The Effect of Government Revenue and Population on Capital

Expenditure and Its Impact on Economic Growth

in North Sumatera Province

Octreshia Ellendythia Marpaung

, Indra Maipita

and Muhammad Fitri Rahmadana

Faculty of Economics, Universitas Negeri Medan, Medan, Indonesia

Keywords: Balancing Funds, Capital Expenditures,Economic Growth,Lokal Revenuesand Population.

Abstract: Developing countries depend on expanding fiscal policies to increase economic growth. Fiscal policy

affects the economy of a country through government revenues and expenditures. This study aims to

analyze the effect of local revenue, balancing funds and population to capital expenditure and analyze the

effect of capital expenditure on economic growth of districts / cities in North Sumatra Province. This study

uses economic growth rate, capital expenditure, local revenue, balancing fund and population of 33 districts

/ cities in North Sumatera Province for the period from 2011 to 2016 in percent. This study analyzes the

data by applying pooled dataanalysis with random effect model. The result indicates that local revenue,

balancing fund and total population together significantly influence capital expenditure in regencies / cities

in North Sumatera Province. Partially population has no effect on the allocation of capital expenditure.

Capital expenditure has a positive and significant impact on economic growth. However, the development

should be based on the concept of environmentally sustainable development in economic, social and

environmental aspects to meet current needs without sacrifice fulfillment the needs of future generations.

1 INTRODUCTION

Economic growth becomes an important discourse

in a country because it is an indicator of economic

achievement and performance of a country.

According to Musgrave, in order to achieve the goal

of economic development, government as a

development facilitator uses various economic

policies to create a conducive climate for the

productive activities of society. In the history of its

development, developing countries use the

expansion of fiscal policy to reach an economic

growth (Maipita et al., 2010). Fiscal policy influence

the economy with government revenues and

expenditures. Government trying to direct the

economy to a better condition by using fiscal policy

(Rahmadana and Naibaho, 2015). Governments need

to perform various functions in political, social and

economic activities to maximize social and

economic welfare. Government revenues impact

economic growth through the fulfillment of various

government needs (Muriithi, 2013).

Government spending becomes one of the fiscal

policy instruments that governments use to influence

the economy. The relationship between government

spending and economic growth is debated by

researchers. Some researchers argue that increased

government spending on socio-economic and

physical infrastructure increases economic growth

(Nannan and Jianing, 2012). Government spending

on infrastructure such as roads, communications,

etc., can reduce production costs, increase private

sector investment and corporate profitability,

ultimately will increase economic growth. However,

some researchers argue otherwise and state that

higher government spending may reduce economic

performance (Olulu et al., 2014). To fund its

spending, government can increase taxes or loans

(Chude & Chude, 2013). Higher taxes will increase

production costs and can reduce private sector

investment. Government sometimes increases their

expenditures and investments in unproductive

projects. sometimes governments fail to allocate

resources and reduce economic growth (Ermasova et

al., 2014).

In regional government system, economic

growth is indicated by the increase of goods and

service production measured through Gross

Regional Domestic Product (GRDP). North Sumatra

province is one of the provinces in Indonesia which

Ellendythia Marpaung, O., Maipita, I. and Fitri Rahmadana, M.

The Effect of Government Revenue and Population on Capital Expenditure and Its Impact on Economic Growth in North Sumatera Province.

DOI: 10.5220/0009902300002480

In Proceedings of the International Conference on Natural Resources and Sustainable Development (ICNRSD 2018), pages 325-331

ISBN: 978-989-758-543-2

325

has a higher rate of economic growth than

Indonesia's economic growth rate. However,

between 25 districts and 5 cities in North Sumatera

Province there are some districts / cities that have

lower economic growth rate than the economic

growth rate of North Sumatra Province and

Indonesia's economic growth rate.

Figure 1: Economic Growth Rate of Districts / City in North Sumatra Province Year 2016

In 2016 the rate of economic growth in some

districts / cities is higher than the economic growth

rate of North Sumatra Province. However, in some

districts / cities have lower economic growth rate

than the economic growth rate of North Sumatra

Province. This means that in the implementation of

regional autonomy which gives authority to regional

governments to regulate the regional economy, some

local governments in districts / cities are still unable

to improve their regional economies.

