Week 4 Discussion

BUDGETING AND FINANCIAL MANAGEMENT

Public budgeting and financial management are concerned with allocating limited resources to problems that governments and other public organizations face. Just as you establish a personal budget to track your income and expenses and, just as businesses create budgets to aid in decisions affecting profits and losses, so do public organizations employ budgets to help in planning and management. Public organizations must carefully and responsibly manage large amounts of money and other resources—taking in taxes and other revenues, purchasing goods and services, investing surplus funds, and managing debt wisely.

From the point of view of the manager or citizen trying to influence public policy, the budget is an extremely important tool for planning and control. To manage public programs effectively, you must be able to manage resources, both practically and politically. In this chapter we focus on the budget process from the standpoint of the individual public manager, examining how budget decisions are made and how you can influence budgetary outcomes. Although much of the budget process is highly charged politically, specific technical knowledge about budgeting systems will give you a distinct advantage.

The elaborate systems that public organizations have developed to manage their fiscal affairs are relatively recent. Prior to 1900, revenues were easily sufficient to cover the expenses of government, and financial management was merely record keeping. As the scope of government grew and new demands were placed on its resources, the need for more sophisticated systems of decision making became apparent. Moreover, repeated instances of corruption and waste made more effective control over the public's resources necessary.

In establishing its executive budget process through the Budgeting and Accounting Act of 1921, the federal government followed the lead of several local and state governments that had already taken similar actions. This municipal reform movement emphasized the budget process as a means of bringing order to public spending; consequently, by the 1920s, most big cities had established a formal budget process. Similar developments were also occurring at the state level. In 1910, Ohio became the first state to require an executive budget; within the next decade, similar actions took place in most other states. At the federal level, a special Commission on Economy and Efficiency, known as the Taft Commission, recommended establishing an executive budget in 1912; the recommendation was implemented nearly a decade later.

Since the 1920s, the federal budget has grown in both size and complexity, as have budgets at the state and local levels. This growth means that budgeting and financial management have come to involve far more than keeping a record of income and expenses. Today, how government spends its money affects many other areas of the economy; consequently, the budget is an instrument of fiscal policy. Moreover, the budget is a primary expression of government priorities; it constitutes a record of the decisions that are made concerning various public policies.

Networking

General information on budgeting and financial management can be found at ­w­w­w­.­g­a­s­b­.­o­r­g and at ­w­w­w­.­n­a­s­b­o­.­o­r­g.

The Budget as an Instrument of Fiscal Policy

Budgets express the public policy choices of governments and others. Among these are choices with respect to the impact of the public sector on the economy. Fiscal policy is concerned with the impact of government taxation and spending on the economy generally. Before the Great Depression, little attention was paid to how the federal budget affected the economy, which was presumably regulated by the business cycle. Periods of economic growth featuring inflation and high employment were followed by periods of recession or depression featuring deflation and unemployment. Meanwhile, the federal government sought to balance its budget each year—that is, to make revenues and expenditures approximately equal.

Economists soon began to realize, however, that this pattern of government spending was influencing the economy in a negative way. In periods of economic growth, government revenues naturally increased. In an effort to balance the budget, taxes could be lowered to the level of expenditures; in periods of economic decline, the budget was balanced by lowering spending to meet the lower revenues. The unanticipated result was to increase citizens' income during good times and decrease their income in bad times—just the opposite of what would be desirable. Government taxation and spending had the effect of accentuating economic instability.

Economists such as the British scholar John Maynard Keynes argued, in contrast, that all else being equal, positive government action could lead to greater economic stability. A key to Keynes's analysis was the relationship between inflation and unemployment. Keynes noted that periods of rapid economic growth are typically accompanied by high inflation, which is harmful to individuals because it lowers their purchasing power, especially if they are on fixed incomes. On the other hand, periods of economic decline are typically accompanied by high unemployment, which not only hurts individuals but also lowers revenues for government. In either case, government action aimed at achieving greater stability might be both possible and desirable.

There are many ways the federal government can influence the economy, but one important way is simply by varying its own spending or, somewhat more indirectly, by raising or lowering taxes. The capacity of government spending patterns to influence the economy so dramatically is not hard to understand if you recognize the enormous role of government in the economy. The gross domestic product (GDP), the rate of inflation, and the rate of unemployment are the key indicators of economic health. Gross domestic product, a measure of total economic output, is measured by the market value of goods and services. Almost three-quarters of our current GDP is private in nature, but about one-quarter (about 24.7 percent in 2010) is based on government spending. Based on revenues, the U.S. federal government is the single largest organization in the world, almost 10 times the size of Walmart, Exxon, or Chevron (top three in the Fortune 500). Obviously, decisions at the federal level play an important role in the health and stability of the economy generally.

