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

INST 275 – Administrative INST 275 – Administrative Processes in GovernmentProcesses in Government

Lecture 13 – Public Financial Lecture 13 – Public Financial Management IIManagement II

Line-Item BudgetingLine-Item Budgeting

The line-item budget was the original The line-item budget was the original budget format – each item of expense had budget format – each item of expense had a literal line in a ledger book.a literal line in a ledger book.

It classified budgetary accounts according It classified budgetary accounts according to narrow, detailed objects of expenditure to narrow, detailed objects of expenditure used within each particular agency.used within each particular agency.

Useful as a record of expenditures and the Useful as a record of expenditures and the criteria against which audits could measure criteria against which audits could measure compliance.compliance.

But, did not allow assessment of whether But, did not allow assessment of whether the expenditures were effective.the expenditures were effective.

Performance BudgetingPerformance Budgeting

Origin: New York City.Origin: New York City. Performance budgeting required a Performance budgeting required a

performance measure to be stated performance measure to be stated alongside each line item, so that alongside each line item, so that elementary calculations of unit cost and elementary calculations of unit cost and efficiency could be made.efficiency could be made.

Line items were grouped in functional Line items were grouped in functional terms.terms.

Efficiency could be measured from budget Efficiency could be measured from budget to budget.to budget.

Still did not help in planning, identification Still did not help in planning, identification of global resource allocation, or of global resource allocation, or effectiveness.effectiveness.

Program BudgetingProgram Budgeting

Program budgeting consolidated spending Program budgeting consolidated spending into programs so that total resources into programs so that total resources allocated to a single purpose could be allocated to a single purpose could be identified.identified.

Global understanding of expenditure Global understanding of expenditure purposes.purposes.

Compliance could be assessed, but so Compliance could be assessed, but so could effectiveness and efficiency.could effectiveness and efficiency.

Budget could become a planning document Budget could become a planning document and a document supporting alternative and a document supporting alternative expenditures.expenditures.


RAND proposed planning – RAND proposed planning – programming – budgeting programming – budgeting (PPBS).(PPBS). Forward planning (the analysis of Forward planning (the analysis of

alternatives).alternatives). The allocation of resources in a The allocation of resources in a

multi-year cycle.multi-year cycle. Budgeting related to broad program Budgeting related to broad program

groups rather than line items.groups rather than line items.


Budgeting during the 1960s dominated Budgeting during the 1960s dominated by PPBS.by PPBS. Imported to the federal government by Imported to the federal government by

Robert McNamara in the Defense Robert McNamara in the Defense Department.Department.

Required by LBJ for all agencies.Required by LBJ for all agencies. Required program objectives, indicators of Required program objectives, indicators of

evaluations, five-year expenditure forecasts, evaluations, five-year expenditure forecasts, and numerous cost-benefit analyses and and numerous cost-benefit analyses and zero-based budget reviews.zero-based budget reviews.

Failed miserably because of insufficient lead Failed miserably because of insufficient lead time.time.


Countered by Aaron Wildavsky, Countered by Aaron Wildavsky, who championed incremental who championed incremental budgeting.budgeting. Planning and analysis were Planning and analysis were

contradictory to the essential contradictory to the essential nature of budgeting.nature of budgeting.

Budgeting is an inherently political Budgeting is an inherently political process.process.

Zero-based BudgetingZero-based Budgeting

Introduced by Verne B. Lewis in 1952.Introduced by Verne B. Lewis in 1952. Adopted by Texas Instruments and the Adopted by Texas Instruments and the

State of Georgia in the early 1970s.State of Georgia in the early 1970s. Zero-based budgeting is a budgeting Zero-based budgeting is a budgeting

process that rejects incrementalism.process that rejects incrementalism. It demands a rejustification of the entire It demands a rejustification of the entire

budget submission (from ground zero), budget submission (from ground zero), whereas incremental budgeting whereas incremental budgeting respects the outcomes of previous respects the outcomes of previous budgetary decisions (the budget base).budgetary decisions (the budget base).

Zero-based BudgetingZero-based Budgeting

Under ZBB, an agency would Under ZBB, an agency would have to rank its programs by have to rank its programs by importance and face the importance and face the possibility of the least important possibility of the least important being eliminated.being eliminated.

