Assoc. Prof. Yesim Kustepeli 1 ESTABLISHING THE BUDGET PARAMETERS.

Assoc. Prof. Yesim Kustepeli 1

ESTABLISHING THE

BUDGET PARAMETERS


Revenue Forecasting in the Budget Process

It is essential to know what financial resources are available to support the needs. The budget process provides an opportunity to adjust the levels of spending so that they will match the revenues that are available. This contrasts to the private sector, where revenues are first adjusted to meet expenditure needs.

If a private company projects revenues that are below anticipated expenditure levels, the first goal is to generate more money through sales and advertising before resorting to laying people off or cutting expenditures. For the public sector, the opposite strategy is followed. First, revenue estimates ere undertaken, which then serve as the basis for deciding the levels of expenditure and program service.


No matter how technically accurate the work of revenue forecasters, if this work does not have the faith and confidence of the budget actors, it will be ignored.

Revenue estimates must have sufficient accuracy. Accuracy is often measured in terms of some kind of percentage deviation of actual revenues from the forecast. A forecast that predicts revenue within two percentage points of anticipated expenditures is considered within the acceptable margin of error.

Consistent matching of forecasts and actual revenues rarely happens. For this reason, some “cushion” always needs to be built into the revenue and expenditure balancing equation.


Types of Revenues in Public Budgeting

States or local governments may generate their own revenues through taxes and fees. Some revenues originate from other levels of government as direct grants or on a matching basis.

Various borrowing and debt instruments are used to generate revenue to finance capital spending, such as water/sewer treatment facilities, transportation infrastructure, public buildings, etc.

Under a balanced blend of revenues, a temporary increase in one source of revenue will help offset a cyclical or temporary decline in another source.


1. Intergovernmental Transfers:

These are revenues provided to a jurisdiction by other levels of government or other agencies. Intergovernmental may result from any of the following combination of circumstances:

Direct grants without restrictions Direct grants for the performance of service Matching funds at a given ratio as a condition of

expenditure Reimbursement of local jurisdictions for the loss of

tax revenue Resources funneled through a government to

another level of government


2. Taxes:

Personal and corporate income tax and sales tax. Property taxes provide the predominant source of revenues for special purpose districts and a significant portion of revenue for counties, cities, and general purpose local governments.

Other major tax sources include: a motor fuels tax, a weight tax on heavy trucks, a cigarette and tobacco products tax, insurance taxes, and gift and inheritance taxes.


3. Fees for Uses and Services:

Governmental jurisdictions at all levels are looking for new ways of generating revenues by charging for the services they may provide to the public, to other agencies, to local governments, or any other entity that may have a demand for a service or special expertise.

Many state agencies generate some form of revenue from these kinds of fees and charges. The most significant characteristic of “fees for service” is that they cannot be used to fund general government services. They are considered “dedicated” funds and can only be used to support the activity for which the fee is collected.


4. Sale of Products and Assets, Rents: A number of state programs generate revenues through

the sales of products and commodities. Other programs generate rents through the lease of state properties.

5. Debt Instruments: Borrowing funds through the sale of bonds or other

financial instruments is an important source of revenue for state and local governments. While borrowing opens governments to debt liability, long-term financing provides an effective means of funding capital projects and other major purchases.


6. Lottery and Other Gaming Revenues:

7. Balance Carried Forward:

All General Funds money must be spent by the close of the current fiscal year. Most routine agency program and activity spending falls within that time frame.

At the end of the fiscal year after all appropriations and adjustments, a net balance remains in the General Fund. Any positive net balance may be carried forward into the next year as available resources.


Taxation as a Revenue Source:

Taxation provides a powerful tool for the achievement of public policy. Taxation also provides a means to redistribute income across society, to discourage or encourage desired behavior, or to redress the hardship of a particular industry, class or group.

For some citizens, taxation represents an intrusion of the community into the development of private wealth and success. Increasing taxes requires a tremendous political effort and the spending of political capital.


1. Tax System Design Principles:

Without careful design and forethought, taxation may have numerous unintended consequences.

