1. The Logic of the Budget Process
Chapter 2
The Logic of the Budget Process

2. Outline: 1. The logic of budgeting 2. Functions of the Budget Process
3. The Budget Cycle
4. Govt. Accounting and Financial
Reporting
5. Budgets and Politics

3. What is the “budget process” ?
Budget Process determines the level of services that a government will provide and how they will be financed.
The basic decision is the how funds will be allocated to one project against another
Markets allocate according to the “invisible hand” of price, demand and supply
Not advantageous for government budgeting to be invisible and cannot use price to determine supply and demand

4. Functions of Budgets Fiscal discipline and control – accountability
Response to strategic priorities – allows an explicit method for prioritizing goods and services demanded by a citizenry
Assists in efficient implementation – increase managerial control over resources

5. Size and Growth of Government Spending
Two types of govt. spending: Purchases & Transfers
Purchases – divert productive resources (land, labor, etc.) away from private use toward government. Includes wages and benefits to govt. employees, suppliers, and contracts to private entities.
Most of this is for current services, but some is long term capital investment (roads, buildings, etc.)
Direct government provision contributes to Gross Domestic Product (GPD) a general measure of a national economy

6. Size and Growth of Government Spending
Transfers – Income to recipients without service being required in return. Includes social security benefits, unemployment insurance, health services and payments to low income households. These account for almost 40% or all govt. spending in the US.

7. History of Govt. Spending
Total Govt. spending about 1/3 of GDP
Steady growth since 1945 and expansion into new areas
1902 = 7%
1945 (during WWII) = 43%
From = 25%
Largely a rise in Federal Govt. Spending
State has increased, but is a small % of total
Local has stayed about the same

8. Total Government Spending in the US
Source: usbudget/fy00/guide01.html

9. Federal revenue sources:
[Does not directly correspond to data in Table 3-1]

10. Where does the money go?

11. Spending vs. Service Delivery
Increased spending does not equal increased service delivery
Two components of govt. spending
1. Purchasing new stuff (more labor, material, etc.)
2. Increased price for the same amount of stuff (inflation)
To compare spending over time, need to convert to similar price levels (real or constant dollars)

12. How does the US compare in terms of Govt
How does the US compare in terms of Govt. spending to other industrial democracies?
Ranges from high of 56.3% in Slovak Republic, to 17% in Mexico.
US percentage 32.7% is much below the mean.
US has a fairly small govt. as measure of GDP
The nature of the spending obviously has more to do with both the degree of services and the burden on the private economy
- Name one reason why it might be difficult to comparison across countries ?

13. Computing Growth Rates
How do you calculate a change across two time periods?
Need to calculate the “rate of growth”
Use compound rate of growth for things like population or interest bearing accounts
R =[(Y / X) 1/N] – 1
Where R=rate, Y=end value, X=beginning value, N=number of periods of growth

14. Example (p. 36 Sidebar 2-2)
Suppose State population goes from 1.8 million in 1990 to 4.5 million in If we assume there is no change in migration patterns or births, what level of population should you plan to have in 2005?
1. Begin by calculating the compound rate of growth:
Formula R =[ (Y / X) 1/N ] – 1
R =[ (4.5/1.8)1/10 ] – 1 = 9.6%

15. Example (continued) 2. Next use the rate you calculated to figure out
what the change would be into the future period,
in this case 5 years.
Formula for Growth at a know rate:
Y = X(1+r)n
where Y is the future level, X is the current level, r is the rate, and N is the number of periods
Solve for the unknown period, Y
Y = 4.5( )5 = 7.11 million
Very useful for projecting budget growth, planning for future service delivery and demands on govt. services, etc…

16. Logic of the Budget Process
Price is the mechanism linking consumer and producer in private markets
Price does not work as a mechanism in govt. service provision because:
1. Many are public goods
2. Resource constraints are different
3. Govt. may operate as a monopoly with many
good, but not necessarily
4. Usually multiple goals in providing any single govt. good

17. Two aspects of Public Spending decisions:
- two aspects to every public good and service provided, distribution of benefits and the distribution of costs
- Examples when matched, examples when not matched?
1. Expenditure – establishes what gets provided, how it is provided, and who receives the benefits
2. Revenue – who pays for the benefit

18. Govt. Accounting and Financial Reporting
Standards
Financial accounting Standards Board (FASB) – private sector
Government Accounting Standards Board (GASB) – public sector
Funds – segregated accounts
(continued next slide)
Accounting Basis
Cash – records when cash received or dispersed “checkbook”
Accrual – all inflows are counted as revenues, and outflows are expenditures

19. The Budget Cycle Overlapping and continuous cycle Phases:
1. Executive preparation
2. Legislative Consideration
3. Execution
4. Audit-Evaluation: financial & performance