Exceptional Proff 612
Introduction
Topics to be covered include:
· State Budget Procedure
· State Budget Basics
· Differences Between State and Federal Budgeting
· Annual and Biennial Budgeting
· Balanced Budget Requirements: General Funds, Cash Reserves
· Budgeting in Local Governments
· Steps in Developing a Budget
· Performance Budgeting at State and Local Levels
· The Theory of Public Choice
· Adequacy of Tax Collection
· Challenges to Tax Revenue Maximization
In Lesson 4, we will discuss state and local budgeting. In many ways, the budgeting process at these levels is not unlike the federal level, with agencies making requests for funds, legislatures allocating those requests, and an executive approving them. However, on this much smaller governmental level, there are also many differences that are noticeable, such as sources of revenue and the expenditures for which these revenues are allocated.
State Budget Procedure
Difference in Budgeting Procedures
Budget procedures vary between state and territorial legislatures, with several important structural differences. These may include state requirements for balanced budgets, whether the budget cycle is annual or biennial, how much authority the Governor possesses to revise the enacted budget, and whether earmarked or federal funds are subject to the appropriations process.
The most important political difference among states is the balance between legislative and executive authority in composing the budget. Tradition and partisanship can be just as decisive in the matter as the Governor’s ability to make a line item veto. The two branches usually cooperate, regardless of which one has the greater authority (if either) in the process. States are expected to enact balanced budgets before their fiscal years begin. Only when a state is experiencing a serious fiscal difficulty is a late budget or veto expected to occur.
Types of Budgets and the Fiscal Year (FY)
Line-item, program-based, performance-based, and modified zero-based are among the types of budgets that states tend to use. Most state fiscal years end on June 30. However, there are four states that follow a different schedule:
· New York begins its fiscal year on April 1
· Texas on September 1
· Alabama and Michigan on October 1
· 30 states operate on an annual budget cycle
· 20 states perform biennial budgeting. You can see an example of a biennial budget at Minnesota’s State Budget
States generally have two different types of budgets: operating budgets and capital budgets. The operating budget is established for the operation of state agencies or programs, while the capital budget is associated with the acquisition or creation of land, buildings, structures, equipment, and other notable capital items. Funds for capital projects are often appropriated from surpluses, earmarked revenues , or the sales of bonds.
State Budget Office Invites and Reviews Requests
The state budget office analyzes agency submissions by placing all funding requests into a statewide budget proposal that the Governor will review and approve. The budget cycle begins when the state budget office begins guiding agencies within the state government to submit budget requests, usually making financial assumptions such as spending targets and inflation. Guidelines are distributed to agencies in the summer months.
Requests are submitted by agencies to the Governor in the fall when the budget office staff begins reviewing the budget requests. Program and management evaluations, economic and revenue analysis, and the examination of demographic data to determine need are included in this review. National and state economic data are also analyzed to predict state business activity and revenues. The budget office and the legislature may collaborate to different degrees, depending on the state, where caseload projections and revenue projections vary. The budget office staff works closely with the agency staff throughout the process to make sure that the request is as clear as possible.
State Budget Office Makes Recommendations to Governor
After sufficiently reviewing and analyzing all budget requests, the budget office staff make recommendations to the Governor on the overall budget proposal. The Governor reviews the recommendations and has the opportunity to provide additional direction towards the budget, which the budget office compiles into the Governor’s proposed budget. The Governor then presents the proposed budget to the legislature. Oftentimes, the Governor delivers the state of the state address around this time, in which he or she prioritizes certain budget requirements.
Legislature Review and Adoption
The budget proposal is submitted by the Governor in late fall or early winter in most states. This proposal is then reviewed by the legislature in committee hearings throughout the winter and spring. Each chamber of the legislature will approve its own version of the budget, and an appointed conference committee will resolve any differences noted between versions.
In the spring before the beginning of the state fiscal year, the budget is typically adopted. First, the legislature must pass the budget. The Governor must then sign it in order for it to become law. The Governor may veto provisions of the budget if he or she does not approve, and overriding such a veto normally requires a super-majority vote. Once approved, the budget office puts the budget in effect.