The key relationships are these: (1) If the economy is experiencing rapid growth—with high inflation and low unemployment—the government might seek to “cool off” the economy by taking money out of the economy through lowering spending, raising taxes, or both. This limits private demand and slows economic growth. On the other hand, (2) if the economy is experiencing recession or depression—with falling prices and high unemployment—the government might want to stimulate the economy by putting more money into circulation, through increasing spending, lowering taxes, or both. This stimulates private demand and increases economic growth. Creating a surplus, as might occur in the first case, would help restrain private spending during prosperity; creating a deficit, as might occur in the second case, might stimulate spending during a recession.

Cumulative state and local spending also affects the economy. State and local government expenditures constitute close to 12 percent of the GDP and must be taken into account in discussions of fiscal policy. If the federal government cuts taxes, but also cuts aid to states and localities, those governments may find it necessary to raise taxes themselves, thus offsetting any economic gains caused by lower federal taxes.

Patterns of spending in many states and in major cities do have some effect on the local economy, and consequently, state and local officials are becoming more cognizant of their role in fiscal policy and especially economic development. These governments, however, often don't have the tools or authority to make certain kinds of decisions. For example, all the states except Vermont have either constitutional or statutory provisions requiring a balanced budget. (Various political leaders, especially Republicans in Congress, have recently called for a balanced budget amendment at the federal level as a way to eliminate deficit spending; however, at this point, no legislation has passed.) Such a proposal, though attractive in a symbolic sense, would limit the flexibility of the federal government in seeking to influence the economy. In any case, it is clear that the budget process has important effects on the economy that must be anticipated when structuring overall patterns of public spending.

The Budget as an Instrument of Public Policy

Although the overall pattern of spending represented in a government budget has an important effect on the economy, individual entries in the budget represent important choices with respect to public policies of all types. The budget is, essentially, a measure of support (or lack of support) for specific programs. Those in favor are funded; those out of favor are not. For this reason, discussions of budgetary priorities are of special importance to political leaders, government officials at all levels, and representatives of various interests in society. As a manager, you will need to understand both where the money comes from and where the money goes.

Where the Money Comes From

Governments obtain funds either from their own sources or through transfers from other governments to operate programs deemed important. There are a variety of ways governments can raise their own revenues, including levying taxes and charging individuals or groups for specific services (see Figure 5.1). Because all public programs are affected by the way governments raise revenues, and because revenue administration is itself an important part of public administration, you will find it helpful to understand the way taxes are structured.

Developing tax policies requires attention not only to the level of taxes being taken from individuals or groups, but also to the fairness, efficiency, and simplicity of the tax system. Everyone agrees that the tax system should be fair and that everyone should pay his or her “fair share.” But what exactly does that mean? Some argue that people should pay according to the benefits they receive; others argue that those who have a greater ability to pay should in fact pay more.

FIGURE 5.1
The Federal Government Receipts: Fiscal Year 2011

SOURCE: Analytical Perspectives, Budget of the US Government, FY 2013 (Table 15.1 Receipts by Source—Summary, p. 187), retrieved March 19, 2012, from ­w­w­w­.­w­h­i­t­e­h­o­u­s­e­.­g­o­v­/­s­i­t­e­s­/­d­e­f­a­u­l­t­/­f­i­l­e­s­/­o­m­b­/­b­u­d­g­e­t­/­f­y­2­0­1­3­/­a­s­s­e­t­s­/­r­e­c­e­i­p­t­s­.­p­d­f.

