17 CHAPTER PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe The Government Budgeting Process

17CHAPTER

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe

The Government Budgeting Process

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Government Budgeting Government Budgeting ProcessProcess

Role of budgeting process Role of budgeting process Allocate resources to most highly valued Allocate resources to most highly valued

usesuses

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The Federal Budgeting The Federal Budgeting ProcessProcess

Budgetary Reform in the 20th CenturyBudgetary Reform in the 20th Century Budget and Accounting Act of 1921Budget and Accounting Act of 1921

Directly involved presidentDirectly involved president Established Bureau of the BudgetEstablished Bureau of the Budget Created General Accounting OfficeCreated General Accounting Office

In 1970 - Bureau of the Budget In 1970 - Bureau of the Budget reorganized and named Office of reorganized and named Office of Management and Budget (OMB)Management and Budget (OMB)

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The President’s BudgetThe President’s Budget

OMB responsible for developing OMB responsible for developing president’s budgetpresident’s budget

OMB solicits requests from federal OMB solicits requests from federal agencies for fundingagencies for funding Sum of agencies requests will be Sum of agencies requests will be

unacceptably largeunacceptably large Requests can be viewed as menu of Requests can be viewed as menu of

choices for those determining budgetchoices for those determining budget Political and economic documentPolitical and economic document

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The Congressional The Congressional BudgetBudget

Congressional Budget Office (CBO) Congressional Budget Office (CBO) assists Congress in evaluating president’s budgetassists Congress in evaluating president’s budget submits report to congressional budget submits report to congressional budget

committees committees Budget resolutions presented to both houses Budget resolutions presented to both houses

of Congressof Congress House Ways and Means Committee and House Ways and Means Committee and

Senate Finance Committee hold hearings on Senate Finance Committee hold hearings on specific appropriationsspecific appropriations

Further budget resolutionsFurther budget resolutions

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The Congressional The Congressional BudgetBudget

Congress does not always follow Congress does not always follow scheduleschedule

Budget resolution late or not passed Budget resolution late or not passed in some yearsin some years Results in continuing resolution rather Results in continuing resolution rather

than final budgetthan final budget

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IncrementalismIncrementalism

Theory of budget determinationTheory of budget determination Suggests budgets of government Suggests budgets of government

agencies will be incrementally larger agencies will be incrementally larger than the previous yearthan the previous year

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Effects of Special Effects of Special InterestsInterests

Special interests important element Special interests important element in budgetary processin budgetary process

Political pressure works toward Political pressure works toward expansion of existing programsexpansion of existing programs

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Incrementalism and Incrementalism and EfficiencyEfficiency

Incrementalism logical within special Incrementalism logical within special interest theory frameworkinterest theory framework

Also logical because of complexity of Also logical because of complexity of government spendinggovernment spending

Incrementalism as a rational Incrementalism as a rational economic policyeconomic policy

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Politics and Federal Politics and Federal BudgetBudget

Changes in politics of budgetary Changes in politics of budgetary process caused byprocess caused by Changes in composition of federal Changes in composition of federal

spending toward social servicesspending toward social services Increasing deficitsIncreasing deficits A drift away from incrementalism as A drift away from incrementalism as

president and Congress attempt to president and Congress attempt to change budget in more radical wayschange budget in more radical ways

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EntitlementsEntitlements

Provide funds to individuals meeting Provide funds to individuals meeting eligibility requirementseligibility requirements

Once in effect, level of expenditures Once in effect, level of expenditures depends on external conditionsdepends on external conditions

No fixed budget - expenditures No fixed budget - expenditures relatively hard to controlrelatively hard to control

Add to uncertainty of budgetary Add to uncertainty of budgetary processprocess

Difficult to eliminateDifficult to eliminate

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Off-Budget ExpendituresOff-Budget Expenditures

Government-owned corporations Government-owned corporations with budgets separate from with budgets separate from government’s budgetgovernment’s budget U.S. Postal ServiceU.S. Postal Service AmtrakAmtrak

Increased dramatically beginning in Increased dramatically beginning in 1950’s1950’s

Activities sometimes placed off-Activities sometimes placed off-budget to reduce scrutinybudget to reduce scrutiny

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Program Budgets Versus Program Budgets Versus Line Item BudgetsLine Item Budgets

Program budget - groups expenditures Program budget - groups expenditures by program goalsby program goals Enumerates objectives soughtEnumerates objectives sought

Line item budget - groups expenditures Line item budget - groups expenditures by types of items purchaseby types of items purchase Enumerates items purchasedEnumerates items purchased