The implementation of regional autonomy has

created a fiscal decentralization with a principled

money follows function which means the delegation

of government authority brings the consequences on

the budget required to implement the authority

(Briando, 2017). Indicators of successful

implementation of regional autonomy can be seen

from various things such as the ability of local

governments in preparing the direction and policies

in finance, improvement of local revenue,

construction of various public service facilities for

local communities. Keynesian theory states that

local revenue (PAD) becomes a source of capital for

economic activities. Increased PAD will increase

local funds that can increase capital spending for

development.

Local governments should be able to finance

their every need including providing public service

facilities with funds sourced from PAD. But in

reality the largest source of revenue comes from

government transfers (balancing funds). Government

transfers become one of the main funds of local

governments to finance their regional expenditures.

This allocation is intended to achieve two goals,

efficiency and equality (Salami, 2011). with a

balance fund there should be no difference in the

rate of economic growth between districts / cities in

North Sumatra Province. According to law No. 33 of

2004 there are 3 (three) types of balancing funds :

General Allocation Fund (DAU), Revenue Sharing

Fund (DBH), and Special Allocation Fund (DAK)

which differ in their allocations. DAU for an area is

allocated on the basis of fiscal gap and basic

allocation. The fiscal gap is the difference between

fiscal needs and fiscal capacity. Fiscal capacity can

be regarded as the ability of a region in

implementing all its mandatory authority in the

implementation of government and regional

development. fiscal need is a regional need to

finance all its expenditures in order to carry out the

functions and authorities of the regions providing

public services. Fiscal needs are measured by

population, area, Construction Cost Index, Gross

ICNRSD 2018 - International Conference on Natural Resources and Sustainable Development

326

Regional Domestic Product per capita, and Human

Development Index.

According to Robert Malthus, an increase in

population will increase demand for foodstuffs

(Winsdel et al., 2015). Not only food needs, large

populations also need more infrastructure and public

infrastructure facilities. North Sumatra Province is

ranked fourth in the province which has the largest

population in Indonesia. Growing population will

affect government spending, the more population

growth the more budget will be needed. Increasing

population requires an increase in public facilities

and infrastructure, in quantity and quality through

the allocation of capital expenditure. Local

governments with larger populations should allocate

more revenue to finance their regional capital

expenditures.

The purpose of fiscal policy is that public goods

spending can provide stable economic growth.

Government spending has played an important role

in shaping physical and human capital. Appropriate

public spending can be effective in promoting

economic growth, even in the short run (Cakerri et

al., 2014). Theory Harrod Domar considers the

formation of capital as an expenditure that will

increase the ability of an economy to produce goods

or expenditures that will increase the effective

demand of the whole society. When a certain

amount of capital formation is established, the

economy will have a greater ability to produce

goods in the future. Each economy should be able to

save a certain share of its revenues to replace

depleted or damaged capital goods such as

buildings, equipment and other materials (Ullah,

2016). This is in accordance with the theory of

Malthus, for the economic development required an

increase in the amount of capital for continuous

investment in the productive sector. The amount of

commitment of local governments in providing

public services through expenditure is evident from

the allocation of government expenditures,

particularly capital expenditures.

Research on the relationship between local

revenue, balancing funds and the number of people

with economic growth has been done by many

researchers. However, studies have shown

inconsistent results. Abdillah and Mursinto's studies

show that local revenue variables have a positive

and significant effect on local spending (Abdillah

and Mursinto, 2016). Amrozi et al study found

different results that local revenue negatively

affected Capital Expenditure and the General

Allocation Fund also negatively affected Capital

Expenditure in 400 districts / cities in Indonesia

(Amrozi et al., 2013). Mutiah and Mappanyuki's

research shows that local revenue and Special

Allocation Fund have a positive effect on Capital

Expenditure and General Allocation Fund negatively

affect capital expenditure (Mutiah and Mappanyuki,

2015). Gorahe et al's research shows that GRDP and

population have a positive effect on regional

expenditure, the area of the region has no effect on

regional expenditure (Gorahe et al, 2014). Iulia

Roşoiu's research found that capital spending had a

positive effect on economic growth in Romania

(Roșoiu, 2015). Okafor's research, Onwumere and

Ibe obtained results that capital spending has no

effect on economic growth in Nigeria (Okafor et al.,

2012).