One way to approach the issue is to think in terms of the relationship between one's tax rate and one's income (vertical-equity concept). A tax structure is proportional (or “flat”) if it taxes everyone at the same effective tax rate. If an effective tax rate is applied to a $20,000 income (yielding $2,000) and the same rate is applied to a $200,000 income (yielding $20,000), even though the amounts differ, the tax is proportional to the amount of income. A tax is progressive if it taxes those with higher income at a higher effective tax rate. Income tax is often cited as progressive. For example, a person with a $20,000 income and tax rate of 10 percent will pay $2,000 in taxes; another individual with a $200,000 income might be taxed at 10 percent for the first $20,000 (yielding $2,000), 20 percent for the next $80,000 (yielding $16,000), and 50 percent for the remaining $100,000 of income (yielding $50,000). The total tax paid on $200,000 will be $68,000, or an effective rate of 34 percent. Finally, a tax is regressive (such as sales taxes) if it taxes those with lower incomes at a proportionally higher effective rate than those with higher incomes. For example, if an individual with a $20,000 income buys a car and pays $500 in taxes, then the effective tax rate for this individual relative to his income is 2.5 percent. If another individual with a $200,000 income buys the same car and pays $500 in taxes, then the effective tax rate for that individual relative to his income is 0.25 percent.

Individual Income Tax  All methods of taxation involve application of a tax rate to a particular tax base; the product of these yields tax revenue. The individual income tax is the single most important tax in our country. It calls for individuals to add up all income from taxable sources, reduce that amount by certain deductions or exemptions, and then apply a tax rate to that base to arrive at the individual's income tax. The current federal income tax, for example, applies rates between 10 and 35 percent to six income brackets.

All advanced industrial nations use some form of income tax. In the United States, income tax is the primary source of revenue for the federal government and is used to a lesser extent in many states and some cities. In most cases, a higher rate is applied to higher incomes, making the income tax a progressive tax. For nearly thirty years after its passage in 1913, the federal income tax applied only to a fairly small number of high-income people. With the advent of World War II, deductions were reduced significantly and higher rates applied.

Managing the task of collecting income tax from everyone in the country is obviously difficult. Yet the Internal Revenue Service (IRS) has developed a relatively efficient mechanism for collection and does so at a cost of about one-half of 1 percent of the revenues produced. Key to the existing system is the requirement that each individual calculate his or her own tax liability. IRS auditors then select a few returns for closer inspection, concentrating on those with unusual features. The extent of compliance with tax regulations in this country, though far from complete, is considered comparatively high.

Corporation Income Tax  The corporation income tax, also a progressive tax, actually predates the individual income tax by several years and, for most of the last century, was a key source of federal revenue. Its proponents justify it as a way of taxing capital accumulation that is not specifically distributed to individuals. Moreover, the corporation income tax is needed to support the individual income tax; without it, individuals could simply keep their income in corporations and avoid paying income taxes. Though most states have corporation income taxes, the tax is far more substantial at the federal level, currently at 35 percent, though there are many proposals to reduce the corporate tax in return for closing loopholes in the tax. Yet, even before these proposals, corporation income tax has been declining in contrast to other sources of revenue. Where it once yielded more revenue than the individual income tax, the corporation income tax has declined to only about one-tenth of federal revenues.

Payroll Taxes  Taxes on payrolls support a variety of Social Security and other social insurance programs, such as unemployment compensation and medical care for the aged. (Do not confuse these specific taxes with the general income taxes that may be deducted from a payroll check.) These programs are primarily financed by taxes paid either by the employer or by the employer and employee in equal amounts. Payroll taxes overall are regressive because there is a flat rate, with no deductions or exemptions, and maximum amounts above which taxes are not required. Payroll taxes at the federal level, which support social insurance, now constitute the second largest source of federal revenue.

Sales and Excise Taxes  Both sales and excise taxes are applied to goods and services. Sales taxes are applied to a broad range of goods and services at either retail or wholesale levels and are a popular source of income at state and local levels. There are significant variations in sales tax rates and in items covered by sales taxes—for example, some jurisdictions exempt food, clothing, and medicine from sales tax. Excise taxes are applied to the sale of specific commodities such as gasoline, tobacco, or alcohol; they are the primary form of consumption tax at the federal level. Typically, excise taxes are applied at specific rates (such as two cents per gallon of gasoline), but they may be applied to the total sales price. Some excise taxes are, in effect, user charges that help support particular activities. Gasoline taxes, for instance, are typically used to support highway construction and maintenance. A major issue concerning sales and excise taxes is that of equity. Because the poor consume a greater portion of their income than the rich, the burden of consumption taxes tends to fall more heavily on the poor, so the taxes are regressive. These taxes also tend to penalize certain groups, such as those with large families or those just starting a household. On the other hand, these taxes tend to provide more stable revenues, something that is especially important at state and local levels.