Alaska’s Budget Process
In Alaska, the fiscal year 2015 became interesting (and challenging) due to the defeat of an incumbent Republican governor and a rapid decline in the global price of oil. Because taxes on oil generate around 90 percent of Alaska's non-transfer revenues, and oil production from Alaska's North Slope oilfields has been in decline since the late 1980s, the state faced a significant deficit going into FY2015. The decline in revenue led the legislature to pass a significantly reduced budget for FY 2015. At the same time, Alaska's sovereign investments have increased in size in recent years and the state's savings and investments totaled more than $60 billion, leaving it with reasonable options for balancing its budget over the long term, but no clear strategy for the future. Glenn Wright and Jerry McBeath (2015) analyze this state’s budget process in their article “Uncharted Waters: Alaska's 2015 Budget Process .”
Differences Between State and Federal Budgeting
DIFFERENCES
In a sense, the budgeting processes for states and the federal government do not seem very much different. However, one key difference is the way money is spent. National defense, Social Security, Medicare, veterans’ benefits, and other federal expenses are not allotted for in state budgets.
CATEGORIES OF STATE SPENDING
PUBLIC WELFARE
Public welfare includes spending on means-tested programs such as Medicaid, Temporary Assistance for Needy Families, and Supplemental Security Income.
ELEMENTARY AND SECONDARY EDUCATION
This category of educational spending includes the operation, maintenance, and construction of public schools for grades kindergarten through high school (K-12). It may also include spending on other educational facilities and programs provided through the school system, such as libraries, technical-vocational training, school lunches, and guidance counseling.
HIGHER EDUCATION
States finance higher education not only through public revenues but also through student tuition and fees. Thirty percent of higher education dollars come from tuition and other charges. Research has shown that in recent years, tuition increases have been driven by declining state financing for public universities.
HEALTH AND HOSPITALS
This category of spending includes community and public health programs, government-owned hospitals, and government payments to privately owned hospitals.
POLICE AND CORRECTIONS
This category includes spending on police, sheriffs, and other government departments that preserve law and order and the operation, maintenance and construction of correctional facilities such as prisons, and jails.
TRANSPORTATION
This category includes the operation, maintenance and construction of highways, streets, roads, sidewalks, bridges, and other related structures, including both regular highways and toll highways.
Annual and Biennial Budgeting
Most States Originally Biennial Budgeters
One key difference between state and federal budgeting is that states have the choice of passing an operating budget that will be in effect for either one year or two. It was once the norm for states to have biennial budgets; in 1940, all but six states did so. Today, many of these states have shifted to annual budgeting structures instead.
In the middle of the twentieth century, state legislatures became more powerful. Only four states held annual sessions at the time; Alabama actually held its session once every four years instead of two. But only Montana, Nevada, North Dakota and Texas follow this rule today. As state budgets grew larger and more complicated, annual budgeting became more necessary for many states. And while many may find it difficult to believe, biennial budgets are also typically more time-consuming, mainly because it takes more time and effort to develop a budget that can hold for two years instead of one. Biennial budgeting states generally enact separate budgets for two fiscal years at once, with true biennial budgeting being extremely rare (only North Dakota and Wyoming practice it).
Governor’s Limited Power to Change Budget
State budgeting practices vary widely, and changes between biennial and annual budgeting models usually do not correlate with differences in budgeting practices. There is no consistent relationship between state budget, legislative cycles, and the authority granted to Governors.
In 1972, the Council of State Governments (CSG) examined a number of states that had recently adopted annual budgets for the first time. It found that a state could develop a good system of executive and legislative fiscal and program planning and controls under either an annual or biennial budget. Proponents of biennial budgeting cite the major advantages to be cost and time savings, claiming that biennial budgeting allows more time for program review and evaluation than annual budgeting, and this makes it more conducive to long-term planning.
Governors in some states with annual legislatures and budgets have a large degree of administrative control over the budget. In only five of the 19 states with biennial budgets does a Governor have substantial power to reduce spending.
Advantages of Biennial Budgeting
It is true that biennial budgeting may reduce costs of preparing budgets within the executive branch since the process is more consolidated than annual budgeting. Annual budgets create greater pressures on budget staff and policymakers than biennial budgets. Closing the previous year’s budget, administering the new year’s budget, and beginning to plan the following year’s budget occur almost simultaneously in an annual budgeting model.