Failed as part of Carter Failed as part of Carter presidency.presidency.

But, still used extensively at the But, still used extensively at the state and local level.state and local level.

Contemporary Budget ReformContemporary Budget Reform

Three important contemporary Three important contemporary budget questions:budget questions: Should an integrated national Should an integrated national

budget and financial statement be budget and financial statement be created?created?

Can multi-year budgetary cycles be Can multi-year budgetary cycles be controlled through shorter-term controlled through shorter-term political processes?political processes?

Can a budget process with a Can a budget process with a greater policy focus be created?greater policy focus be created?

Integrated BudgetsIntegrated Budgets

All corporations have integrated All corporations have integrated budgets and balance sheets.budgets and balance sheets.

The government has no balance The government has no balance sheet and the operating sheet and the operating statement is incomplete.statement is incomplete.


A unified budget is one where A unified budget is one where the receipts and outlays from the receipts and outlays from federal funds and trust funds are federal funds and trust funds are consolidated.consolidated.

But the fiscal activities of off-But the fiscal activities of off-budget federal agencies are not budget federal agencies are not included in the “unified” budget.included in the “unified” budget.

Billions excluded so the budget Billions excluded so the budget is not really “unified.”is not really “unified.”


Some are left off to avoid political Some are left off to avoid political scrutiny.scrutiny.

Some are “black budget” items.Some are “black budget” items. Some are the budgets of public Some are the budgets of public

enterprises.enterprises. Some reflect emergency spending.Some reflect emergency spending. Conflicting principles do apply, but Conflicting principles do apply, but

they do violate the rule of they do violate the rule of transparency.transparency.

Multi-Year BudgetsMulti-Year Budgets

Effective government sometimes Effective government sometimes requires major infrastructure requires major infrastructure investment or strategic research investment or strategic research over several years.over several years.

A case can be made for a biennial A case can be made for a biennial or triennial budget, but the political or triennial budget, but the political realities and elections cycles realities and elections cycles would make the process difficult.would make the process difficult.

A Greater Policy FocusA Greater Policy Focus

The architects of PPBS had a The architects of PPBS had a vision about creating a more policy-vision about creating a more policy-oriented budget through oriented budget through aggregating expenditures into aggregating expenditures into larger, output-oriented categories larger, output-oriented categories called programs.called programs.

This would allow them to take a This would allow them to take a multi-year perspective and engage multi-year perspective and engage in analytical comparison of in analytical comparison of alternatives.alternatives.

A Greater Policy FocusA Greater Policy Focus

Fragmentation makes process Fragmentation makes process difficult.difficult.

Although program budgeting is now Although program budgeting is now used, there are over 2,000 programs used, there are over 2,000 programs in the federal government.in the federal government.

Would require the develop of policy Would require the develop of policy analysis capacity and debate in analysis capacity and debate in Congress.Congress.

Unlikely.Unlikely.

Financing Public ExpenditureFinancing Public Expenditure

Three basic elements to public Three basic elements to public financial managementfinancial management Taxing.Taxing. Spending.Spending. Saving.Saving.

Taxing and spending are the essential Taxing and spending are the essential elements.elements.

Spending must balance with taxing Spending must balance with taxing and borrowing.and borrowing.

Because tax revenues are elastic, one Because tax revenues are elastic, one can only estimate yearly revenues.can only estimate yearly revenues.

Financing Public ExpenditureFinancing Public Expenditure

Principal means of financing Principal means of financing spending requirements:spending requirements: Direct tax;Direct tax; Indirect tax;Indirect tax; User charges;User charges; Grants;Grants; Profits from public enterprises;Profits from public enterprises; Borrowing from the public;Borrowing from the public; Innovative techniques (public-private Innovative techniques (public-private

partnerships); andpartnerships); and Earnings from savings and investments.Earnings from savings and investments.

TaxationTaxation

General taxation (or a general General taxation (or a general property tax in local government) is property tax in local government) is the most traditional means of financing the most traditional means of financing public services.public services.

A tax is a compulsory contribution A tax is a compulsory contribution exacted by a government for public exacted by a government for public purposes.purposes.

Taxes are considered legitimate if they Taxes are considered legitimate if they are levied by elected representatives.are levied by elected representatives.