Property Taxes  Taxes on personal property are widely used at the local level and provide about half of local government revenues. Administration of a property tax involves assessment of an individual's property, most often land and buildings, and then the application of a tax rate. About half the revenue generated by the property tax derives from residential property and half from businesses. Although the property tax is a proportional tax, it is progressive in its effect (those who spend more on housing pay more), administration is difficult and has often not been highly professional. Moreover, recent tax limitations have severely restricted the capacity of local governments to raise additional revenue through the property tax.

Other Revenue Sources  There are, of course, a variety of other sources of government revenues. Whereas public organizations have often charged fees for the use of specific government services, recent limitations on other tax revenues have made such charges increasingly attractive, especially at the local level. For example, fees for the use of parks and recreational facilities are becoming increasingly important. Another recent development in terms of revenues at the state level is the use of lotteries. Nearly half the states and several local governments now conduct lotteries, which provide a highly visible, but relatively small and unstable, source of funds. Lotteries are also highly regressive in their effect (because poorer citizens tend to play the lotteries more); indeed, they are more regressive than even the sales tax.

Nonprofit organizations, which lack the power to tax, derive revenues from quite different sources and, indeed, engage in a wide variety of efforts to support their programs. Obviously, membership organizations depend in large measure on member dues for revenue, but such organizations, along with many others, have recently sought to diversify revenues. Although grant funding remains an important source of revenue for many nonprofit organizations, recent reductions in federal social service programs have seriously limited grant opportunities for many nonprofits. Additional sources of funds include donations (from individuals, corporations, and foundations), sales of goods and services (from books to coffee cups), and joint enterprises involving commercial firms (such as insurance plans or “affinity” credit cards).

Networking

For the budget of the United States, and how to get to the budgets of other governments, see the Department of the Treasury at ­w­w­w­.­u­s­t­r­e­a­s­.­g­o­v. For details on the current fiscal year federal budget and access to historical budget data, go to ­w­w­w­.­g­p­o­a­c­c­e­s­s­.­g­o­v­/­u­s­b­u­d­g­e­t­/­i­n­d­e­x­.­h­t­m­l.

Where the Money Goes

While government revenue figures are staggering, they hardly match up to the demands on governments at all levels. There simply isn't enough money to meet every need or cure every problem, even if money alone were the solution. Instead, difficult choices must be made each year about which programs will be funded and at what levels. The choices made through the public policy process are reflected in the government's budget. The budget, therefore, stands as a record of the government's priorities.

What Would You Do?

You are the director of motor vehicle registration for your state. Your agency, with offices scattered across the state, is responsible for registration and licensing of cars, trucks, and other motor vehicles. About six months into the fiscal year, the governor announces that all state agencies will have to finish the fiscal year with expenditures 5 percent less than originally budgeted. You have already spent half your yearly budget allocation, so the reduction means you actually have to cut spending by 10 percent over the next six months. What would you do?

But government priorities are always shifting. As new conditions arise, new programs are proposed and old programs are expanded or contracted. The emphasis the federal government gives to various areas sometimes has reflected the condition of the country and the world, as in the large percentage of national resources devoted to national defense during periods of international conflict.

We can also trace budgetary changes over shorter time spans to see the policy priorities of various presidents, governors, mayors, or other public officials. Restrictions, however, have been built into the federal budget over the years that somewhat limit the choices any president or Congress can make. For example, Congress has passed a variety of entitlement programs that provide specified benefits to those who meet certain eligibility requirements. For example, legislation might provide benefits to people above a certain age or below a certain income level. The implication, supported by several judicial rulings, is that individuals are entitled to or have a right to certain benefits (primarily social welfare benefits).

For these programs, Congress essentially agrees to provide whatever money is necessary from year to year to ensure a certain level of benefits to all eligible people. Legislation is typically written so that new action is not required each year to keep the program going. Only a projection of likely beneficiaries is needed to determine the level of expenditures for a given year. Unless Congress takes specific steps to limit benefits or eligibility—something that legislators are reluctant to do—funding of these programs is practically automatic.

These programs vary in size over time. In a recession, for example, unemployment would be high, and spending for unemployment compensation would rise. Similarly, the changing character of the population—for example, a larger number of older Americans—would also change the amount of money required to provide benefits to that group. Moreover, most entitlement programs have now been indexed to the cost of living (or related measures) so that benefit levels automatically rise with inflation. (Over the past decade, Congress has passed major expansions of indexing in Social Security and Medicare.) Expenditures for entitlement programs thus increase almost every year. The Congressional Budget Office (CBO) projects that under current law, federal spending on Medicare and Medicaid measured as a share of GDP will rise from 4 percent in 2007 to 12 percent in 2050 and 19 percent in 2082—which, as a share of the economy, is roughly equivalent to the total amount that the federal government spends today (CBO, 2007).