2 LITERATURE REVIEW

The Government of Republic Indonesia formally

declared the implementation of regional autonomy

on 1 January 2001 through MPR Decree No.XV /

MPR / 1998 which has created a new dimensionof

decentralization.Fiscal decentralization makes the

regions have the authority to manage their own

financial resources, so that the regions have more

opportunities to manage their households. In the

implementation of its authority, local government

must have financial resources in order to be able to

provide services and welfare to the people in the

region.

According to Friedman, the increase in tax

revenues will increase government spending.

Government revenues and expenditures have a direct

and linear causality relationship starting from tax

revenue to government spending (Al-Qudair, 2005).

Zimmermannova et al's research shows that local tax

revenues can be a source of information about

regional economic activity in policy-making

decisions at government or regional level

(Zimmermannova et al., 2016). Local revenue as a

source of regional financing should be able to create

new economic activities in the society through

Capital Expenditure. With increasing local revenue,

local governments will be more flexible in planning

and allocating expenditures that will impact on

improving regional development, especially

infrastructure development.

Balancing funds are instruments that solve the

horizontal problems of imbalance allocated between

regions whose use is determined by the regions.

Balancing funds are used to fulfill the financial

needs of local governments that can not be filled by

local revenue. The allocation of balancing funds is

The Effect of Government Revenue and Population on Capital Expenditure and Its Impact on Economic Growth in North Sumatera Province

327

the authority of regional governments that can be

allocated through capital expenditures in the form of

economic facilities and infrastructure. Funds from

the central government require local governments to

build and prosper their people through the

management of local wealth and build sustainable

infrastructure.

The classical economists consider that the

population is a potential input that can be used as a

production factor to increase production. the more

the population will be the more the number of

workers. However, the growing population growth

requires additional investment and facilities to

support the welfare of the people such as education,

health, economy and so on. If the growth of this

population is not supported by the addition of

investment and facilities it will have an adverse

effect on the income of the population and

workmanship.

According to Rostow and Musgrave, government

capital spending in the early stages of economic

development is characterized by the large percentage

of government investment in total investment.

Because the government must provide infrastructure

for education, health, and transportation. It is

expected that the increase in capital expenditure can

encourage the emergence of new investments in

production activities in the regions that ultimately

can increase regional economic growth. Harrod-

Domar's theory explains the role of capital growth in

creating economic growth. a period of capital

formation, then in the future the economy has the

ability to produce more goods and services. Local

governments have a responsibility to provide good

public services to the society in the form of adequate

infrastructure to facilitate the economic activities of

society. The development of efficient, reliable, and

affordable infrastructure is essential for economic

growth (Badalyan et al, 2014). Increased

productivity of society is expected to become higher

and will increase economic growth.

3 METHODOLOGY

The data used in this research are growth ratio of

local revenue, growth ratio of balancing funds,

population growth ratio, growth rate of capital

expenditure and growth rate of PDRB 33 Districts /

City in North Sumatera Province in percent. The

data used in this research is in the form of time

series data for the period from 2011 to 2016 and

cross section consisting of 25 districts and 8 cities in

North Sumatera Province. The data analysis method

used in this research is quantitative with the

following data panel analysis model:

= β0+β1PAD

+β2D P

+β3 JP

+ ɛ

... (1)

= β0+β4BM

+ɛ

.................................... (2)

Information:

= Regional Economic Growth i period t

PAD

= Revenue Growth Ratio OriginalArea i

period t

D P

= Growth Ratio Funds balancing region

i period t

= PopulationGrowth Ratio region i

period t

= Capital Expenditure Growth Ratio i

period t

= Intercept

= The coefficient of independent

variables

i = Districts / City in North Sumatera

Province

t = Time

= Interference Variable / Error

Correction Term

4 EMPIRICAL RESULTS

In the data panel processing method should select

estimation model between Common Effect model,

Fixed Effect model and Random Effect model. To

choose between the three estimation models there

are 3 tests that must be done. Chow test is performed

to determine the most appropriate model used

between Common Effect model or Fixed Effect

model. Hausman test is used to select the model that

will be used between the model Fixed Effect or

Random Effect model. If we get different result from

Chow test and Hausman test, then proceed with

Lagrange Multiplier Test.

