ESTABLISHING THE
BUDGET PARAMETERS
Assoc. Prof. Yesim Kustepeli
1
Revenue Forecasting in the Budget Process

It is essential to know what financial resources are
available to support the needs. The budget process
provides an opportunity to adjust the levels of spending
so that they will match the revenues that are available.
This contrasts to the private sector, where revenues are
first adjusted to meet expenditure needs.

If a private company projects revenues that are below
anticipated expenditure levels, the first goal is to
generate more money through sales and advertising
before resorting to laying people off or cutting
expenditures. For the public sector, the opposite strategy
is followed. First, revenue estimates ere undertaken,
which then serve as the basis for deciding the levels of
expenditure and program service.
Assoc. Prof. Yesim Kustepeli
2

No matter how technically accurate the work of revenue
forecasters, if this work does not have the faith and
confidence of the budget actors, it will be ignored.

Revenue estimates must have sufficient accuracy.
Accuracy is often measured in terms of some kind of
percentage deviation of actual revenues from the forecast.
A forecast that predicts revenue within two percentage
points of anticipated expenditures is considered within the
acceptable margin of error.

Consistent matching of forecasts and actual revenues
rarely happens. For this reason, some “cushion” always
needs to be built into the revenue and expenditure
balancing equation.
Assoc. Prof. Yesim Kustepeli
3
Types of Revenues in Public Budgeting

States or local governments may generate their own
revenues through taxes and fees. Some revenues
originate from other levels of government as direct grants
or on a matching basis.

Various borrowing and debt instruments are used to
generate revenue to finance capital spending, such as
water/sewer treatment facilities, transportation
infrastructure, public buildings, etc.

Under a balanced blend of revenues, a temporary
increase in one source of revenue will help offset a
cyclical or temporary decline in another source.
Assoc. Prof. Yesim Kustepeli
4
1. Intergovernmental Transfers:
These are revenues provided to a jurisdiction by other
levels of government or other agencies.
Intergovernmental may result from any of the following
combination of circumstances:






Direct grants without restrictions
Direct grants for the performance of service
Matching funds at a given ratio as a condition of
expenditure
Reimbursement of local jurisdictions for the loss of
tax revenue
Resources funneled through a government to
another level of government
Assoc. Prof. Yesim Kustepeli
5
2. Taxes:

Personal and corporate income tax and sales tax.
Property taxes provide the predominant source of
revenues for special purpose districts and a significant
portion of revenue for counties, cities, and general
purpose local governments.

Other major tax sources include: a motor fuels tax, a
weight tax on heavy trucks, a cigarette and tobacco
products tax, insurance taxes, and gift and inheritance
taxes.
Assoc. Prof. Yesim Kustepeli
6
3. Fees for Uses and Services:

Governmental jurisdictions at all levels are looking for
new ways of generating revenues by charging for the
services they may provide to the public, to other
agencies, to local governments, or any other entity that
may have a demand for a service or special expertise.

Many state agencies generate some form of revenue
from these kinds of fees and charges. The most
significant characteristic of “fees for service” is that they
cannot be used to fund general government services.
They are considered “dedicated” funds and can only be
used to support the activity for which the fee is collected.
Assoc. Prof. Yesim Kustepeli
7
4. Sale of Products and Assets, Rents:

A number of state programs generate revenues through
the sales of products and commodities. Other programs
generate rents through the lease of state properties.
5. Debt Instruments:

Borrowing funds through the sale of bonds or other
financial instruments is an important source of revenue
for state and local governments. While borrowing opens
governments to debt liability, long-term financing
provides an effective means of funding capital projects
and other major purchases.
Assoc. Prof. Yesim Kustepeli
8
6. Lottery and Other Gaming Revenues:
7. Balance Carried Forward:

All General Funds money must be spent by the close
of the current fiscal year. Most routine agency program
and activity spending falls within that time frame.

At the end of the fiscal year after all appropriations and
adjustments, a net balance remains in the General
Fund. Any positive net balance may be carried forward
into the next year as available resources.
Assoc. Prof. Yesim Kustepeli
9
Taxation as a Revenue Source:

Taxation provides a powerful tool for the achievement
of public policy. Taxation also provides a means to
redistribute income across society, to discourage or
encourage desired behavior, or to redress the hardship
of a particular industry, class or group.

For some citizens, taxation represents an intrusion of
the community into the development of private wealth
and success. Increasing taxes requires a tremendous
political effort and the spending of political capital.
Assoc. Prof. Yesim Kustepeli
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1. Tax System Design Principles:

Without careful design and forethought, taxation may
have numerous unintended consequences.