Such programs constituted just over 50 percent of the proposed fiscal year 2013 federal budget, with Social Security amounting to 20 percent of the entire budget. When they are combined with farm price supports (also indexed), interest on the national debt (which must be paid), and expenditures based on previous commitments, these so-called uncontrollable expenditures constitute almost two-thirds of the federal budget.

The remainder of the federal budget might be termed discretionary spending; meaning the president and Congress are open to make changes in this relatively small portion of the budget. This includes defense spending (about 18 percent) and domestic discretionary spending (only about 19 percent). These are the areas that generate the most difficult policy choices.

From Deficits to Surplus and Back

A great deal of political debate in the 1980s and early 1990s centered on strategies for controlling the federal deficit. However, by 2000, a booming economy and fiscal measures taken by Congress in the late 1990s changed the debate from how to control the deficit to ways to spend a growing budget surplus. To understand this change in fortune, it may be helpful to examine some of the deficit reduction methods employed by the federal government during the past decades.

Let's begin with the deficit. As noted, traditional economic theory does not necessarily disapprove of public borrowing; indeed, there may be benefits to deficit spending in particular years. But at some point, a growing deficit becomes unmanageable, especially as interest payments become a substantial part of government spending. Large deficits are generally thought to limit both short-term and long-term economic recovery, especially because they limit private investment. Moreover, large deficits contribute to an understandable lack of public confidence concerning their political leaders' ability to deal effectively with the budget.

The budget deficits of the Reagan years were substantial. The administration's accumulated debt exceeded that of all previous administrations combined. By 1984 it became clear that if no further actions were taken to reduce the deficit, by the end of the Reagan years, the accumulated deficit would total over $2.6 trillion. Interest payments alone would require one out of every six federal dollars. Facing this prospect, Congress passed the Gramm-Rudman-Hollings Act of 1985. Under this legislation, deficit targets were set for each of the next five budget years and aimed at reducing the deficit to zero in 1990 (though a later amendment pushed the target to 1992). Unfortunately, the president and Congress were overly optimistic in their economic projections and employed several questionable budget techniques to evade the restraints set by Gramm-Rudman-Hollings.

With the deficit still out of control in 1990, President Bush and Congress faced very difficult budget deliberations. For the 1990 budget, the Gramm-Rudman-Hollings law had targeted an annual deficit of no more than $110 billion. By October, when the fiscal year began, there was still no agreement on the budget. (As we will see, it is not unusual for a federal fiscal year to begin before the year's budget is approved.) Consequently, automatic, across-the-board spending cuts were applied to all federal agencies.

Finally, in late November, a deficit-reduction plan was approved that would bring the projected deficit below the Gramm-Rudman-Hollings target. The plan that was agreed to, however, contained a number of provisions that appeared to be budgetary “smoke and mirrors.” The biggest reduction item was to simply maintain for another 130 days the across-the-board cuts that had been imposed in October. Many observers read this as a failure of the administration and Congress to come to grips with the hard choices that deficit reduction requires.

As part of the budget agreement, the Budget Enforcement Act (BEA) was passed to police the deficit even further. The BEA set annual ceilings on several categories of discretionary spending, with violation of the caps requiring across-the-board cuts. BEA also required that legislative actions affecting mandatory spending not increase the deficit in any year. (This is known as the “pay as you go” provision.) Though these provisions seem to have had the desired effect on the budget process, the deficit continued to grow, driven in part by incorrect economic assumptions and in part by increased spending for healthcare programs and the savings and loan bailout.

Networking

Check out the National Debt Clock at ­w­w­w­.­b­r­i­l­l­i­g­.­c­o­m­/­d­e­b­t­_­c­l­o­c­k and the Department of the Treasury's FAQs about the budget at http://­w­w­w­.­t­r­e­a­s­u­r­y­.­g­o­v­/­P­a­g­e­s­/­d­e­f­a­u­l­t­.­a­s­p­x.

In 1997, the Clinton administration led a bipartisan effort in Congress to pass yet another landmark piece of legislation aimed at balancing the federal budget. The budget agreement was originally scheduled to eliminate the deficit by 2002, phasing in $121 billion in spending cuts over a five-year period. Much of the savings were planned to come from reductions in Medicare payments to health providers and hospitals. An additional $55 billion was to have been saved each year through mandates imposed on future spending bills. The budget agreement also featured $95 billion in tax cuts over the five years, including credits for higher education, relief for families with children, and reductions in capital gains.

