security contributions and other labor costs. Gross wages and salaries can be deflated by a suitable wage index or by extrapolation with the number of employees (preferably adjusted for productivity growth). Employers social security contributions and other labor costs can be extrapolated with the same volume growth rate as gross wages and salaries. Other taxes on production can be extrapolated with the number of employees. Compiling consumption of fixed capital is not easy, one simple method is to deflate it with the implicit deflator for gross fixed capital formation. The components of intermediate consumption should be deflated with appropriate price indexes. Often suitable consumer price indexes are used, supplemented by special indexes such as the construction cost index. Sales at constant prices can be compiled by applying a sales volume index. Transfers in kind of market products via market producers directly to households can be deflated by the consumer price index. The compilation of NPISH final consumption expenditure at constant prices can be done along similar lines. i.e. as non-market output at constant prices less sales at constant prices. Non-market output at constant prices is estimated by the input approach as a sum of value added and intermediate 14 Government deficit and debt are two of the euro convergence criteria (also known as the Maastricht criteria) for European Union member states to enter the third stage of European Economic and Monetary Union and adopt the euro as their currency. The deficit, measured approximately by B9 must be less than 3% of GDP. The second criterion is the notified public debt which has to be less than 60% of GDP. The notified public debt is different from debt as it appears in the national accounts, for a number of reasons. First, the notified debt is consolidated, meaning that debts owed by one general government unit to another are cancelled out. Also, the notified debt includes only part of the debt, excluding a number of items such as debt relating to pension liabilities. See Understanding National Accounts, OECD 2006, chapter 9, section 4. 15 For background, see the papers: National Accounts in Constant Prices, part 1: Elementary Indexes and part 2: Aggregated Indexes. 16 See the paper Services in National Accounts, part 2b: Value added in constant prices 8
consumption, both at constant prices. Sales at constant prices can be compiled by applying a sales volume index. Concluding remarks This paper set out to provide some background on the methodology of compiling for final consumption expenditures the MRDS tables on expenditures in current and constant prices. In the current paper we explored general government and NPISH, in the previous paper we looked at households. In the next paper we will explore the next main expenditure category: gross capital formation. To find out more, Essential SNA: Building the Basics (2012 edition), Chapter 7 The 2008 SNA, European Commission, IMF, OECD, UN, World Bank, 2009, Chapter 15 Price and volume measures Handbook on price and volume measures Eurostat, Luxembourg 2001 9