A strong argument for biennial budgeting is that it can provide time for administrators and legislators to focus on the results of their decisions and not just the budgeting process. The biennial cycle was intended to focus on making major program and budget decisions in the first year, with the second year dedicated to a more in-depth evaluation of these agency programs. However, second-year adjustments and revisions are often extensive.
No Strong Advantages
Overall, little evidence exists that either annual or biennial state budgets have any advantages over the other. Biennial budgeting is believed to be more conducive to long-term planning than annual budgeting, but the support for this idea is not strong (Snell, 2011). Some evidence indicates that biennial budgeting is more favorable to program review and evaluation and is likely to reduce budgeting costs for executive agencies. However, it is also likely to reduce the familiarity legislators have with the budgets.
Balanced Budget Requirements for States
On the federal level, it is uncommon for an annual budget to have no deficit.
But what about state budgets?
Balancing the budget is considered to be a foundational principle of state fiscal practices, but keeping a budget balanced in times of fiscal stress can be a challenge none-the-less.
For state policymakers, the requirement of a balanced budget largely refers to the operating budget. Less attention is given to the question of whether a state’s entire budget is in balance.
Some states have balanced budget requirements to ensure that expenditures in a fiscal year are within the cash available for that fiscal year. In Oklahoma, there is such a provision in the state constitution. Other states may have constitutional limitations on the amount of debt a state can have. Still, others lack any type of explicit language requiring a balanced budget but have traditional practices that prohibit deficit spending. State balanced budget requirements can include requirements that the Governor’s proposed budget must be balanced, that the enacted budget must be balanced, or that no deficit can be carried forward from one fiscal period into the next.
State governments practice fund accounting . All state revenues are deposited in particular funds, with every expenditure being taken from a particular fund. The most important of these is the general fund. In almost every state, the general fund receives most tax and fee collections and miscellaneous revenues. Most appropriations made by the state legislature are made from the general fund. Balancing the general fund budget is what is commonly meant by balancing the state budget.
Balanced Budget Requirements: General Funds, Cash Reserves
GENERAL FUNDS
State general funds receive 50 to 60 percent or more of all state revenue collections from all state sources. Thus, there are large amounts of money outside the general fund. Of revenues raised by states, motor fuel taxes, tuition and fees for higher education, and collections from public hospitals are the most important non-general fund revenues and are good examples of earmarked revenues. Federal funds are separate from general funds in virtually every state.
The general fund budget receives the most attention because there are few annual decisions to make about the rest of the budget. Almost all federal reimbursements and grants are designated for specific purposes, and the Governor and legislature cannot exercise their discretion on how they are spent. Some states allow agencies, universities, or programs to collect and spend fees, charges, or tuition without being appropriated in the budget. Capital expenditures may be separate from the general fund budget. These revenues and expenditures cannot be imbalanced, as they are controlled by available funds.
CASH RESERVES
State governments usually plan to carry cash reserves from one fiscal period into the next in order to help with cash management and to make up for possible shortfalls in revenues. A state can have a balanced budget despite a revenue shortfall if reserves are available to make up the difference. Restrictions on borrowing also cause state governments to hold reserves. In many states, even short-term loans cannot be made without approval from the legislature. The alternative to borrowing is to maintain reserves. Reserves measured as a percentage of state spending are a useful measurement of state fiscal well-being. Five percent of budgeted expenditures is considered adequate for reserves in most cases.
DEBT RESTRICTIONS
Restrictions on debt induce many states to maintain balance budgets. There are five states whose constitutions prohibit debt altogether, and many others require a voter referendum to take on debt. No state allows the executive branch to borrow routinely, as the federal government does. But for the majority of states, the most important factor contributing to balanced budgets is the expectation that state budgets will be balanced.
Budgeting in Local Governments
Source: Village of Somers Tax Allocation Pie Chart
An example of a local budget for the village of Somers, Wisconsin. KUSD is the local school district and GTC is the Gateway Technical College.
