Types of Budgets
 The budget document can be constructed in various ways,
depending on the desired purpose, such as control,
management, planning, or performance.
 Historically, control or fiscal accountability has been the
main purpose of budgeting.
 Incrementalism (using the last year’s budget as the basis for
next year’s budget) has dominated the process, and the lineitem budget has been the typical format.
 There are two main types of budgets: operating budgets,
which are in effect for one fiscal year, and capital budgets,
which include large items such as buildings and expensive
Line-Item Budgets and Incrementalism
 The line-item budget allows control by specifying the
amount of funds, line by line in each category, that an
agency receives.
 This system allows for the greatest control because
decision makers know in advance how much money has
been allocated for each category.
 Thus, it is easy to follow how the money was spent and
what was purchased.
 This makes it possible to watch every dollar and to ensure
that funds are spent for the items listed in the budget.
 Line-item budgets show exactly where the money goes
better than any other format.
 But, these type of budgets do not tell us how effectively the
money was spent.
 That is, they are a great way to track and control money,
but they say nothing about whether objectives are being
met because they are not tied in any way to stated
objectives.
 Line-item budgets simply look at last year’s budget as the
basis for constructing next year’s budget.
 The process is called Incrementalism and remains the
dominant method used by legislatures.
 There are several reasons why Incrementalism is a popular
method: first, it allows for the greatest control over
spending.
 Second, politicians are not usually technical experts, and
they approve many aspects of a budget without any
expertise in the area.
 Third, time constraints do not allow for the more arduous
process of developing objectives.
 Typically, once a program is in the budget, it tends to
remain there until something occurs to force decision
makers to consider eliminating it as a budget line.
 The hallmarks of Incrementalism are consistency and
continuity.
 Aron Wildavsky spent a career studying this process and
concluded that Incrementalism is the most feasible method
for the legislative process.
Performance Budgeting: Planning-ProgrammingBudgeting Systems (PPBS)
 By the 1940s there was a need to use budgeting for more
than just control.
 There was a need to monitor programs more closely and to
better manage a much larger, more complex government.
 The goal was to make programs more effective.
 Budgets that focus on management and planning are
intended to help move budgeting away from the constraints
of line items and Incrementalism toward a rational and
more flexible process that focuses on results.
 The focus on planning-programming-budgeting system
(PPBS) is on objectives.
 The intention is to ensure that money is actually achieving
something.
 Sometimes called program-based budgeting (PBB), those
involved in the process set objectives for their agencies and
construct budgets that are needed to attain those objectives.
 The focus is not on line items but on how much funding
will be needed to actually reduce crime, patrol and protect
the nation’s coast-line from drug traffickers, or maintain
the nation’s defense systems.
 The key is that there are measurable indicators that will
illustrate whether an agency is meeting its objectives.
 Although PPB systems are rational, they are timeconsuming and require enormous amounts of paperwork.
 This type of budgeting was largely abandoned by the
Nixon administration but was revived at the agency level
years later.
 President Nixon preferred management by objectives
(MBO).
 Management by objectives involves setting objectives for
agencies and requiring regular reports on the progress of
achieving the stated objectives.
 It is less formal and simpler than PBB.
 The US Congress today, continues to use the basic
incremental line-item budget.
 Program based budgeting systems were revived at the
agency level and continue to be used to this day.
Zero-Based Budgets (ZBB)
 This is a simple idea and each year agencies must justify
their budgets by starting with a “blank sheet” of paper.
 In theory, the budget is viewed as independent from that for
the previous year.
 It focuses on one fiscal year.
 Both incremental and PBB budgets usually include fiveyear projections.
 Zero-based budgeting can also incorporate objectives.
 Thus, it can be viewed as a type of performance budget.
 The problem with ZBB is that one essentially “reinvents
the wheel” each year, and the benefits of performing this
task usually fail to justify the costs in time and frustration.