ICNRSD 2018 - International Conference on Natural Resources and Sustainable Development

328

Table 1: Data Panel Model Validity Test

Chow Test

Effects Test Statistic Prob

Equation 1 Cross-section F 0.528409 0.9821

uation 2 Cross-section F 2.246951 0.0005

Hausman Test

Test Summar

Chi-S

. Statistic Prob

Equation 1 Cross-section random 3.063575 0.3819

uation 2 Cross-section random 0.179059 0.6722

Lagrange Multiplier Test

Cross-section

uation 1 Breusch-Pa

an 0.0411

uation 2 Breusch-Pa

an 0.0002

After chow test with α = 5% in equation 1 obtained

probability 0.9821, so the right model used is model

estimation of Common Effect Model. The result of

chow test on equation 2 obtained probability 0.0005,

so the right model used is Fixed Effect Model

estimation model. The result of hausman test in

equation 1 obtained probability 0.3819 then the

panel data model used in equation 1 is the Random

Effect Model. The result of hausman test on

equation 2 obtained probability 0.6722 then the

panel data model used in equation 2 is the Random

Effect Model. The results of Chow Test and

Hausman Test on equation 1 and equation 2 are

obtained different results, should be continued with

Lagrange Multiplier Test. The result of Lagrange

Multiplier Test in equation 1 shows that the value of

Prob. Cross-section Breusch-Pagan 0.0411 so the

estimation model that should be used in equation 1 is

the Random Effect Model. The result of Lagrange

Multiplier Test in equation 2 shows that the value of

Prob. Cross-section Breusch-Pagan 0.0002 so the

estimation model that should be used in equation 2 is

the Random Effect Model estimation model

Table 2: Estimation of Panel Data Equation

Coefficient Prob

uation 1

PAD

R-Squared = 0.440079

F-Stat = 50.82583

Sig = 0.000000

-9.210742

0.074363

2.606277

-3.386183

0.2225

0.0485

0.0000

0.0961

Equation 2

5.620256

0.001815

0.0000

0.0433

R-S

uare

= 0.013014

The result of t-statistic test on equation 1 obtained

local revenue variable probability value 0.0485, so

this can prove that local revenue have significant

effect to capital expenditure of Districts / City in

North Sumatera Province. Variable balancing fund

probability value 0.0000, so this proves that

balancing fund have significant effect to capital

expenditure of Districts / City in North Sumatera

Province. Variable population has probability value

0.0961, then this can prove that variable of

population do not have significant effect to capital

expenditure of Districts / City in North Sumatera

Province. F-statistic test results obtained probability

value 0.000000, it can be concluded that together -

the local revenue variables, balancing funds and

population have significant effect on capital

expenditure in the District / City of North Sumatra

Province period of 2011-2016. In Table 2 obtained

value of coefficient of determination 0.440079. This

means that 44 percent of capital expenditures in 33

districts / municipalities of North Sumatra Province

for the period of 2011-2016 can be explained by

The Effect of Government Revenue and Population on Capital Expenditure and Its Impact on Economic Growth in North Sumatera Province

329

local revenue variable, balancing fund and

population. Table 2 shows the result of t-statistic test

of equation 2, capital expenditure variable

probability value 0.0433, so this can prove that

variable of capital expenditure have significant

influence to economic growth of Districts / City in

North Sumatera Province. Determined coefficient

value of 0.013014. This means that 1.3 percent

economic growth in 33 districts / municipalities of

North Sumatra Province for the period of 2011-2016

can be explained by the variable of capital

expenditure.

