The fiscal balance is the difference between government revenues and spending. This balance could be negative, resulting in a deficit, or positive, resulting in a surplus. Consecutive large fiscal deficits are strongly detrimental to the sustainability of public finances. When the level of outstanding debt is high, the cost of servicing that debt (interest payments) can push a country further into deficit, thereby hindering fiscal sustainability. Conversely, improvements in the fiscal balance over time signal good fiscal health. Improvements result from a combination of the following factors: political commitment to fiscal discipline, sound institutional arrangements for budgeting and/or favourable performance of the economy.

Government debt represents governments’ outstanding liabilities stemming from the need to finance deficits through borrowing. Fluctuations of the exchange and interest rates can have a strong effect on government debt when it has a relevant foreign currency component, creating external vulnerability. Historically, LAC countries have been sensitive to fluctuations in external conditions resulting in high volatility of public finances. Thus, many countries have experienced low credibility about their fiscal policy, affecting their ability to obtain long-term credit at low premiums. However, in recent years some countries such as Chile, Colombia and Mexico established fiscal rules and stabilisation funds, which together with a recomposition from external to internal debt and prudent fiscal policy resulted in enhanced conditions to access debt markets.

Revenues raised by governments are used to finance the provision of goods and services to citizens and businesses and carry out a redistributive role. The two main sources of government revenues are taxes and social contributions. The amount of revenues raised by governments is determined by multiple factors such as government policies, political institutions, the stage of economic and social development, the endowment of non-renewable natural resources, and macroeconomic conditions. While for a certain period of time, additional revenue requirements could be financed by acquiring debt, in the long run, revenues and expenditures should be balanced to guarantee the sustainability of public finances.

The capacity to tax their citizens is one of governments’ core attributes. Revenues collected from taxes represent the most important source of public funds and are crucial to provide public goods and services, guarantee government operations, undertake public investments and a higher or lower degree of income redistribution. As a general trend, during the last two decades, LAC countries increased their tax collection, strengthened tax administrations and attempted to curb tax evasion (OECD/ECLAC/CIAT/IDB 2016).

Revenues from non-renewable natural resources (NRNR) represent a key source of income for many LAC countries. Between 2000 and 2013, the region experienced a commodity boom that resulted from high international commodity prices, increasing significantly the fiscal resources available. During the boom period, a few countries had established reserve funds and put in place stabilisation mechanisms aimed at counterbalancing possible price plunges from commodities and guaranteeing inter-generational equity. However, in 2014 the trend reverted and a decline in tax and non-tax revenues from NRNR occurred in the region. The negative effects of declining commodity prices on government revenues across the majority of LAC countries have been acute, adding pressure on the sustainability of public finances.

Governments spend money to provide goods and services, redistribute income and pursue economic development objectives. The amount of financial resources spent by governments provides an indication of the size of the public sector. Nevertheless, the size of government does not necessarily reflect its performance. Although government expenditures are usually less elastic than government revenues, they are also sensitive to economic developments associated with macroeconomic conditions and the business cycle. They also reflect past and current political decisions.

Different levels of government share responsibility for providing public goods and services. Central and sub-central governments (state and local) also vary in terms of their ability to levy taxes and collect social contributions. These differences could be explained by historical, economic, institutional and political factors. Commonly, sub-central governments are responsible for the provision of services and could be considered better equipped than central governments to obtain information on local needs and better placed to tailor public services accordingly.

The composition of government expenditures by transaction provides an indication of policy priorities, the type of service delivery model (e.g. focus on direct provision or focus on outsourcing) and the size of financial commitments resulting from public debt, among others. In addition, the expenditures breakdown reveals information on the importance of the government’s role in redistributing income compared to simply guaranteeing that public services are provided.

Government investment creates public infrastructure essential for long-term economic growth and societal well-being. For instance, public investment supports the provision of public services (e.g. schools). Further, governments invest in transport infrastructure, and other large-scale projects to improve productivity and competitiveness. Finally, governments can also invest in research and development to promote new technologies or products.

Cost-benefit analysis (CBA) aims to inform decision makers on the economic feasibility of projects, programmes, policies or regulatory initiatives. Its main purpose is to compare the costs associated with a policy or investment with the benefits of its implementation. The focus of this section is on CBA as a tool for the evaluation of investment projects. The content and methodology of CBA varies across countries. Nonetheless, a standard structure in the LAC region may consist of a description of the socio-economic and political context, definition of objectives, identification of the project, technical feasibility, environmental sustainability, financial analysis, economic analysis and risk assessment.

Cost-benefit analysis (CBA) is a methodology for calculating all social benefits and all social costs of an investment project. It determines the viability of an investment and can provide a basis for the comparison of alternative projects before spending public money. In essence, CBA consists of comparing the expected cost of a project against its expected benefits, in order to determine whether benefits exceed costs and hence decide if the investment is convenient for society and leads to an efficient allocation of resources. In CBA, benefits and costs are expressed in monetary terms, and are adjusted for the time value of money; therefore expressed in terms of their net present value (NPV). The most important application of cost-benefit analysis has been to decide upon public investment projects, thought it has also been used in other areas such as the evaluation of regulatory initiatives, called Regulatory Impact Assessment (RIA).