 There are several different versions of ZBB, but all appear
to have similar problems to PBB-too much paperwork,
documentation, and the like, and the amount of time
expended usually does not justify the effort.
Capital Budgets
 Capital budgets are separate budgets for assets that will be
used over a longer period of time.
 They involve special outlays for items such as school
buildings, bridges, sewage systems, water systems, and
similar items that will last for many years.
 In contrast, operating budgets usually involve purchasing
goods and services that will last for only about a year.
 For instance, while school buildings will be used for many
years, office supplies such as pens, paper, staples, and
printer cartridges will be used up quickly.
 Building a sewer treatment plant is a capital expenditure,
but the chemicals used in the plant are a current
expenditure.
 The general guideline is that anything that will last for a
year is classified as a current expenditure regardless of the
cost.
 Small goods that may last for years, such as staplers,
desktop computers, or cases of paper, are also classified as
current expenditures.
Taxation, Revenues, and Expenditures
 There are 2 sides of the budget: revenues and expenditures.
 Government revenues mainly come from taxes.
 The justification for taxes is obvious; government must
provide certain essential services, such as national defense,
and citizens must pay for it.
 Taxes are unpopular and no one likes to pay them; but they
must be collected to pay for the functions of government in
order to pay for public goods.
 There are two types of public goods: social wants and
merit wants.
 Social wants are those that must be consumed equally.
 Those who do not want to pay for these goods (free riders)
cannot be excluded from consuming or benefiting from the
goods.
 For example, no one who lives in the US can be excluded
from enjoying the protection of national defense.
 In this type of traditional public good, the satisfaction of
the citizen/consumer is independent of his or her
contribution.
 Merit wants are also public goods, but the exclusion
principle applies in varying degrees.
 Examples include welfare benefits, public housing, and
school lunches.
 In these cases, everyone must pay, but most people are
excluded from using the specific good or service.
Tax Equity and Tax Expenditures
 How does government construct a tax structure that is fair to
individuals who run the gamut in terms of their incomes?
 Confusion and debate usually emerge regarding the fairest
way to levy taxes.
 The concepts that are involved are regressive versus
progressive tax systems.
 The most regressive taxes are flat taxes, which usually hurt
poor citizens because they spend a greater portion of their
income on taxed items.
 Flat taxes, such as sales taxes charge the same amount to all
regardless of their income or ability to pay.
 If income taxes are constructed as flat proportional
structures, then everyone pays the same percentage of their
income in taxes, but proportions penalize those with lower
incomes.
 For example, if the income tax were 10 percent for everyone
regardless of income, then a person earing $10.000 would
pay $1.000 in taxes, leaving $9.000 for all other
expenditures.
 A person earning $100.000 per year would pay more taxes
($10.000), but would have $90.000 left.
 Critics do not view this as fair.
 But others argue that the alternative provides a disincentive
to earn money and work toward being financially successful.
 The alternative is a progressive tax structure that takes a
larger proportion of a person’s income as income increases.
 That is, the more you earn, the larger the percentage of your
income must go for taxes.
 Progressive taxes use brackets that attempt to adjust equity
by placing a greater burden on those with higher incomes.
 In US, federal income tax brackets and most state income
taxes are progressive.
 The idea of imposing higher tax rates on people with higher
incomes is based on the belief that the tax structure should
be based on the “ability to pay”.
 In the US, during the 1970s, bracket creep occurred
because rising prices caused income to increase, which
pushed people into higher tax brackets, while losing buying
power to inflation.
 To get rid of this problem, indexing method is used; it
involves adjusting income relative to prices.
 Other concepts associated with taxation include tax
expenditures, which are simply revenues that could have
been collected, but were deliberately not collected.
 These include tax exemptions, special exclusions, special
credits, and other deductions.
 High taxes on the wealthy, such as luxury taxes on highdollar items like exotic cars or yachts, can have an adverse
impact because they encourage the wealthy to spend more
time on leisure and less time working and earning more
income.