Tax system may be:

Regressive: places the greatest tax burden on those with the least wealth to spend beyond necessities and the least ability to pay;

Proportional: the tax burden affects the same percentage of income or wealth across all groups;

Progressive: places the greatest tax burden on those with the greatest wealth and ability to pay.


Each tax applies a burden. The burden is frequently calculated as the effective rate of the tax payments as a percentage of income.

the “ability to pay principle” becomes an important tax system design criterion. Regardless of the recipient of the benefit, those with the greatest ability to pay contribute the most tax support.

the adoption of a “benefits received principle” places the greatest tax burden on those receiving the greatest program benefits, regardless of income. For example, under the “benefit received principle” citizens with school-aged children would be required to carry a greater load of education related taxes.


A number of other taxation principles often guide tax system design:

1. Individual Equity: Depending on the equity criteria selected by the jurisdiction, the tax burden should be equitably distributed;

2. System Equity: The application of a tax to achieve a policy goal should have a minimal impact on the overall equity of the larger tax system;

3. Economic Growth: The tax system should support economic growth and stabilization;

4. Relative Tax Burden: Designers of a tax system must understand how the actual tax burden is shifted through the economic system. For example, the increase in corporate income tax may in reality shift the actual tax burden from corporations to individuals.


2. Major Types of Taxes:

a. Income tax:

Income taxes apply to citizens and to corporations.

For citizens, the income tax base includes salary and wages, but may, or may not include interest income, income from investments (capital gains), and income from other sources. The income tax rate structure determines the actual burden carried by each payer.

The income tax can effectively combine all forms of income under a tax with efficient administration.


Income tax revenues are subject to the cycles of the economy. In a strong economy, income tax revenues often exceed forecasts, while in a declining economy, income tax revenues drop. In inflationary times, taxpayers may be pushed into higher tax brackets before government can make adjustments.

b. Corporate income taxes:

The tax base for a corporate income tax is often defined as corporate net earnings. In practice, corporations can pass the costs of an income tax onto consumers through higher prices, reduced wages to workers, or to reduced dividends to shareholders.


c. Property taxes:

Whenever local governments improve the level and quality of services it provides to citizens (water/sewer service, transportation, housing, parks, etc.), property values increase. The property tax captures this increased value of wealth.

For citizens, property taxes often apply to the real property of land and improvements such as homes. A property tax also is applied to personal property, including: automobiles, trailers, and other vehicles, furniture, clothing and jewelry. Corporations often pay property taxes on land, buildings and equipment.


Insulated from economic cycles, the property tax can provide a stable stream of revenue under most economic conditions. Unlike income taxes and sales taxes, decision-makers can precisely set the property tax rate to meet proposed spending equipments, as long as the maximum limit set by law is not exceeded.

But, property taxes are difficult to administer. A property tax system requires assessors, collectors, and administrators. Keeping up with the changing value of taxable wealth is difficult. Identifying financial and other intangible assets may be especially difficult in an age of computerized, global transactions.


d. Sales tax:

The general sales tax is levied at a single point in the economic exchange process, usually at the retail level between the retailer and the consumer.

In contrast to the lump sum annual payment of a property tax, a general sales tax applies a small incremental rate at each transaction. Once begun, the incremental nature of a general sales tax may make it more acceptable to taxpayers.

In some countries, all transactions are taxed. In many others, food and prescription drugs are exempted from the tax. To compensate for the regressive nature of a general sales tax, state legislatures may provide refunds for low-income residents.


Sales taxes are relatively easy to administer. Computerized checkout equipment that can quickly identify exempted items.

Special purpose sales taxes, or excise taxes, include: gasoline and diesel fuel taxes; tire and air travel excise taxes; taxes on cigarettes, tobacco products and alcoholic beverages.

Local governments rely on property taxes, general sales taxes, fees for services, and intergovernmental transfers to generate a balance in revenue flow. Sales and income taxes reflect the fluctuations of the state economy.


Tax Expenditures: Lost Revenues or Purposeful Policy Decision?

The structure and implementation of a tax code at any level of government serves not only to raise the necessary revenues, but also to effect public policy decisions and to influence citizen and corporate behavior.