Tax system may be:


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Regressive: places the greatest tax burden on those
with the least wealth to spend beyond necessities
and the least ability to pay;
Proportional: the tax burden affects the same
percentage of income or wealth across all groups;
Progressive: places the greatest tax burden on
those with the greatest wealth and ability to pay.
Assoc. Prof. Yesim Kustepeli
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
Each tax applies a burden. The burden is frequently
calculated as the effective rate of the tax payments as a
percentage of income.

the “ability to pay principle” becomes an important tax
system design criterion. Regardless of the recipient of
the benefit, those with the greatest ability to pay
contribute the most tax support.

the adoption of a “benefits received principle” places the
greatest tax burden on those receiving the greatest
program benefits, regardless of income. For example,
under the “benefit received principle” citizens with
school-aged children would be required to carry a
greater load of education related taxes.
Assoc. Prof. Yesim Kustepeli
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
A number of other taxation principles often guide tax
system design:
1.
Individual Equity: Depending on the equity criteria
selected by the jurisdiction, the tax burden should be
equitably distributed;
System Equity: The application of a tax to achieve a
policy goal should have a minimal impact on the overall
equity of the larger tax system;
Economic Growth: The tax system should support
economic growth and stabilization;
Relative Tax Burden: Designers of a tax system must
understand how the actual tax burden is shifted through
the economic system. For example, the increase in
corporate income tax may in reality shift the actual tax
burden from corporations to individuals.
2.
3.
4.
Assoc. Prof. Yesim Kustepeli
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2. Major Types of Taxes:
a. Income tax:

Income taxes apply to citizens and to corporations.

For citizens, the income tax base includes salary and
wages, but may, or may not include interest income,
income from investments (capital gains), and income
from other sources. The income tax rate structure
determines the actual burden carried by each payer.

The income tax can effectively combine all forms of
income under a tax with efficient administration.
Assoc. Prof. Yesim Kustepeli
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
Income tax revenues are subject to the cycles of the
economy. In a strong economy, income tax revenues
often exceed forecasts, while in a declining economy,
income tax revenues drop. In inflationary times,
taxpayers may be pushed into higher tax brackets
before government can make adjustments.
b. Corporate income taxes:

The tax base for a corporate income tax is often
defined as corporate net earnings. In practice,
corporations can pass the costs of an income tax onto
consumers through higher prices, reduced wages to
workers, or to reduced dividends to shareholders.
Assoc. Prof. Yesim Kustepeli
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c. Property taxes:

Whenever local governments improve the level and
quality of services it provides to citizens (water/sewer
service, transportation, housing, parks, etc.), property
values increase. The property tax captures this
increased value of wealth.

For citizens, property taxes often apply to the real
property of land and improvements such as homes. A
property tax also is applied to personal property,
including: automobiles, trailers, and other vehicles,
furniture, clothing and jewelry. Corporations often pay
property taxes on land, buildings and equipment.
Assoc. Prof. Yesim Kustepeli
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
Insulated from economic cycles, the property tax can
provide a stable stream of revenue under most economic
conditions. Unlike income taxes and sales taxes, decisionmakers can precisely set the property tax rate to meet
proposed spending equipments, as long as the maximum
limit set by law is not exceeded.

But, property taxes are difficult to administer. A property tax
system requires assessors, collectors, and administrators.
Keeping up with the changing value of taxable wealth is
difficult. Identifying financial and other intangible assets
may be especially difficult in an age of computerized,
global transactions.
Assoc. Prof. Yesim Kustepeli
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d. Sales tax:

The general sales tax is levied at a single point in the
economic exchange process, usually at the retail level
between the retailer and the consumer.

In contrast to the lump sum annual payment of a
property tax, a general sales tax applies a small
incremental rate at each transaction. Once begun, the
incremental nature of a general sales tax may make it
more acceptable to taxpayers.

In some countries, all transactions are taxed. In many
others, food and prescription drugs are exempted from
the tax. To compensate for the regressive nature of a
general sales tax, state legislatures may provide
refunds for low-income residents.
Assoc. Prof. Yesim Kustepeli
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
Sales taxes are relatively easy to administer.
Computerized checkout equipment that can quickly
identify exempted items.

Special purpose sales taxes, or excise taxes, include:
gasoline and diesel fuel taxes; tire and air travel excise
taxes; taxes on cigarettes, tobacco products and
alcoholic beverages.

Local governments rely on property taxes, general sales
taxes, fees for services, and intergovernmental transfers
to generate a balance in revenue flow. Sales and income
taxes reflect the fluctuations of the state economy.
Assoc. Prof. Yesim Kustepeli
19
Tax Expenditures: Lost Revenues or Purposeful
Policy Decision?

The structure and implementation of a tax code at any
level of government serves not only to raise the
necessary revenues, but also to effect public policy
decisions and to influence citizen and corporate
behavior.

