INST 275 – Administrative
Processes in Government
Lecture 13 – Public Financial
Management II
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.
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.
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.
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.

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.
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.

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).
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.
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?

Integrated Budgets


All corporations have integrated
budgets and balance sheets.
The government has no balance
sheet and the operating
statement is incomplete.
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 offbudget federal agencies are not
included in the “unified” budget.
Billions excluded so the budget
is not really “unified.”
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.
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.
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.
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.
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.
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.
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.
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.
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.”
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.
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.
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.

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.
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.
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.
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.
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.
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

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.
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%).

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.

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;
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.
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.
Municipal Bonds

General obligation bonds;


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 backed by the credit and "taxing power" of
the issuing jurisdiction rather than the revenue from a given
project.
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.
Municipal Bonds

Junk bonds;


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 rated BB or lower because of its high default risk. Also known
as a high-yield bond, or speculative bond.
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.
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.
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.
Local Government Financial
Management



Property tax (Discuss).
Sales tax (Discuss).
School tax (Discuss).
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.

Economic Policy

Federal Reserve System.
Open-market operations.
 Discount rate.
 Reserve requirement.

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.