DIVERSITY OF LOCAL GOVERNMENTS
WIDE VARIETY OF LOCAL BUDGETING PROCESSES
The thousands of local governments throughout the United States are as diverse as the people they represent. Some represent cities and others represent rural areas. County governments may represent both. Municipal governments provide public education in some states, while in others a special purpose government does so. Thus, it is no surprise that their budgetary processes differ widely as well. But it can be said that in all instances, the general purpose of the local government budget is the raising and spending of public money. Local budgets are normally composed of three separate but connected parts: the annual operating budget, the capital budget, and the enterprise or utilities budget.
OPERATING AND CAPITAL BUDGET
The annual operating budget lays out the expenditures that all municipal agencies anticipate during the upcoming year. Spending for public safety, planning and development, social services, and other expenditures are identified here. It also identifies the revenues that the local government expects to receive during the upcoming year. Intergovernmental revenues, special charges for services such as the use of public facilities or public approvals, and most importantly, the amount of property tax revenue are all identified in this budget.
The capital budget reflects the expenditures on projects that will have a life that extends into the future. This budget is the result of an extensive planning exercise to show the amount of spending that will occur on capital items during the upcoming year and the revenues that will be used to finance them.
PUBLIC SERVICES
Public services are usually divided into separate enterprises or utilities. Water use, for example, is supplied to specific homes or businesses and in turn, public charges for it can be tied to specific customers. Local government enterprises often are self-financing. Annual revenues cover annual costs, but the general local government budget can also supply it with an operating subsidy when necessary. Revenues generally include user charges and general purpose revenues (such as property taxes) for local governments.
ACCOUNTING CATEGORIES
Local government budgets are typically described by their expenditures and revenues on an accounting level. Where expenditures are concerned, they can be described either by function or by type of input. Revenues are commonly categorized into three parts: own source (revenues generated by individuals or companies within their boundaries), external (funds coming from other governments or individuals or companies outside their boundaries) or debt (borrowing).
FISCAL SUSTAINABILITY
In their article “Using Common‐Pool Resource Principles to design Local Government Fiscal Sustainability,” Shui-Yan Tang, Richard F. Callahan, and Mark Pisano (2014) analyze local government fiscal sustainability as a common‐pool resource (CPR) problem. Comparing the experiences of Los Angeles County, San Bernardino City, and San Bernardino County, California, the analysis applies a framework developed from three decades of CPR research to show the importance of six micro‐situational variables—communications with the full set of participants, known reputations of participants, high marginal per capita return, entry or exit capabilities, longer time horizon, and agreed‐upon sanctioning capabilities—in shaping collective action dynamics and building the trust and reciprocity among stakeholders needed to achieve fiscal sustainability (Tang, Callahan, and Pisano, 2014, pp. 791-803).
THE SYSTEMS APPROACH
“America's Local Governments: Their Annual Budget Process,” Roger L. Kemp describes this approach (Kemp 2015, pp. 55-56).
Steps in Developing a Budget
A GUIDE FOR PLANNERS
The details of the local budgeting process vary, but most local governments’ processes employ the following five steps (Huddleston, 2005):
ESTABLISHING BUDGET PARAMETERS AND INSTRUCTIONS
The person or agency in charge of overseeing the process identifies the context for the upcoming budget and establishes parameters of how the budget will be initially constructed. Local priorities can be identified in this step, and broad or specific parameters can be set for each agency or function.
AGENCY REQUESTS
Each agency or function then assembles its budget requests for the upcoming year. They anticipate the resources that they will require to meet ongoing needs and new resources that will be needed to provide public infrastructure and services for new population or economic activity. Budget requests focus heavily on the spending side of the local budget, commonly identifying annual operating expenditure needs and long-term capital improvement needs.
EXECUTIVE BUDGET PROPOSAL
The office in charge of the overall budget process (for example, the Mayor) reviews the requests and decides what will and what will not be included in the proposed budget for the upcoming year. These decisions must ultimately be supportable by the taxpayers and voters. The executive budget proposal is submitted to a legislative body for approval and possible modification.
LEGISLATIVE CONSIDERATION AND APPROVAL
In most cases, local government budgets must be approved by elected legislative bodies, such as city councils or school boards. Before approval, it is common for individual members or committees to consider and alter the budget as they deem necessary.