 Luxury taxes, which were tried by the US Congress in the
1980s, were disastrous and caused some industries to leave
the country, such as the yacht industry in South Florida.
Major Types of Taxes
 Several major types of taxes are used by governments.
 Each level of government relies on a different type of tax
for its primary source of income.
 The three major methods of taxation impose taxes on
income, wealth (typically property taxes), and consumption
(typically general sales taxes).
 For the US Federal Government, the main source of tax
revenue is the individual income tax.
 In the US, personal income taxes at the federal level ran
from 15 percent to 39.1 percent in 2001.
 The income tax structure used at the national level is a net
income tax rather than gross income tax.
 This means that people are allowed to deduct items and pay
their taxes on the net value.
 The tax is progressive; the more one earns, the more one
pays.
 Most states tax both personal and corporate income.
 Corporate income taxes are controversial because they are
considered to be a double tax.
 That is, corporations pay income taxes, based on net
income, and then people holding stocks are taxed on the
 Businesses often view this as unfair, since the tax has
already been paid before paying dividends.
 Sales taxes are consumption taxes.
 Sales taxes are very regressive; they tax everyone equally,
but the burden on those with lower incomes is greater.
 Property taxes are tax on personal wealth.
 In principle, those with more wealth will pay the most.
 The rationale behind taxing real estate is that local
government must support the property with police, fire, and
infrastructure.
 Middle and lower income families tend to pay a much
larger proportion of their income than wealthier families
do.
 This is because, for the middle class, their home is usually
their largest asset.
 Thus, most of their wealth is being taxed each year.
Fiscal Policy, Monetary Policy, and Public Budgeting
 In the US, government spending currently, account for about
one-third of the gross domestic product (GDP).
 The overall goals of fiscal policy are to manage the economy
in such a way that high levels of employment are sustained,
prices remain relatively stable, and economic growth
continues.
 Slowdowns in economic growth are a normal part of the
business cycle, but more severe slowdowns are called
recessions, while extreme slowdowns are called depressions.
 Fiscal policy is heavily based in economics and has four
primary policy goals; full employment, price stability,
 Full employment is viewed by economists as about 4 percent
of the working population is unemployed.
 At this rate, the number of people looking for jobs is about
the same as the number of available jobs.
 Price stability is another goal of fiscal policies.
 Inflation causes prices to increase, and it can occur under
several conditions.
 One way that it can occur is when too much money is in the
economy.
 If there are too many dollars chasing too few goods, the price
of goods rises because the value of the dollar has been
 Another way that inflation occurs is when the price of
some commodity, such as oil, rises significantly.
 There are other reasons for inflation, but when inflation
rises significantly, there is a shift in the distribution of real
income from those whose incomes are relatively inflexible
to those whose incomes are relatively flexible.
 Thus, inflation tends to hurt people on fixed incomes.
 Constant economic growth is one of the major goals of
fiscal policy and it is to tax and spend in such a way as to
sustain continued economic growth.
 As the population increases, it is imperative that economic
growth continues.
 If an economy does not continue to grow but the
population continues to increase, not enough jobs are
available for the working population.
 Also, when economies stagnate, tax revenues fall and the
government has to borrow money to pay for services.
 Public goods or collective goods are activities, and services
such as national defense, police and fire protection,
schools, highways, and the like.
 These services that are provided by the government create
a rationale for forcing people to pay taxes to pay for the
services and reduce the number of free riders.
 One of the goals of fiscal policy is to ensure that there is an
adequate supply of collectively consumed goods.
 Fiscal policy assumes that there is a relationship between the
total level of spending in an economy and inflation or
unemployment.
 Total spending usually refers to the gross domestic product
(GDP), which is the sum of personal consumption, gross private
domestic investment, government purchases of goods and
services, and net export of goods and services.
 The ideal unemployment rate is about 4 percent, while an ideal
inflation rate is between 3-5 percent annually.
 Simply stated, in a given year, if the GDP is at the anticipated
target level, unemployment is at 4 percent, and inflation is about