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

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 17-2 Government Budgeting Process  Role of budgeting process  Allocate resources to most highly valued uses

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 17-3 The Federal Budgeting Process  Budgetary Reform in the 20th Century  Budget and Accounting Act of 1921  Directly involved president  Established Bureau of the Budget  Created General Accounting Office  In Bureau of the Budget reorganized and named Office of Management and Budget (OMB)

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 17-4 The President’s Budget  OMB responsible for developing president’s budget  OMB solicits requests from federal agencies for funding  Sum of agencies requests will be unacceptably large  Requests can be viewed as menu of choices for those determining budget  Political and economic document

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 17-5 The Congressional Budget  Congressional Budget Office (CBO)  assists Congress in evaluating president’s budget  submits report to congressional budget committees  Budget resolutions presented to both houses of Congress  House Ways and Means Committee and Senate Finance Committee hold hearings on specific appropriations  Further budget resolutions

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 17-6 The Congressional Budget  Congress does not always follow schedule  Budget resolution late or not passed in some years  Results in continuing resolution rather than final budget

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 17-7 Incrementalism  Theory of budget determination  Suggests budgets of government agencies will be incrementally larger than the previous year

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 17-8 Effects of Special Interests  Special interests important element in budgetary process  Political pressure works toward expansion of existing programs

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe 17-9 Incrementalism and Efficiency  Incrementalism logical within special interest theory framework  Also logical because of complexity of government spending  Incrementalism as a rational economic policy

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Politics and Federal Budget  Changes in politics of budgetary process caused by  Changes in composition of federal spending toward social services  Increasing deficits  A drift away from incrementalism as president and Congress attempt to change budget in more radical ways

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Entitlements  Provide funds to individuals meeting eligibility requirements  Once in effect, level of expenditures depends on external conditions  No fixed budget - expenditures relatively hard to control  Add to uncertainty of budgetary process  Difficult to eliminate

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Off-Budget Expenditures  Government-owned corporations with budgets separate from government’s budget  U.S. Postal Service  Amtrak  Increased dramatically beginning in 1950’s  Activities sometimes placed off-budget to reduce scrutiny

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Program Budgets Versus Line Item Budgets  Program budget - groups expenditures by program goals  Enumerates objectives sought  Line item budget - groups expenditures by types of items purchase  Enumerates items purchased  Program budgets best evaluate effectiveness of government expenditures

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Planning-Programming- Budgeting System (PPBS)  Government expenditures grouped by objective  Facilitates undertaking of cost-benefit analyses of programs  Define objectives, consider alternatives, undertake cost-benefit analyses  Most useful when considering whether a new program should be implemented

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Cost-Benefit Analysis  Intended to compare costs/benefits of a program  Requires costs/benefits be estimated and weighed

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Steps of Cost-Benefit Analysis  Enumerate the options  Enumerate the costs and benefits  Avoid double counting  Concentrate on primary effects  Convert costs/benefits to dollar terms

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Cost-Benefit Analysis as Decision-Making Tool  Results of cost-benefit study can be used as guideline as to whether program should be initiated  Favorable benefit-to-cost ratio may not imply that program should be undertaken  Unfavorable benefit-to-cost ratio may not imply that program should not be undertaken

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Cost-Benefit Analysis and Public Interest  Cost-benefit analysis is utilitarian  Dollar costs weighed against dollar benefits  Cost-benefit analysis should be used as a guide to final decision  Determination of public interest is normative

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Discount Rate  Affects cost-benefit analysis  Rate of interest at which future costs/benefits discounted to compute present value  Selecting appropriate rate important when benefits extend into the future

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Present Value Measurement of Costs and Benefits  Present value of benefit to be received one year from now:  PV = B1/(1+r)  Present value of benefit to be received two years from now:  PV = B1/(1+r) + B2/[(1+r)(1+r)]  General Formula:

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Choosing the Right Discount Rate  Effects estimate of present value of project  More important the longer the time horizon  Options of choosing discount rate:  Apply rate on government bonds of same maturity as project  Use private market interest rate  Should be a risk-free rate

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Choosing the Right Discount Rate  Problems when choosing discount rates  Inflation  Discount rate should account for opportunity costs of forgone tax revenues to the government

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Average and Marginal Benefits  Optimal project produces highest net benefits  Ratio of benefits to costs – ratio of average benefits to average costs  Optimal output equates marginal costs with marginal benefits  Limitations of cost-benefit analysis  Difficult to measure costs/benefits  Does not provide sufficient information

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy Randall Holcombe Taxing and Spending  Differences between how political decisions on spending and revenue generation are made  Spending more susceptible to special interest activity than taxes