PROPERTY TAX LEVY DETERMINATION
If a local government uses property taxes to fund any of their activities, the final step is determining the local property tax levy. The property tax is often determined by the amount of revenue needed to balance the local budget after all other revenues have been taken into account. But total property tax collections or the property tax rate are typically determined first, and then local spending is adjusted as needed to produce a balanced budget.
EXAMPLES: STATE BUDGET PROCESS
INDIANA
State of Indiana Budget Process
1. Preparation
2. Adoption
3. Implementation
4. Audit
OHIO
State of Ohio Budget Process
1. The General Assembly is an essential participant in spending decisions.
2. The Interactive Budget provides open access to the financial and transactional data.
3. OhioCheckbook.com sets a new standard for transparency by displaying over $400 billion in spending with full search, compare and share tools.
4. The Budget of the State of Ohio rests on the essential foundation of fiscal stability.
TEXAS
1. The Budget and Policy Division work jointly to assist the Governor in formulating and implementing state policy.
2. The Legislative Budget Board (LBB) has a wide range of responsibilities that are intended to serve the fiscal policy and analysis needs of the Texas Legislature.
· Fiscal Year begins in September – agencies begin spending appropriated funds.
· Agencies report to the LBB regarding their performance relative to performance targets.
· The Texas Comptroller presents certification revenue estimates to the legislature.
VIRGINIA
State of Virginia Budget Process
1. Virginia operates under a two-year (biennial) budget cycle . Each year the Governor prepares the proposed budget bill for introduction by the General Assembly.
2. Amendments to the budget bill can add, modify, endorse or delete items in the Governor's proposed budget.
3. The House Appropriations Committee (HAC) and Senate Finance Committee (SFC) examine the Governor’s budget , analyze funded and unfunded items, consider alternative approaches, and develop recommended funding policies.
*YOUR STATE
Take some time to explore the above sites then search for your state.
· Are any easier to understand than others?
· Are they presented to be friendly to the public?
Now go into more detail, search the capital city of your state for their budget, then the city/town where you live.
· What similarities and differences do you see?
Performance Budgeting at State and Local Levels
Performance Budgeting Benefits
State and local governments have begun to view performance measurement as a necessary tool for an effective and efficient government, and this includes the use of performance data to allocate budgetary resources. As the government continues to rely heavily on information technology, the use of performance measurement has increased even further. Performance budgeting can further strengthen decision-making along with the allocation of resources.
The use of performance information by policymakers is extremely valuable, especially at lower levels of government, since they often have a greater deal of discretion at this level. It has been found that performance information is more likely to be used at the program level as opposed to the department level and that budget appropriations have little to do with the actual performance of the program. Yet several factors might prevent state and local governments from using performance information when allocating resources, which include:
· Insufficient knowledge of performance measurement to maximize use
· Lack of time to implement system
· Unreliable performance data
· Poor resources, in particular, information technology capacity
· The absence of elected official buy-in/support (Fudge, 2013).
INTERNATIONAL CITY/COUNTY MANAGEMENT
ASSOCIATION (ICMA) – FINANCE & BUDGET
Performance Budgeting and Legislation
Perhaps the most compelling factor that impacts performance measurement used in the budgetary process is legislation. Nearly 80 percent of U.S. states have performance measurement legislation that requires state agencies to link resource allocation to performance measures (Fudge, 2013). Using performance data to inform budgetary decisions may increase among local governments as well. In order for this trend to continue, policymakers will need to hold themselves accountable for their actions regarding budgeting.
Policymakers are able to use performance data to make budgetary decisions, but elected officials may believe that strict use of performance information in budgeting may limit their ability to negotiate and make compromises. Negotiation will always be an integral component of budgeting, and performance information will only minimize the need for negotiation that may slow down the process. The use of this information in budget negotiations also assists informed decision-making. Legislation may be the best manner to encourage the use of performance information in budgeting. When performance data is dismissed during the budgeting process, fiscal challenges will be more frequent. Thus, performance information should be used extensively and consistently in the budgetary process.