Exceptions to a tax code provide relief from taxes to certain segments of society. Such targeted relief from taxes is known as a tax expenditure. Not collecting taxes serves to encourage a particular behavior by corporations or citizens.


Tax expenditures are criticized for the following reasons:

1. They are not widely debated and aid a limited group of beneficiaries. Establishing a tax expenditure is a quiet legislative action buried in the details of the tax code.

2. the policy outcomes, impacts and effectiveness of tax expenditures are rarely reviewed or debased for broad public benefit.

3. They tend to erode broad general taxes. Once one group receives relief, other groups desire equal treatment.

4. They are granted during times of economic stress without regard for their impacts on government revenues or policy implications.


Debt Instruments as a Revenue Source

Borrowing funds through the sale of bonds and other financial instruments presents an important source of revenues for state and local governments.

In emergency situations, governments can use short-term borrowing to smooth out gaps in cash flows. However, extended and excessive reliance on borrowing reduces the jurisdiction’s credit rating and increases borrowing costs.

One of the central principles of public debt management is that governments should not use borrowing to finance routine spending for operations.


There are two forms of long-term debt financing : “guaranteed debt” and “nonguaranteed debt”.

1. Guaranteed debt takes one of two forms.

“full faith and credit” obligations are packaged as “general obligation bonds”, which receive the full backing of all the revenues and resources of a jurisdiction.

“revenue bonds” are backed by a specific stream of revenues and resources generated by a particular project, program or new facility.

short-term borrowing is often undertaken with the expectation that the debt will be paid by anticipated tax revenues. This type of borrowing is known as “tax or revenue anticipation borrowing.”


2. Nonguaranteed debt:

This kind of borrowing in the public sector takes the form of bonds, which can be issued either as term or serial bonds.

With term bonds, the issuing jurisdiction makes periodic interest payments on a regular basis and must pay off the principal in a lump sum after a set period of years.

With serial bonds, the jurisdiction makes periodic interest and principal payments on a regular basis from the time of issue to repayment.


In setting the level of borrowing, the jurisdiction should balance among the following set of considerations:

1. community needs, 2. repayment ability reflecting recent revenue flows,

operating expenses and borrowing, 3. the strength of the economy, 4. the value of the real estate property tax base, 5. public opinion, 6. willingness to accept higher interest cost due to a

reduced credit rating, and 7. the essential purpose of the capital project.


Organization of Revenues

A public budgeting process must effectively separate revenue sources and revenue uses. This separation into “funds” ensures that spending meets the intent and requirements set by law or by the granting source.

Public budgeting recognizes seven major types of revenue funds:

1. governmental or general funds; 2. special revenue funds; 3. capital project funds; 4. debt service funds; 5. enterprise funds; 6. internal service funds; and 7. fiduciary funds.


A general fund gathers all revenues without spending or accounting restrictions.

General funds may be used by the entity for any legal purpose so they are classified as discretionary funds. Revenues raised through general taxes, fees generated for services provided, and fines often provide revenues to the general fund.

Capital project funds are dedicated revenues collected and managed for the construction of buildings and facilities, or for the purchase of major pieces of equipment. Revenues for capital project funds may originate as a transfer from the general fund, or from bond sales paid by general fund revenues.


Special revenue funds are collected for a specific purpose or program support. These funds are often categorized as dedicated funds.

Debt service funds provide the dedicated resources to meet interest and principal payments on general long-term debt.

Proprietary or enterprise funds operate in a business-like manner separately from the rest of the government activities and accounting. Revenues collected from water and sewer services, public electricity provision, road and bridge tolls, and the sale of timber are often managed under enterprise funds.


Internal service funds set up accounts that describe a “business” function within government. For example, a general motor pool, a common equipment pool, human resource services, or public affairs services may operate as an internal business with each operational department paying general fund revenues for services

Fiduciary funds provide a means to separate unique assets from the general functions of government operations. The Social Security Trust Fund provides a major example.

Assoc. Prof. Yesim Kustepeli 1 ESTABLISHING THE BUDGET PARAMETERS.

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