Program budgets best evaluate Program budgets best evaluate effectiveness of government effectiveness of government expendituresexpenditures

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Planning-Programming-Planning-Programming-Budgeting System Budgeting System

(PPBS)(PPBS) Government expenditures grouped by Government expenditures grouped by

objective objective Facilitates undertaking of cost-benefit Facilitates undertaking of cost-benefit

analyses of programsanalyses of programs Define objectives, consider alternatives, Define objectives, consider alternatives,

undertake cost-benefit analysesundertake cost-benefit analyses Most useful when considering whether a Most useful when considering whether a

new program should be implementednew program should be implemented

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Cost-Benefit AnalysisCost-Benefit Analysis

Intended to compare costs/benefits Intended to compare costs/benefits of a programof a program

Requires costs/benefits be estimated Requires costs/benefits be estimated and weighed and weighed

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Steps of Cost-Benefit Steps of Cost-Benefit AnalysisAnalysis

Enumerate the optionsEnumerate the options Enumerate the costs and benefitsEnumerate the costs and benefits

Avoid double countingAvoid double counting Concentrate on primary effectsConcentrate on primary effects

Convert costs/benefits to dollar termsConvert costs/benefits to dollar terms

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Cost-Benefit Analysis as Cost-Benefit Analysis as Decision-Making ToolDecision-Making Tool

Results of cost-benefit study can be Results of cost-benefit study can be used as guideline as to whether used as guideline as to whether program should be initiatedprogram should be initiated

Favorable benefit-to-cost ratio may Favorable benefit-to-cost ratio may not imply that program should be not imply that program should be undertakenundertaken

Unfavorable benefit-to-cost ratio may Unfavorable benefit-to-cost ratio may not imply that program should not be not imply that program should not be undertakenundertaken

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Cost-Benefit Analysis Cost-Benefit Analysis and Public Interestand Public Interest

Cost-benefit analysis is utilitarianCost-benefit analysis is utilitarian Dollar costs weighed against dollar Dollar costs weighed against dollar

benefitsbenefits Cost-benefit analysis should be used Cost-benefit analysis should be used

as a guide to final decisionas a guide to final decision Determination of public interest is Determination of public interest is

normativenormative

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Discount RateDiscount Rate

Affects cost-benefit analysisAffects cost-benefit analysis Rate of interest at which future Rate of interest at which future

costs/benefits discounted to compute costs/benefits discounted to compute present valuepresent value

Selecting appropriate rate important Selecting appropriate rate important when benefits extend into the futurewhen benefits extend into the future

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Present Value Present Value Measurement of Costs Measurement of Costs

and Benefitsand Benefits Present value of benefit to be received one Present value of benefit to be received one year from now:year from now: PV = B1/(1+r)PV = B1/(1+r)

Present value of benefit to be received two Present value of benefit to be received two years from now:years from now: PV = B1/(1+r) + B2/[(1+r)(1+r)]PV = B1/(1+r) + B2/[(1+r)(1+r)]

General Formula:General Formula:

T

tt

t

r

BPV

0 1

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Choosing the Right Choosing the Right Discount RateDiscount Rate

Effects estimate of present value of Effects estimate of present value of projectproject

More important the longer the time More important the longer the time horizonhorizon

Options of choosing discount rate:Options of choosing discount rate: Apply rate on government bonds of Apply rate on government bonds of

same maturity as projectsame maturity as project Use private market interest rateUse private market interest rate

Should be a risk-free rateShould be a risk-free rate

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Choosing the Right Choosing the Right Discount RateDiscount Rate

Problems when choosing discount Problems when choosing discount ratesrates InflationInflation Discount rate should account for Discount rate should account for

opportunity costs of forgone tax opportunity costs of forgone tax revenues to the governmentrevenues to the government

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Average and Marginal Average and Marginal BenefitsBenefits

Optimal project produces highest net Optimal project produces highest net benefitsbenefits

Ratio of benefits to costs – ratio of Ratio of benefits to costs – ratio of average benefits to average costsaverage benefits to average costs

Optimal output equates marginal Optimal output equates marginal costs with marginal benefitscosts with marginal benefits

Limitations of cost-benefit analysisLimitations of cost-benefit analysis Difficult to measure costs/benefitsDifficult to measure costs/benefits Does not provide sufficient informationDoes not provide sufficient information

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Taxing and SpendingTaxing and Spending

Differences between how political Differences between how political decisions on spending and revenue decisions on spending and revenue generation are madegeneration are made

Spending more susceptible to special Spending more susceptible to special interest activity than taxesinterest activity than taxes

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17 CHAPTER PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe The Government Budgeting Process