The performance budgeting process often takes several years to reap considerable benefits. But once it is in place it becomes absolutely integral, a part of the ingrained culture of the organization. The public will expect it of its government as a means of ensuring their tax dollars are spent wisely. While it may not fix every fiscal issue on the state and local level, it is a likely remedy to eliminate the gap between public manager efforts and elected official action.
The Theory of Public Choice
STUDY OF TAXATION AND PUBLIC SPENDING
A branch of economics developing from the study of taxation and public spending, public choice theory first received public attention when its co-creator James Buchanan began the Center for Study of Public Choice at George Mason University (Shaw, 1993). Public choice applies the principles that are used by economists to analyze consumer choices and applies them to collective decision-making. This theory assumes that people are motivated by self-interest in all decisions, whether these decisions involve shopping for goods or choosing elected officials. Public choice economists also assume that although those making political decisions (voters, politicians, lobbyists, or bureaucrats) have some concern for others, their main motive is what will be the best for themselves.
Public choice theory advocates are quick to note that reasons exist for why government intervention does not achieve its desired effects. For example, the U.S. Congress has passed a number of laws to protect against environmental pollution, but in reality, many of these laws have actually required stronger regulations in undeveloped areas than in the more developed and more polluted areas. In other words, these laws have stunted industrial growth in places such as the Sunbelt while proving a boon to the Midwest and other established industrial regions (Shaw, 1993).
VOTER IGNORANCE
Another central idea of public choice theory is the insistence that voters have a rational ignorance of political issues, largely because they have no incentives to monitor political developments. An election’s result may be very important, but what impact does one person’s vote have on an election? Even if a person takes the time to educate himself or herself sufficiently to make a well-formed decision it will make little difference, so following the issues is essentially a waste of time. However, this incentive to be ignorant is not as prevalent in the private sector. When a person buys a house or a car, or even a more minor purchase, they will typically do their research. A wise choice will behoove the buyer, who will suffer from the effects of a poor one. A voter, on the other hand, may suffer from the effects of an election for a candidate whom they did not choose.
MEAGER INCENTIVE FOR GOOD MANAGEMENT
The actions of legislators are of particular interests to public choice economists. These people make decisions on how to use other people’s resources, not their own, as they pursue what is best for the “public interest.” Taxpayers are the ones who provide these resources, and they are the ones who are hurt by poor management of them. In addition, incentives for good management in the public interest are weak, as an ethical legislator may be powerless in the face of special interest groups that are organized by people who have much to gain from governmental action. Legislators do, however, have something to gain if they bend to the interest groups; this includes funds for their campaigns and other perks. In other words, the behavior of legislators causes citizens to suffer in this instance.
SPECIAL INTEREST GROUPS INFLUENCE ON BUDGETS
Public choice economists also analyze the role of bureaucrats in government to better understand why many regulatory agencies are captured by special interests. Bureaucrats have no profit goal to guide their behavior, and usually, have a different goal or mission driving their presence in government. Congress allocates their budgets, and interest groups that will benefit from their mission can influence Congress to provide more funds. These relationships can lead to bureaucrats being captured by interest groups.
To solve the problems associated with government intervention, public choice economists believe that as much government action as possible should take place at the local level. They also advocate rule changes to legislation catering to special interests that leads to greater expenditures and support term limits and line-item vetoes. Since public choice tends to err towards skepticism regarding the government, it is viewed as a libertarian branch of economics. But not all public choice economists take a political position; others utilize formal mathematical models of voting strategies or game theory.
Adequacy of Tax Collection
The Laffer curve. As the tax rate percentage increases, revenue increases for rates up to near 35 percent. After 35 percent the growth in revenue slows until revenue declines when the tax rate is over 70 percent.
We now move on to the subject of taxation. It is clear that if a tax is levied, that tax should raise revenues. Otherwise, evaluating tax schedules is meaningless. Therefore, when evaluating a tax system, the first criterion must be the adequacy of revenue collection.
It may be assumed that raising tax rates will immediately increase revenue. However, raising tax rates does not necessarily guarantee maximum tax revenues. As jurisdictions increase their tax rates, revenues will actually begin to decline. Taxpayers with low incomes might stop working and collect public assistance instead; businesses that have paid taxes might leave the jurisdiction for one with a lower tax burden. This relationship is best depicted in the Laffer curve. The curve depicted here shows that as an effective tax rate increases, tax revenues will grow in proportion to the increased tax rate—but only to a certain point.