When President Clinton signed the measure into law, few would have imagined that in less than three years the Congressional Budget Office would be projecting a budget surplus. But the federal government turned the tide, thanks to a variety of factors—including old-fashioned good luck. One of the most significant contributors to the government's change in fortune came in the “dot-com” craze of 1999–2000, as thousands of Internet companies went public on the stock market, leading to a dramatic increase in tax revenues and an overall expansion in the American economy. Reductions in military spending in the wake of the cold war also helped, as the government was able to invest its resources in more productive areas (Uchitelle, 2000, p. A1). The net outcome was a projected surplus of $81 billion, scheduled to materialize during the next decade. This is a far cry from the crisis years of the early 1980s.

The Bush Tax Plan  President George W. Bush seized upon the opportunity afforded by this emerging surplus to advance one of the key themes in his election platform: a reduction in federal taxes. Given the estimates early in the year from both the Congressional Budget Office and the president's Office of Management and Budget, few could stand in the way of the new administration's drive for sweeping tax reform.

The administration's original plan called for a $1.6 trillion cut in the federal income tax, but even the president's most ardent supporters on Capitol Hill cautioned that it would be extremely difficult to pass such an enormous reduction plan. Recognizing the importance of a victory on his administration's first key policy initiative, President Bush worked with lawmakers to pare down the original proposal and gain the necessary votes. The final measure, which was signed into law on June 7, 2001, featured a $1.3 trillion tax cut to be phased in over the next decade and a fundamental restructuring of federal income taxes.

Supporters of the plan said that reducing the tax burden on the American public, particularly with the projected federal surplus, was a way to return “an overcharge” to taxpayers and to curb federal spending. For example, House Majority Leader Dick Armey said, “The addicts are going to have to take the cure. We're no longer going to get stoned on the other people's money” (Stevenson, 2001, p. A1). Proponents also argued that the tax rebates, which the IRS began sending out in the summer of 2001, would help to stimulate an economy that had declined sharply in the preceding months.

Some of the central elements of the Bush plan included reducing personal income tax rates, phasing out the estate tax, increasing the child tax credit (and expanding the number of low-income families eligible for this credit), and increasing the contribution limits to 401(k) and individual retirement accounts. For nonprofits, the tax reduction plan that finally passed Congress lacked many of the provisions from the original Bush proposal that would have encouraged increases in charitable giving.

Critics of the Bush tax plan in the governmental sector predicted that it would prove to be too much, too soon. Senator Tom Daschle, who became majority leader when the Democrats took control of the Senate in June 2001, said, “We think this is good short-term politics. [But] it is disastrous long-term policy” (Stevenson, 2001, p. 26). Daschle and others suggested that the plan would not leave enough in reserve to cover the cost of upgrading the military, much less the substantial reforms to Social Security and Medicare that remained on the horizon. And even the president's own economic advisers moved away from their original optimism, saying that the more cautionary estimates of the federal surplus, which were released just weeks after the tax plan became law, would require Congress to revisit some of its main provisions.

Even so, President Bush succeeded in pushing through three more major tax cuts aimed at reducing revenue by $1.9 trillion over a ten-year period. Unfortunately, the surplus did not materialize, and spending far outstripped revenue to produce high levels of debt. During the Bush administration, economic recessions, terrorist attacks, and corporate scandals, coupled with the tax cuts and new spending for military action in Iraq and Afghanistan, put the federal government further and further into debt. Instead of the surplus forecasted at the beginning of the Bush administration, there were federal budget deficits each year beginning in 2002, and in January 2009, just before President Bush left office, the Congressional Budget Office projected a deficit of $1.2 trillion for FY 2009 based on a continuation of the Bush administration policies and the effects of the financial collapse of 2008 (Tritch, 2011). Overall, under the Bush administration the total federal debt increased from $5.7 trillion in January 2001 to $10.7 trillion in December 2008 (United States Department of the Treasury).

Obama and Economic Recovery  The deep recession spurred by the financial collapse in 2008 framed the context for the incoming Obama administration. One of President Obama's first acts was to sign into law the American Recovery and Reinvestment Act (ARRA) in February 2009, a $787 billion economic stimulus package that included spending on job preservation and creation, health care, education, and energy; investments in infrastructure; tax breaks; expanded unemployment benefits; and a host of other programs designed to halt further economic deterioration.