Exceptions to a tax code provide relief from taxes to
certain segments of society. Such targeted relief from
taxes is known as a tax expenditure. Not collecting taxes
serves to encourage a particular behavior by
corporations or citizens.
Assoc. Prof. Yesim Kustepeli
20

Tax expenditures are criticized for the following reasons:
1.
They are not widely debated and aid a limited group of
beneficiaries. Establishing a tax expenditure is a quiet
legislative action buried in the details of the tax code.
2.
the policy outcomes, impacts and effectiveness of tax
expenditures are rarely reviewed or debased for broad
public benefit.
3.
They tend to erode broad general taxes. Once one group
receives relief, other groups desire equal treatment.
4.
They are granted during times of economic stress without
regard for their impacts on government revenues or policy
implications.
Assoc. Prof. Yesim Kustepeli
21
Debt Instruments as a Revenue Source

Borrowing funds through the sale of bonds and other
financial instruments presents an important source of
revenues for state and local governments.

In emergency situations, governments can use shortterm borrowing to smooth out gaps in cash flows.
However, extended and excessive reliance on
borrowing reduces the jurisdiction’s credit rating and
increases borrowing costs.

One of the central principles of public debt
management is that governments should not use
borrowing to finance routine spending for operations.
Assoc. Prof. Yesim Kustepeli
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
There are two forms of long-term debt financing :
“guaranteed debt” and “nonguaranteed debt”.
1.
Guaranteed debt takes one of two forms.

“full faith and credit” obligations are packaged as
“general obligation bonds”, which receive the full backing
of all the revenues and resources of a jurisdiction.

“revenue bonds” are backed by a specific stream of
revenues and resources generated by a particular
project, program or new facility.

short-term borrowing is often undertaken with the
expectation that the debt will be paid by anticipated tax
revenues. This type of borrowing is known as “tax or
revenue anticipation borrowing.”
Assoc. Prof. Yesim Kustepeli
23
2. Nonguaranteed debt:

This kind of borrowing in the public sector takes the
form of bonds, which can be issued either as term or
serial bonds.

With term bonds, the issuing jurisdiction makes periodic
interest payments on a regular basis and must pay off
the principal in a lump sum after a set period of years.

With serial bonds, the jurisdiction makes periodic
interest and principal payments on a regular basis from
the time of issue to repayment.
Assoc. Prof. Yesim Kustepeli
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
In setting the level of borrowing, the jurisdiction should
balance among the following set of considerations:
1.
community needs,
repayment ability reflecting recent revenue flows,
operating expenses and borrowing,
the strength of the economy,
the value of the real estate property tax base,
public opinion,
willingness to accept higher interest cost due to a
reduced credit rating, and
the essential purpose of the capital project.
2.
3.
4.
5.
6.
7.
Assoc. Prof. Yesim Kustepeli
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Organization of Revenues

A public budgeting process must effectively separate
revenue sources and revenue uses. This separation
into “funds” ensures that spending meets the intent and
requirements set by law or by the granting source.

Public budgeting recognizes seven major types of
revenue funds:
governmental or general funds;
special revenue funds;
capital project funds;
debt service funds;
enterprise funds;
internal service funds; and
fiduciary funds.
1.
2.
3.
4.
5.
6.
7.
Assoc. Prof. Yesim Kustepeli
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
A general fund gathers all revenues without spending or
accounting restrictions.

General funds may be used by the entity for any legal
purpose so they are classified as discretionary funds.
Revenues raised through general taxes, fees generated
for services provided, and fines often provide revenues
to the general fund.

Capital project funds are dedicated revenues collected
and managed for the construction of buildings and
facilities, or for the purchase of major pieces of
equipment. Revenues for capital project funds may
originate as a transfer from the general fund, or from
bond sales paid by general fund revenues.
Assoc. Prof. Yesim Kustepeli
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
Special revenue funds are collected for a specific
purpose or program support. These funds are often
categorized as dedicated funds.

Debt service funds provide the dedicated resources to
meet interest and principal payments on general longterm debt.

Proprietary or enterprise funds operate in a business-like
manner separately from the rest of the government
activities and accounting. Revenues collected from water
and sewer services, public electricity provision, road and
bridge tolls, and the sale of timber are often managed
under enterprise funds.
Assoc. Prof. Yesim Kustepeli
28

Internal service funds set up accounts that describe a
“business” function within government. For example, a
general motor pool, a common equipment pool, human
resource services, or public affairs services may operate
as an internal business with each operational
department paying general fund revenues for services

Fiduciary funds provide a means to separate unique
assets from the general functions of government
operations. The Social Security Trust Fund provides a
major example.
Assoc. Prof. Yesim Kustepeli
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