Nothing is in such bad odor that it Nothing is in such bad odor that it cannot be taxed.cannot be taxed.

TaxationTaxation

Taxes are the most volatile of political Taxes are the most volatile of political issues.issues.

Federal government relies heavily on Federal government relies heavily on the income tax and trust funds.the income tax and trust funds.

State and local governments have State and local governments have more diversity (property taxes, income more diversity (property taxes, income taxes, sales taxes, user charges, taxes, sales taxes, user charges, lotteries, and federal grants).lotteries, and federal grants).

Still, local governments rely heavily on Still, local governments rely heavily on the property tax; state governments the property tax; state governments rely on the income and sales tax.rely on the income and sales tax.

Ability-to-pay PrincipleAbility-to-pay Principle

The art of taxation is “so The art of taxation is “so plucking the goose as to obtain plucking the goose as to obtain the largest amount of feathers the largest amount of feathers with the least possible amount with the least possible amount of hissing.”of hissing.”

Ability-to-pay PrincipleAbility-to-pay Principle

The two basic principles for achieving The two basic principles for achieving this are ability-to-pay and hiding the this are ability-to-pay and hiding the taxes.taxes. Ability-to-pay – tax burden should be Ability-to-pay – tax burden should be

distributed according to a person’s wealth.distributed according to a person’s wealth. Basis of progressive taxation.Basis of progressive taxation. But many forms of wealth are exempt But many forms of wealth are exempt

(deductions from taxable income and (deductions from taxable income and exemptions).exemptions).

Hidden tax – tax burden occurs at stages Hidden tax – tax burden occurs at stages not always visible to the public.not always visible to the public.

Value-added tax.Value-added tax.

The Flat TaxThe Flat Tax

Income tax with fixed Income tax with fixed percentage and no brackets.percentage and no brackets.

Seems simple and fair.Seems simple and fair. But a shift to that system would But a shift to that system would

penalize the poor and give tax penalize the poor and give tax relief to the rich.relief to the rich.

User ChargesUser Charges

User charges are specific fees User charges are specific fees that users or consumers of a that users or consumers of a government service pay to government service pay to receive that service.receive that service. Examples: water bills, toll roads, Examples: water bills, toll roads,

charges for public swimming charges for public swimming pools, public transportation.pools, public transportation.

Often earmarked.Often earmarked.

GrantsGrants

Grants represent an important category Grants represent an important category of assistance for state and local of assistance for state and local governments.governments. Federal grants-in-aid.Federal grants-in-aid. Block grants.Block grants.

Developing countries often finance Developing countries often finance significant portions of their expenditures significant portions of their expenditures from international, multilateral, or from international, multilateral, or bilateral aid agencies.bilateral aid agencies.

Recipient governments are really Recipient governments are really implementing agencies for the granting implementing agencies for the granting agency. Lots of strings attached.agency. Lots of strings attached.

ProfitsProfits

Profits from public enterprises Profits from public enterprises can and should be a useful can and should be a useful revenue stream.revenue stream.

However, poorly managed However, poorly managed enterprises have generally enterprises have generally reduced rather than increased reduced rather than increased the bottom line.the bottom line.

Financial InnovationsFinancial Innovations

Leasing from the private sector.Leasing from the private sector. Build-Own-Operate-Transfer Build-Own-Operate-Transfer

(BOOT).(BOOT). A BOOT is a concession contract, the A BOOT is a concession contract, the

government entity selects a private government entity selects a private company (or consortium) to develop, company (or consortium) to develop, finance, build, own, and operate a finance, build, own, and operate a power project for a designated period of power project for a designated period of time, after which time the ownership of time, after which time the ownership of the project is transferred to the the project is transferred to the government without compensation.government without compensation.

These are often complex and secret. These are often complex and secret. Sometimes violate transparency. Sometimes violate transparency.

The Problem of DebtThe Problem of Debt

Nowhere can the urgency of Nowhere can the urgency of developing adequate standards of developing adequate standards of public financial management and public financial management and reporting be seen more clearly than reporting be seen more clearly than in the management of debt.in the management of debt.

The ability to incur debt is a hallmark The ability to incur debt is a hallmark of government.of government.

They usually exist to undertake They usually exist to undertake projects the value of which will last projects the value of which will last for many generations.for many generations.