The new president, who began his term with a budget deficit that was larger than any since World War II, set out in his 2010 budget proposal to capitalize on what he called a “once in a generation” opportunity to reverse “an era of profound irresponsibility that engulfed both private and public institutions” (OMB 2009, p. 1). The budget proposal included measures intended to help jumpstart the economy and stabilize the country's financial system, including appropriations to buy toxic bank assets, expand a consumer loan program, and continue funding for the Troubled Asset Relief Program (TARP), a program that was signed into law by President Bush in October 2008 to address the subprime mortgage crisis by buying assets and equity from financial institutions. President Obama's 2010 budget proposal also addressed the overhaul of the nation's healthcare system and called for investments in clean energy, education, and the country's infrastructure (Calmes, 2009).

One of the issues facing the Obama administration early on was whether to extend the tax cuts enacted under President Bush, which were set to expire in December 2010. Critics of the cuts argued that these cuts spurred an increase in income inequality, that they played a pivotal role in the budget deficits that began in 2002, and that, contrary to predictions, they failed to encourage economic growth. Others, however, contended that the tax cuts created higher marginal rates for the very wealthy and actually generated an increase in federal tax receipts from 2004 to 2007. After a great deal of debate, during which it was projected that extending the cuts through 2020 would add more than $3 trillion to the national debt, these cuts were extended for two years.

The Obama budget proposal for FY 2013, released early in 2012 and totaling $3.8 trillion, called for $4 trillion in cuts over ten years and $1.5 trillion in tax hikes for households earning more than $250,000. It included $7.5 billion in administrative cuts and increased funding for education, rail and road construction, electric cars, and general research and development. Provisions included ending the Bush tax cuts, restoring the estate tax to 2009 levels, increasing the tax rate on dividends for the wealthy, and instituting the “Buffet Rule,” which would subject those earning more than $1 million to a tax rate of at least 30 percent (Lee & Paletta, 2012). The budget also called for elimination of tax breaks for oil and gas companies; caps on discretionary spending; reforms to Medicare, Medicaid, and other health programs; and mandatory savings in a variety of areas. An analysis by the Congressional Budget Office noted that under the 2013 budget proposal, the deficit for 2012 would equal $1.3 trillion, or 8.1 percent of GDP. This would decline to $977 billion in 2013, or 6.1 percent of GDP; fall further relative to GDP in subsequent years to 2.5 percent in 2017; and then increase to 3.0 percent of GDP by 2022. The estimated accumulated federal debt as of the end of FY 2011 (September 30, 2011) was $14.8 trillion, for which the government incurred $454 billion in interest expenses during FY 2011 (United States Department of the Treasury). President Obama's proposed 2013 budget put forward a  balanced plan of spending cuts and revenue increases that reduce the deficit by more than $4 trillion over the next decade, including $1 trillion in spending cuts he signed into law in the summer of 2012.

For an outline of the issues that these presidents have struggled with, see the box “Exploring Concepts: Issues in Budgeting”.

1. The fiscal health of the federal government, particularly in light of unprecedented deficits

2. The struggles of state and local governments to balance their budgets in both the short term and the longer term

3. Pressures on spending at all levels of government, particularly focused on two areas—health care spending, which affects all levels of government, and education spending, the effects of which are felt primarily at the state and local level

4. Concerns about revenue structure and reliance on various sources, particularly intergovernmental revenues and sales tax revenues

5. The problems created by the need to deal with (and finance) an aging infrastructure

6. The influence of financial and performance data on budgeting decisions

7. Institutional and organizational responses to the management of the finance and budget function

SOURCE: Phillip G. Joyce and Scott Pattison, “Public Budgeting in 2020: Return to Equilibrium, or Continued Mismatch between Demands and Resources?” Public Administration Review 70 (2010): s24–s32.

Expenditure comparisons at the state and local levels are complicated by our system of intergovernmental transfers. In education, for example, the federal government provides money directly to individuals (in the form of student grants and loans), but it also transfers large sums to state and local governments. States spend money directly (for colleges and universities), but they also transfer money received from the federal government and some raised at the state level to local governments, primarily to support education. Consequently, local governments provide less than 30 percent of the money spent on education in this country and actually are involved in spending 70 percent of that money.

