INST 275 – Administrative Processes in Government

1. INST 275 – Administrative Processes in Government Lecture 13 – Public Financial Management II

2. Line-Item Budgeting • The line-item budget was the original budget format – each item of expense had a literal line in a ledger book. • It classified budgetary accounts according to narrow, detailed objects of expenditure used within each particular agency. • Useful as a record of expenditures and the criteria against which audits could measure compliance. • But, did not allow assessment of whether the expenditures were effective.

3. Performance Budgeting • Origin: New York City. • Performance budgeting required a performance measure to be stated alongside each line item, so that elementary calculations of unit cost and efficiency could be made. • Line items were grouped in functional terms. • Efficiency could be measured from budget to budget. • Still did not help in planning, identification of global resource allocation, or effectiveness.

4. Program Budgeting • Program budgeting consolidated spending into programs so that total resources allocated to a single purpose could be identified. • Global understanding of expenditure purposes. • Compliance could be assessed, but so could effectiveness and efficiency. • Budget could become a planning document and a document supporting alternative expenditures.

5. Program Budgeting • RAND proposed planning – programming – budgeting (PPBS). • Forward planning (the analysis of alternatives). • The allocation of resources in a multi-year cycle. • Budgeting related to broad program groups rather than line items.

6. Program Budgeting • Budgeting during the 1960s dominated by PPBS. • Imported to the federal government by Robert McNamara in the Defense Department. • Required by LBJ for all agencies. • Required program objectives, indicators of evaluations, five-year expenditure forecasts, and numerous cost-benefit analyses and zero-based budget reviews. • Failed miserably because of insufficient lead time.

7. Program Budgeting • Countered by Aaron Wildavsky, who championed incremental budgeting. • Planning and analysis were contradictory to the essential nature of budgeting. • Budgeting is an inherently political process.

8. Zero-based Budgeting • Introduced by Verne B. Lewis in 1952. • Adopted by Texas Instruments and the State of Georgia in the early 1970s. • Zero-based budgeting is a budgeting process that rejects incrementalism. • It demands a rejustification of the entire budget submission (from ground zero), whereas incremental budgeting respects the outcomes of previous budgetary decisions (the budget base).

9. Zero-based Budgeting • Under ZBB, an agency would have to rank its programs by importance and face the possibility of the least important being eliminated. • Failed as part of Carter presidency. • But, still used extensively at the state and local level.

10. Contemporary Budget Reform • Three important contemporary budget questions: • Should an integrated national budget and financial statement be created? • Can multi-year budgetary cycles be controlled through shorter-term political processes? • Can a budget process with a greater policy focus be created?

11. Integrated Budgets • All corporations have integrated budgets and balance sheets. • The government has no balance sheet and the operating statement is incomplete.

12. Integrated Budgets • A unified budget is one where the receipts and outlays from federal funds and trust funds are consolidated. • But the fiscal activities of off-budget federal agencies are not included in the “unified” budget. • Billions excluded so the budget is not really “unified.”

13. Integrated Budgets • Some are left off to avoid political scrutiny. • Some are “black budget” items. • Some are the budgets of public enterprises. • Some reflect emergency spending. • Conflicting principles do apply, but they do violate the rule of transparency.

14. Multi-Year Budgets • Effective government sometimes requires major infrastructure investment or strategic research over several years. • A case can be made for a biennial or triennial budget, but the political realities and elections cycles would make the process difficult.

15. A Greater Policy Focus • The architects of PPBS had a vision about creating a more policy-oriented budget through aggregating expenditures into larger, output-oriented categories called programs. • This would allow them to take a multi-year perspective and engage in analytical comparison of alternatives.

16. A Greater Policy Focus • Fragmentation makes process difficult. • Although program budgeting is now used, there are over 2,000 programs in the federal government. • Would require the develop of policy analysis capacity and debate in Congress. • Unlikely.

17. Financing Public Expenditure • Three basic elements to public financial management • Taxing. • Spending. • Saving. • Taxing and spending are the essential elements. • Spending must balance with taxing and borrowing. • Because tax revenues are elastic, one can only estimate yearly revenues.

18. Financing Public Expenditure • Principal means of financing spending requirements: • Direct tax; • Indirect tax; • User charges; • Grants; • Profits from public enterprises; • Borrowing from the public; • Innovative techniques (public-private partnerships); and • Earnings from savings and investments.

19. Taxation • General taxation (or a general property tax in local government) is the most traditional means of financing public services. • A tax is a compulsory contribution exacted by a government for public purposes. • Taxes are considered legitimate if they are levied by elected representatives. • Nothing is in such bad odor that it cannot be taxed.

20. Taxation • Taxes are the most volatile of political issues. • Federal government relies heavily on the income tax and trust funds. • State and local governments have more diversity (property taxes, income taxes, sales taxes, user charges, lotteries, and federal grants). • Still, local governments rely heavily on the property tax; state governments rely on the income and sales tax.

21. Ability-to-pay Principle • The art of taxation is “so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing.”

22. Ability-to-pay Principle • The two basic principles for achieving this are ability-to-pay and hiding the taxes. • Ability-to-pay – tax burden should be distributed according to a person’s wealth. • Basis of progressive taxation. • But many forms of wealth are exempt (deductions from taxable income and exemptions). • Hidden tax – tax burden occurs at stages not always visible to the public. • Value-added tax.

23. The Flat Tax • Income tax with fixed percentage and no brackets. • Seems simple and fair. • But a shift to that system would penalize the poor and give tax relief to the rich.

24. User Charges • User charges are specific fees that users or consumers of a government service pay to receive that service. • Examples: water bills, toll roads, charges for public swimming pools, public transportation. • Often earmarked.