Debt is a way of matching costs Debt is a way of matching costs with those who benefit from the with those who benefit from the borrowing, of seeing that future borrowing, of seeing that future generations pay their share of generations pay their share of costs of roads or buildings that costs of roads or buildings that we put in place now.we put in place now.

In the U.S., tens of thousands of In the U.S., tens of thousands of governments can incur debt.governments can incur debt.


The national debt is the total The national debt is the total outstanding debt of a central outstanding debt of a central government.government. The U.S. national debt on October The U.S. national debt on October

24, 2007: $9,058,742,365,997.64.24, 2007: $9,058,742,365,997.64. Your share of the national debt: Your share of the national debt:

$29,876.88 $29,876.88


Deficit financing is a situation in Deficit financing is a situation in which a government’s excess of which a government’s excess of outlays over receipts for a given outlays over receipts for a given period is financed primarily by period is financed primarily by borrowing from the public.borrowing from the public.

Largely a 20Largely a 20thth century century phenomenon.phenomenon.


Historical perspective.Historical perspective. Debt only large as a percentage of Debt only large as a percentage of

GDP from 1980 to 1995.GDP from 1980 to 1995. Comparative perspective.Comparative perspective.

U.S. debt 3% of GNP.U.S. debt 3% of GNP. Japan (4%), Greece, Sweden, Japan (4%), Greece, Sweden,

Italy (>=10%).Italy (>=10%).


Deficit wars.Deficit wars. Budget Enforcement Act 1990.Budget Enforcement Act 1990. Omnibus Budget Reduction Act.Omnibus Budget Reduction Act. 1994 Republican Congress.1994 Republican Congress.

Seven-year plan.Seven-year plan. Budget surpluses caused by Budget surpluses caused by

economy.economy. Deficits caused by economy and Deficits caused by economy and

war.war.

Abuse of Public DebtAbuse of Public Debt

Borrowing to finance operating Borrowing to finance operating expenditures;expenditures;

Borrowing beyond the level of Borrowing beyond the level of repayments the community can repayments the community can meet;meet;

Borrowing under poorly Borrowing under poorly structured contracts that leave structured contracts that leave the borrower no protection the borrower no protection against large interest rate hikes;against large interest rate hikes;

Abuse of Public DebtAbuse of Public Debt

Borrowing to finance projects that dive Borrowing to finance projects that dive no return or are highly speculative;no return or are highly speculative;

Borrowing where government lacks Borrowing where government lacks the administrative capacity to manage the administrative capacity to manage or implement projects without major or implement projects without major losses; and.losses; and.

Borrowing where there is widespread Borrowing where there is widespread corruption and high proportion of the corruption and high proportion of the funds will be creamed off to corrupt funds will be creamed off to corrupt politicians and administrators.politicians and administrators.

Municipal BondsMunicipal Bonds

Municipal bonds are debt instruments of Municipal bonds are debt instruments of subnational governments.subnational governments. A debt security issued by a state, municipality, A debt security issued by a state, municipality,

or county, in order to finance its capital or county, in order to finance its capital expenditures. Municipal bonds are exempt from expenditures. Municipal bonds are exempt from federal taxes and from most state and local federal taxes and from most state and local taxes, especially if you live in the state the bond taxes, especially if you live in the state the bond is issued. is issued.

Certificate of indebtedness issued by a Certificate of indebtedness issued by a borrower to a lender that constitutes a legal borrower to a lender that constitutes a legal obligation to repay the principal of the loan obligation to repay the principal of the loan plus accrued interest.plus accrued interest.


General obligation bonds;General obligation bonds; A municipal bond backed by the credit and "taxing power" of A municipal bond backed by the credit and "taxing power" of

the issuing jurisdiction rather than the revenue from a given the issuing jurisdiction rather than the revenue from a given project. project.

Callable bonds;Callable bonds; A bond that can be redeemed by the issuer prior to its A bond that can be redeemed by the issuer prior to its

maturity. Usually a premium is paid to the bond owner when maturity. Usually a premium is paid to the bond owner when the bond is called. Also known as a "redeemable bond". the bond is called. Also known as a "redeemable bond".