State and local revenues come from several sources, taxes being foremost among these (see Figure 5.2). The majority of tax receipts collected for state and local governments are sales and gross receipts taxes (34.1 percent), property taxes (33.4 percent), and individual income taxes (21.3 percent) (U.S. Census, 2009). But, of course, as we would expect, state and local revenues declined significantly during the recession. Overall, tax revenue declined 4.5 percent in 2009, to $1.3 trillion. Individual and corporate income taxes saw the largest declines in 2009, at 11.3 percent and 19.2 percent, respectively (U.S. Census, 2009). This has caused governments at the state and local level to experience significant fiscal stress and to limit spending in vital areas such as education and health care.

Other areas of spending are significant, too. If we include intergovernmental transfers spent at the state and local levels in our calculations of state and local spending, the following patterns emerge: States spend the greatest portion of their funds on education, with public welfare next, followed by highways, health, and natural resources. At the local level, the largest amount again is spent on education, with health, public works, and social welfare next. Because of intergovernmental transfers, federal fiscal policies can have a significant impact on state and local governments. Cuts at the federal level directly affect not only federal agencies, but also state and local governments that depend on federal funding. In fact, in a statement by the National Council of State Legislatures, states have an “incalculable stake” in the manner in which the federal government balances its budget (see ­w­w­w­.­n­c­s­l­.­o­r­g­/­s­t­a­t­e­f­e­d­/­f­e­d­b­u­d­.­h­t­m­#­F­e­d­e­r­a­l­G­r­a­n­t­s).

FIGURE 5.2
State and Local Revenues, Fiscal Year 2009

NOTE: Total exceeds 100 percent because of sampling errors.

SOURCE: U.S. Census Bureau, Appendix Table A-1, State and Local Government Finances Summary 2009, retrieved March 19, 2012, from http://­w­w­w­2­.­c­e­n­s­u­s­.­g­o­v­/­g­o­v­s­/­e­s­t­i­m­a­t­e­/­0­9­_­s­u­m­m­a­r­y­_­r­e­p­o­r­t­.­p­d­f.

As a public manager, you will find that the budget process is critical to your success and that of your agency, quite simply because it establishes the level of funding for your programs. A variety of steps are required to enable an agency to spend money. First, legislation must be passed and signed by the chief executive to authorize the program. This authorizing legislation permits the establishment or continuation of a particular program or agency. (Authorizing legislation usually covers multiple years or is even open-ended, although some programs, such as the space program, require new authorization each year.) Next come appropriations, whereby the legislature sets aside funds and creates budget authority for the funds' expenditure. Only after both steps have been taken can an agency spend money in pursuit of its stated objectives.

In most cases, governments use a fiscal year as their basic accounting period. The federal fiscal year begins on October 1 and runs through September 30 of the following year. The fiscal year carries the name of the year in which it ends; thus, fiscal year 2013, or FY 2013, begins October 1, 2012, and ends September 30, 2013. States and localities differ widely in terms of fiscal years; some follow the federal pattern, whereas others start July 1 (as did the federal government until 1976). Still others match the fiscal year to the calendar year. Kentucky and a few other states actually have a two-year-long fiscal year because their legislatures meet and pass a budget only every other year.

The fiscal year is the key period in which money is spent, but a variety of steps must be taken before and after the fiscal year that can affect an agency's expenditures. The budget must be developed, typically by the chief executive (president, governor, mayor) and transmitted to the legislature; it must be approved by the legislature (hopefully) prior to the beginning of the fiscal year; it must be executed during the fiscal year; and it must be reviewed and audited following the fiscal year. At any given point in the budget cycle, there are actually several budgets being worked on. While one budget is being executed (say, FY 2012), another (FY 2013) is being formulated and approved, while another, (FY 2011) is being audited.

In the federal government and in many state and local jurisdictions, the chief executive has primary responsibility for preparing the budget. The budget cycle (see Figure 5.3) typically begins with a letter from a central budget office to agencies outlining the timetable for preparing the budget, transmitting forms for use in the process, and indicating any policy concerns of special priority for the fiscal year. The agencies then prepare their own budget requests and forward them to the central budget office for review (see the box “Take Action: Financial Management: The Program Manager's Role”). Often a series of meetings (or sometimes hearings) are held to negotiate differences in the views of the central budget office (reflecting the priorities of the chief executive) and the agencies. Finally, the budget document is prepared by the central budget office and transmitted by the chief executive to the legislature for approval.