25. Grants • Grants represent an important category of assistance for state and local governments. • Federal grants-in-aid. • Block grants. • Developing countries often finance significant portions of their expenditures from international, multilateral, or bilateral aid agencies. • Recipient governments are really implementing agencies for the granting agency. Lots of strings attached.

26. Profits • Profits from public enterprises can and should be a useful revenue stream. • However, poorly managed enterprises have generally reduced rather than increased the bottom line.

27. Financial Innovations • Leasing from the private sector. • Build-Own-Operate-Transfer (BOOT). • A BOOT is a concession contract, the government entity selects a private company (or consortium) to develop, finance, build, own, and operate a power project for a designated period of time, after which time the ownership of the project is transferred to the government without compensation. • These are often complex and secret. Sometimes violate transparency.

28. The Problem of Debt • Nowhere can the urgency of developing adequate standards of public financial management and reporting be seen more clearly than in the management of debt. • The ability to incur debt is a hallmark of government. • They usually exist to undertake projects the value of which will last for many generations.

29. The Problem of Debt • Debt is a way of matching costs with those who benefit from the borrowing, of seeing that future generations pay their share of costs of roads or buildings that we put in place now. • In the U.S., tens of thousands of governments can incur debt.

30. The Problem of Debt • The national debt is the total outstanding debt of a central government. • The U.S. national debt on October 24, 2007: $9,058,742,365,997.64. • Your share of the national debt: $29,876.88

31. The Problem of Debt • Deficit financing is a situation in which a government’s excess of outlays over receipts for a given period is financed primarily by borrowing from the public. • Largely a 20th century phenomenon.

32. The Problem of Debt • Historical perspective. • Debt only large as a percentage of GDP from 1980 to 1995. • Comparative perspective. • U.S. debt 3% of GNP. • Japan (4%), Greece, Sweden, Italy (>=10%).

33. The Problem of Debt • Deficit wars. • Budget Enforcement Act 1990. • Omnibus Budget Reduction Act. • 1994 Republican Congress. • Seven-year plan. • Budget surpluses caused by economy. • Deficits caused by economy and war.

34. Abuse of Public Debt • Borrowing to finance operating expenditures; • Borrowing beyond the level of repayments the community can meet; • Borrowing under poorly structured contracts that leave the borrower no protection against large interest rate hikes;

35. Abuse of Public Debt • Borrowing to finance projects that dive no return or are highly speculative; • Borrowing where government lacks the administrative capacity to manage or implement projects without major losses; and. • Borrowing where there is widespread corruption and high proportion of the funds will be creamed off to corrupt politicians and administrators.

36. Municipal Bonds • Municipal bonds are debt instruments of subnational governments. • A debt security issued by a state, municipality, or county, in order to finance its capital expenditures. Municipal bonds are exempt from federal taxes and from most state and local taxes, especially if you live in the state the bond is issued. • Certificate of indebtedness issued by a borrower to a lender that constitutes a legal obligation to repay the principal of the loan plus accrued interest.

37. Municipal Bonds • General obligation bonds; • A municipal bond backed by the credit and "taxing power" of the issuing jurisdiction rather than the revenue from a given project. • Callable bonds; • A bond that can be redeemed by the issuer prior to its maturity. Usually a premium is paid to the bond owner when the bond is called. Also known as a "redeemable bond". • Revenue bonds; • A municipal bond supported by the revenue from a specific project, such as a toll bridge, highway, or local stadium. • Industrial development bonds; • Municipal debt securities issued by a government agency on behalf of a private sector company and intended to build or acquire factories or other heavy equipment and tools.

38. Municipal Bonds • Junk bonds; • A bond rated BB or lower because of its high default risk. Also known as a high-yield bond, or speculative bond. • Moral obligation bonds; • A type of revenue bond, issued by a municipality or similar government body, which not only gives investors the tax exemption benefits inherent in a municipal bond but also provides an additional moral pledge of commitment against default. The issuing body's commitment is supported via a reserve fund established to meet any debt service costs the government may be unable to make. • Serial bonds; • A bond issue in which a portion of the outstanding bonds matures at regular intervals until eventually all of the bonds have matured. As they mature gradually over a period of years, these bonds are used to finance a project providing regular, level or predictable income streams. Serial bonds are also used to finance projects with regular, level debt payments such as residential developments. • Term bonds. • A bond issue that may be short-, intermediate-, or long-term.

39. Rating Agencies • Standard & Poor’s and Moody’s. • Rate or assess the creditworthiness of borrowers and assigning a credit rating. • AAA to BBB, below that junk. • Given the size of government borrowing, rating has a profound influence on interest repayments. • Not value free. • Clearinghouse for information and confidence. • But ratings have policy implications.

40. Local Government Financial Management • 80,000 local governments. • Small governments relatively simple, but large cities have complex budgets. • Driven by balance budgets. • Usually use performance and program budgeting, but could use reform in some cases.

41. Local Government Financial Management • Property tax (Discuss). • Sales tax (Discuss). • School tax (Discuss).

42. Economic Policy • Monetary policy. • Manage the money in the economy to meet specific policy goals. • Decisions about the amount of money in circulation. • Decisions about the level of interest rates. • Decisions about the functioning of credit markets and the banking system.

43. Economic Policy • Federal Reserve System. • Open-market operations. • Discount rate. • Reserve requirement.

44. Economic Policy • Fiscal policy. • Manipulation of government finances by raising or lowering taxes or levels of spending to promote economic stability and growth. • Keynes. • Full Employment Act of 1946. • Use of transfer payments, tax rates, and deficits and surpluses to manage the economy.