Revenue bonds;Revenue bonds; A municipal bond supported by the revenue from a specific A municipal bond supported by the revenue from a specific

project, such as a toll bridge, highway, or local stadium. project, such as a toll bridge, highway, or local stadium. Industrial development bonds;Industrial development bonds;

Municipal debt securities issued by a government agency on Municipal debt securities issued by a government agency on behalf of a private sector company and intended to build or behalf of a private sector company and intended to build or acquire factories or other heavy equipment and tools. acquire factories or other heavy equipment and tools.


Junk bonds;Junk bonds; A bond rated BB or lower because of its high default risk. Also known A bond rated BB or lower because of its high default risk. Also known

as a high-yield bond, or speculative bond. as a high-yield bond, or speculative bond. Moral obligation bonds;Moral obligation bonds;

A type of revenue bond, issued by a municipality or similar A type of revenue bond, issued by a municipality or similar government body, which not only gives investors the tax exemption government body, which not only gives investors the tax exemption benefits inherent in a municipal bond but also provides an additional benefits inherent in a municipal bond but also provides an additional moral pledge of commitment against default. The issuing body's moral pledge of commitment against default. The issuing body's commitment is supported via a reserve fund established to meet any commitment is supported via a reserve fund established to meet any debt service costs the government may be unable to make.debt service costs the government may be unable to make.

Serial bonds; Serial bonds; A bond issue in which a portion of the outstanding bonds matures at A bond issue in which a portion of the outstanding bonds matures at

regular intervals until eventually all of the bonds have matured. As regular intervals until eventually all of the bonds have matured. As they mature gradually over a period of years, these bonds are used they mature gradually over a period of years, these bonds are used to finance a project providing regular, level or predictable income to finance a project providing regular, level or predictable income streams. Serial bonds are also used to finance projects with regular, streams. Serial bonds are also used to finance projects with regular, level debt payments such as residential developments. level debt payments such as residential developments.

Term bonds.Term bonds. A bond issue that may be short-, intermediate-, or long-term.A bond issue that may be short-, intermediate-, or long-term.

Rating AgenciesRating Agencies

Standard & Poor’s and Moody’s.Standard & Poor’s and Moody’s. Rate or assess the creditworthiness of Rate or assess the creditworthiness of

borrowers and assigning a credit rating.borrowers and assigning a credit rating. AAA to BBB, below that junk.AAA to BBB, below that junk. Given the size of government borrowing, Given the size of government borrowing,

rating has a profound influence on rating has a profound influence on interest repayments.interest repayments.

Not value free.Not value free. Clearinghouse for information and Clearinghouse for information and

confidence.confidence. But ratings have policy implications.But ratings have policy implications.

Local Government Financial Local Government Financial ManagementManagement

80,000 local governments.80,000 local governments. Small governments relatively Small governments relatively

simple, but large cities have simple, but large cities have complex budgets.complex budgets.

Driven by balance budgets.Driven by balance budgets. Usually use performance and Usually use performance and

program budgeting, but could program budgeting, but could use reform in some cases.use reform in some cases.

Local Government Financial Local Government Financial ManagementManagement

Property tax (Discuss).Property tax (Discuss). Sales tax (Discuss).Sales tax (Discuss). School tax (Discuss).School tax (Discuss).

Economic PolicyEconomic Policy

Monetary policy.Monetary policy. Manage the money in the economy Manage the money in the economy

to meet specific policy goals.to meet specific policy goals. Decisions about the amount of Decisions about the amount of

money in circulation.money in circulation. Decisions about the level of interest Decisions about the level of interest

rates.rates. Decisions about the functioning of Decisions about the functioning of

credit markets and the banking credit markets and the banking system.system.


Federal Reserve System.Federal Reserve System. Open-market operations.Open-market operations. Discount rate.Discount rate. Reserve requirement.Reserve requirement.


Fiscal policy.Fiscal policy. Manipulation of government finances Manipulation of government finances

by raising or lowering taxes or levels by raising or lowering taxes or levels of spending to promote economic of spending to promote economic stability and growth.stability and growth.

Keynes.Keynes. Full Employment Act of 1946.Full Employment Act of 1946. Use of transfer payments, tax rates, Use of transfer payments, tax rates,

and deficits and surpluses to and deficits and surpluses to manage the economy.manage the economy.

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

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