Local revenue and balancing funds have a

positive relationship with capital expenditure, which

means that increasing local revenue and balancing

funds will increase the allocation of capital

expenditure. Local revenue of Districts / City in

North Sumatra Province is smaller than total

regional revenue used to finance Districts / City

government expenditure in North Sumatra Province.

Local governments have an additional source of

income in providing their public services from

central government transfers in the form of

equalization funds. The number of transfers from the

center to the regions increases each year as demand

for public services such as education, health,

transport and police services has grown rapidly.

Dominate of transfers in regional income is expected

to make the region able to allocate to productive

sectors that can encourage an increase in investment

that impact on improving public services, thereby

increasing the contribution of local revenue (PAD)

in financing the needs of the region.

Large population with good quality will push

economic growth. In contrast the large population

with low quality levels, making the population as a

burden for development. The low level of society

productivity will lead to an increasing number of

poor people requiring subsidy spending and social

assistance included in indirect spending posts in

local government expenditures. The more subsidized

spending and social assistance the amount of

government revenue that can be allocated for capital

expenditure will be less.

Capital expenditure has a positive relationship

with economic growth, which means that increasing

capital expenditure allocation will increase the rate

of economic growth. After fiscal decentralization,

local governments will increasingly concentrate on

strategizing and prioritizing regional economic

development to push economic growth. Local

governments have a responsibility to provide public

goods that can not be provided by the private sector

such as roads, hospitals, schools and so on. This

development should be directed to improving the

productivity of society through improving the

quality of the population and access to capital and

marketing of products that will ultimately promote

economic growth. However, local governments have

not been able to properly allocate their expenditures.

Local government should carry out development in

accordance with the potential of the area, so that

development can increase the productivity of people

in the region.

Every development and change always has

derivative activities such as preparing infrastructure,

education and training and other activities related to

regional economic development. With the

development of facilities and infrastructure is

expected to be able to increase private investment

that will ultimately drive the rate of economic

growth. However, the development should be based

on the concept of sustainable development that is

environmentally oriented covering the economic,

social and environmental aspects to fulfill current

needs without sacrifice future generations.

According to UUPLH 1982 clause 3, Environmental

management is based on the preservation of

harmonious, balanced environmental capability to

support sustainable development for the

improvement of human welfare. Therefore, the

development should pay more attention to the

impacts on the environment and the exploitation of

natural resources should be done in accordance with

the prevailing rules and do not damage the

ecosystem.

5 CONCLUSION

The results show that local revenue andbalance

funds have a positive and significant effect on

capital expenditure in regencies / cities in North

Sumatera Province. These results indicate that

increasing local revenue and balancing funds will

increase capital expenditure in regencies / cities in

North Sumatra Province. The regression coefficient

of balanced fund variable is bigger than the

regression coefficient of local revenue variable,

which means that the districts / city capital

expenditure in North Sumatra Province is more

obtained from the balance fund.

Population does not affect the capital expenditure

of districts / city in North Sumatra Province. This

shows that the allocation of balance fund, which is a

source of funding for capital expenditure, no longer

focuses on the population. Capital expenditure has a

positive and significant impact on the economic

ICNRSD 2018 - International Conference on Natural Resources and Sustainable Development

330

growth of regencies / cities in North Sumatra

Province. These results indicate that increased

capital expenditure will increase the rate of

economic growth.In order to accelerate regional

development in all fields, the government needs

large capital to fund its expenditure. Government

needs private investment to get more funds for

regional development.

The development should be based on the concept

of sustainable development that is environmentally

sound on the economic, social and environmental

aspects to meet current needs without sacrifice

future generations. Governments should pay more

attention to the impact of development on the

environment and the exploitation of natural

resources should be done according to the rules and

do not damage the ecosystem. Infrastructure

development will be useless if it is not offset by an

increase in population quality.

REFERENCES

Abdillah, K., Mursinto, D., 2016. The Effects of Financial

Balance Transfer and Regional Own-Source Revenue

on Regional Expenditure of Regencies and

Municipalities in East Java Province. International

Journal of Scientific and Research Publications 6(5).

