Public sector expenditure as it appears in the national income accounts can be classified in two main categories:
1) exhaustive expenditure vs transfer payments/expenditure
2) operating vs capital expenditure.
Exhaustive Expenditure: This refers to expenditure by government that consumes or exhausts the purchasing power of the money it spends, hence the name. Included are purchases of inputs used in government’s own production of goods and services, and purchases of outputs from the private sector. It also includes investment in fixed assets such as roads, machinery, buildings, etc. Also known as government income producing payments, exhaustive expenditure represents the purchase of goods or services by the government and therefore it results in the creation of employment and income. As a result, it has a profound effect on people’s standard of living and life chances or opportunities.
Transfer payments/expenditure: These refer to expenditure where the government does not purchase factors of production or use resources. Instead it involves the transfer of money from government to individuals in the society. These include subsidies, interest payments, loans, welfare payments, pensions, etc. Transfer payments represent the mere transfer of funds from the government to individuals and do not involve any employment or income creation activity.
Operating Expenditure: Operating expenditure, also known as consumption expenditure, includes all expenditure involved in sustaining the government machinery. It includes salaries and wages, travel and communications, maintenance and operations, purchase of goods and services, operating grants and transfers, pensions, allowances and debt charges.
Capital Expenditure: This expenditure includes all payments made by the state to raise the productive capacity of the economy. This expenditure will provide a sustained source of returns for the economy. Expenditure in this category includes capital construction, capital purchase and capital grants and transfers.
There are two other categories of fiscal policy changes, automatic expenditure (or built-in change) and discretionary expenditure changes. => Built-in changes are expenditure that happens automatically. In other words, the government does not have exact control over the level of this type of expenditure.
=> The most obvious example of this is spending on benefits. The government sets regulations for who is entitled to benefits, and it sets the level of the benefits. However, the one thing that it cannot dictate is the number of people who may then be entitled to them, as this will often depend on the state of the economy.
=>As the economy goes into recession and people lose their jobs, more people will be entitled to benefits. This will mean government expenditure will rise—not because the government chose to spend more, but simply because of the state of the economy. This spending is therefore automatic spending.
=> However, discretionary spending is, by contrast, spending the government chooses to make. In a time of recession, it may choose to spend more to try to boost the level of aggregate demand and therefore equilibrium output.
=> At other times, it may choose to lower the level of expenditure to avoid 'crowding out’ private sector spending. Either way, it is said to be operating a discretionary fiscal policy.