Public Budgeting and Financial Management

What is a budget?

• A budget is a statement of allocation of (scarce) resources to achieve an organization's objectives for a specific time period.
• A budget is the financial plan for how an organization will receive and spend money for a set time period (the fiscal period).
• According to Aaron Wildavsky, a preeminent expert, a budget is:
  • a prediction of expenses;
  • the "link between financial resources and human behavior in order to accomplish policy objectives";
  • a representation in monetary terms of governmental activity
  • a record of the outcomes of the struggle over political preferences; and "attempts to allocate scarce financial resources through political processes in order to realize disparate visions of the good life."

• According to the Office of Management and Budget:

  • "The budget system of the United States Government provides the means for the President and Congress to decide how much money to spend, what to spend it on, and how to raise the money they have decided to spend. Through the budget system, they determine the allocation of resources among the agencies of the Federal Government. The budget system focuses primarily on dollars, but it also allocates other resources, such as Federal employment."

Why is a Budget required?

• Accountability: Public is not taxed any more than that required for appropriate government functions
• Prioritization: Identify those public functions to which scarce resources should be allocated

What are the major components of a Public Budget?

• Revenues: Funds that are raised through various means.
• Expenditure: Funds used for spending on specific programs or capital projects.

What are the revenue sources for a government?

The revenue sources differ depending on the level of government (i.e. federal, state, and local). Although the federal government collects most amount of tax, states and local governments have a wider menu of choices with respect to taxing:

• Federal government:
  • Federal taxes
    • Individual and Corporate taxes
    • Capital gains tax
    • Excise (i.e. manufacturing) taxes
    • Social security tax (Federal Insurance Contributions Act, FICA tax).
    • Inheritance and estate taxes
  • Borrowings (e.g. treasury bonds)
  • User charges
• State governments
  • Intergovernmental transfers
  • State taxes
    • Individual and Corporate taxes
    • Sales taxes
    • Fuel taxes
    • Inheritance and estate taxes
    • Special taxes on specific products/ services (e.g. tobacco, alcohol, parimutuels)
  • Licenses (business; occupation; hunting and fishing; motor vehicles; motor vehicle operators; public utilities)
  • Lottery
  • Borrowings (e.g. state bonds)
• Local governments (city/ county)
  • Intergovernmental transfers
  • Local taxes
    • Property taxes (ad valorem)
    • Sales tax
  • Special Assessments (for special districts like school districts; mosquito districts; water management districts; business improvement districts; etc.)
  • User fees/ charges
  • Borrowings (e.g. local bonds)

What are the major classes of public expenditure?

• Public Program budgets: These are costs due to specific public policy programs. Examples include welfare programs (e.g. entitlements); medical programs; environmental programs; housing programs; education programs.
• Capital budgets: These are costs due to specific capital projects. Examples include infrastructure (highway, sewage, water, utilities, etc.) costs; building costs.
• Debt servicing: Repayment of borrowings
• Administration: Personnel and other general costs

What are the major differences between the Federal government and other governments (i.e. state and local) in terms of budgeting?

• Federal government is in charge of the mint; hence, it can legally print money (i.e. currency). Federal government directly monitors circulation of currency through the Federal Reserve. State and local governments cannot mint money.
• Federal government monitors/ regulates the economy through interest rates, to control inflation and to boost economy during stagnation. State governments do not control the interest rates.
• Since the Federal government can monitor the economy, it could indulge in deficit spending for achieving broader economic goals. In times of economic recession, the federal government could increase spending (despite lower revenue sources) in order to boost the economy (such as large capital projects started after the Depression to increase employment). In times of economic surplus, the federal government could reduce spending to keep the surplus (at least theoretically). (This is a rather crude statement of Keynesian economics). Unfortunately, however, the federal government deficit has ballooned over the years, despite a short period of economic surplus created by the internet economic boom. State and local governments cannot indulge in large scale deficit spending.
• Federal government is in charge of national defense; state governments have a much much smaller role. Much of federal government budget is allocated to defense, much of which could be secretive.

What are the different approaches to preparing a budget? [The time periods shown in parentheses are when the Federal government broadly subscribed to such policies]

• Lumpsum budget (Until about World War I): In lumpsum budgets, agency funds were fixed as an overall amount with little political control on how to spend it. In modern times, public agencies hardly use such lumpsum budgets. Small scale contracts could be based on lumpsums, where detailing each of the items could be time consuming and more costly.
• Line-item budget (1920 to 1940s): Also called traditional budgeting, the Line item budget is in contrast to lumpsum budget in giving control over each spending item. The budget outlines the items on which money will be spent, but may not necessarily provide  information on what exactly will be done. Each line item is given the same weight or importance even though some are more complex. Generally a line item budget has categories such as personnel, equipment, maintenance, etc. Revenue sources are linked to each item of expenditure, providing a greater degree of relationship between revenue source and expenditure.
• Performance budget (1940-60): Performance budget classifies expenditures by administrative units, by functions, and by items. It includes outputs as well as inputs to government activity. Administrative skills are emphasized; activities are given preference over item purchases; management responsibility is centralized. It involves: (i) formulation and adoption of a plan of activities and programs for a time period; (ii) funding, i.e. relating program costs and performance to resources; and (iii) execution, i.e. achievement of the plan within the time frame.
• Program budget: Although somewhat similar to performance budget, the program budget is different in considering the purpose (i.e. the program) as a unit, rather considering the separate administrative units. Thus, program budgets may overlap certain administrative units.
• PPBS (Planning Programming Budgeting System) (1960-71): PPBS involves four stages of budget making: (i) planning, where program goals are defined; (ii) programming, where different alternatives of achieving the goals are identified; (iii) evaluation, where the costs and benefits of the various alternatives are evaluated; (iv) implementation, where the best alternatives are adopted for implementation.
• Zero base budgeting (1976): This was introduced as a rational budget innovation by President Carter in 1976, along with the concept of "Sunset" provisions (where a program or an agency expires after a certain time unless specifically renewed). The concept of ZBB is that existing programs and activities should not automatically be funded, but rather should have to justify their continuation as part of the annual budget cycle. Each program or project is thus vulnerable to zero funding.
• Supply side economics (1980s): Not exactly a budgeting practice, but this was Reagan's formula for federal government. The approach argues for a reduced government role in the economy--less regulation, lower taxes. More regulation is considered unhealthy since it limits corporate entrepreneurship; high taxation is considered unhealthy since it removes money from further investment in the private sector. If corporations are taxed less, they will have more money for employment and reducing prices, thus benefiting even the poor (the "trickle down economy"). Budget deficits, however, increased sharply during Reagan years.
•  New Performance Budgeting (1990s): This is a results oriented (or objectives oriented) budgeting under the Government Performance and Results Act of 1993. The effort is to link resource allocation with managerial performance. According to GPRA, agencies are required to formulate five year strategic plans, along with annual performance plans.
• Balanced Budget (1997-2002): In a balanced budget, income equals or exceeds spending. Deficits from one fiscal year cannot be carried over to the next. Most states require balanced budgets, but the federal government does not (as you may have noticed from difference between Federal and State/ Local governments). 32 states have constitutional requirements on balancing the budget; 11 more have statutory provisions. In practice, much of the balancing the budget at state level is applied to general funds (where much of the taxes are pooled in) and expenditure in this category.

Most of the above budget approaches are managerial in their nature, in the sense that there is a rational decision making process involved. Yet, budgets also have a political angle, where the decisions are ratified based on political power play and narrow interests of one's constituency. For example, "pork barrel" projects tend to be based on one's political ability to get such projects to his or her constituency.