Al-Qudair, K., 2005. The Relationship between

Government Expenditure and Revenues in the

Kingdom of Saudi Arabia: Testing for Cointegration

and Causality. Journal of King Abdulaziz University-

Economics and Administration 19(1).

Amrozi, A.I., Wahidahwati, Riharjo, I.B., 2013. Effect of

General Allocation Funds (DAU) and Regional

Original Revenues (PAD) on Local Government

Expenditures. Journal of Accounting Science &

Research 2(9).

Badalyan, G., Herzfeld, T., Rajcaniova, M., 2014.

Transport infrastructure and economic growth : Panel

data approach for Armenia, Georgia and Turkey. In

142nd EAAE Seminar Growing Success Agriculture

and rural development.

Briando, B., 2017. Literature Study: Village Fiscal

Decentralization. ASSETS Journal of Accounting and

Education 6(2).

Cakerri, L., Petanaj, M., Muharemi, O., 2014. The Effect

of Government Expenditures on Economic Growth:

The case of Albania. European Journal of Social

Sciences 2(1).

Chude, P.N., Chude, I.D., 2013. Impact of government

expenditure on economic growth in Nigeria.

International Journal of Business and Management

Review 1(4).

Ermasova, N., Mikesell, J.L., Ermasov, S., 2014. Impact

of Recession on Total Revenue of Regional

Governments in Russia. Business Systems &

Economics 4(2).

Gorahe, I.A.M.M.V., Engka, D., 2014. Analysis of

regional expenditure and the factors that influence it in

North Sulawesi Province. Journal of Scientific

Periodic Efficiency, 14(3).

Maipita, I., Jantan, M.D., Razak, N.A.A., 2010. The

Impact of Fiscal Policy Toward Economic

Performance and Poverty Rate in Indonesia. Bulletin

of Monetary, Economics and Banking 12(4).

Muriithi, C., 2013. The Relationship between Government

Revenue and Economic Growth in Kenya.

International Journal Os Social Sciences and Project

Planning Management.

Mutiah, Mappanyuki, R., 2015. The Effect of Surplus

Budget Financing, Special Allocation Fund, General

Allocation Fund, Regional Revenue, and

Characteristics of Local Government on Decision of

Capital Expenditure (Survey in Local Government in

Indonesia). Research Journal of Finance and

Accounting 6(9).

Nannan, Y., Jianing, M., 2012. Public infrastructure

investment, economic growth and policy choice:

evidence from China. Proceedings of the 2012

International Conference on Public Management

(ICPM-2012).

Okafor, R.G., Onwumere, J.U.J., Ibe, I.G., 2012. Impact of

Recurrent and Capital Expenditure on Nigeria’s

Economic Growth. European Journal of Business and

Management

4(19).

Olulu, R.M., Erhieyovwe, E. K., Andrew, U., 2014.

Government Expenditures and Economic Growth: The

Nigerian Experience. Mediterranean Journal of Social

Sciences, 5(10).

Rahmadana, M.F., Naibaho, M., 2015. Interdependence

Analysis on Government Income and Government

Expenditure in Indonesia. International Journal of

Management, Accounting and Economics, 2(8).

Roșoiu, I., 2015. The Impact of the Current and Capital. In

Int’l Conference on Business, Marketing &

Information System Management (BMISM’15).

Salami, A., 2011. Taxation, revenue allocation and fiscal

federalism in Nigeria: Issues, challenges and policy

options. Economic Annals 56(189).

Ullah, N., 2016. The Relationship of Goverment Revenue

and Government Expenditure: A Case Study of

Malaysia. Munich Personal RePEc Archive.

Winsdel, K., Pieris, D., Airlangga, U., 2015. Resilience

and Food Crisis in Malthus, Depedensi and Gender

Perspective ( Women in Development ). Journal of

International Relations VIII(1).

Zimmermannova, J., Skalickova, J., Siroky, J. 2016. What

can tax revenues tell us about the economic activity of

regions? Economics and Sociology 9(1).

The Effect of Government Revenue and Population on Capital Expenditure and Its Impact on Economic Growth in North Sumatera Province

331