The linear relationship between tax revenues and tax rates does not take into account how individual and business taxpayers respond to increasing tax burdens. When governments impose extremely high tax rates, some of the tax bases on which they depend may vanish. In the Laffer curve shown, once the tax rate surpasses 70 percent the amount of revenue collected plummets as the tax rate continues to rise. If a local jurisdiction imposes extremely high property tax rates on commercial and industrial properties, businesses may be unwilling to pay them and will decide to relocate elsewhere to seek lower taxes. As higher tax rates cause jurisdictions to lose their tax bases, revenues will steadily decline. But as the effective tax rate increases, tax revenues might grow as well.
Challenges to Tax Revenue Maximization
TAX EXEMPTIONS
Even if an optimal tax rate is discovered and equilibrium is achieved, challenges in maximizing tax revenue exists. One challenge to tax-revenue maximization involves earnings that are not taxed. The federal income tax allows numerous exemptions, deductions, and credits, and on the state and local level food, prescription drugs, education, and clothing are often exempted from sales taxation. A sales tax creates an especially large burden on low-income earners, and exempting sales tax paid on necessities such as these reduces this burden.
Employer contributions for medical insurance premiums and medical care are excluded from taxable income. Homeowners who are paying mortgages on their residences can deduct mortgage interest and state and local property taxes. Charitable contributions can also be deducted. Local governments also exempt charitable organizations from property taxes and may reduce or defer property tax payment for elderly and disabled residents.
Tax exemptions such as these are believed to stimulate certain economic activities or improve equity, which is why they are allowed. Charity contributions are exempted to encourage public donations. The exemption of mortgage interest on owner-occupied homes encourages home ownership. The child tax credit reduces the tax liability of taxpayers with dependent children, and the Earned Income Tax Credit (EITC) provides tax credits to low-income earners. But exemptions can potentially cause jurisdictions to lose revenues, and when this happens the only choice is to raise other taxes accordingly.
However, as of the end of 2017, President Trump and Congress passed and signed into law the Tax Cuts and Jobs Act. At the time of this writing, the implications are still being studied. You can start your exploration with this Heritage Foundation article but continue to explore as this is only the preliminary assessment.
PROPERTY TAX AND OTHER TAXES
Property tax, the primary source of revenue for local governments, is usually subject to numerous exemptions for charitable organizations and economic development, shrinking the property tax base. Family-owned farms enjoy considerable tax relief, which environmentalists have supported as a means of slowing urban and suburban sprawl. However, many studies have indicated that tax relief has failed to preserve family farms or to prevent urban sprawl.
Other challenges have also been identified. In recent years, more sales have been made through the Internet and other remote channels, and collecting state or local sales tax on these sales is difficult if not impossible. The prevalence of online sales significantly reduces state and local sales tax revenues. As Americans continue to grow older, state and local governments allow older people more tax preferences, which also leads to tax revenue loss. The deregulation of electricity, gas, telecommunications, and financial services industries has resulted in less tax revenue, especially for local governments. Lastly, it is very easy for tax exemption and state spending edicts to be passed, requiring only a simple majority vote on the state level while a supermajority is typically required for increasing tax revenues.
Conclusion
Reflection:
· Do you think that the federal budgeting process should more closely resemble that of the states? For example, do you think it would be better if the federal government took the same approach to budget deficits that the states do?
· Do you agree with the theory of public choice? Why or why not?
· What would be the best way to resolve the challenges to tax maximization that are present today?
· Does the 2017 Tax Cuts and Jobs Act address your suggestions?
Budget procedures vary between state and territorial legislatures. The most important political difference among states is the balance between legislative and executive authority in composing the budget. In a sense, the budgeting processes for states and the federal government do not seem very much different, but one key difference is the way money is spent. Public welfare, education, healthcare, police and corrections, and highways and roads make up the majority of state expenditures. Some states have biennial budgeting processes rather than annual ones, and states also differ where balanced budget requirements are concerned. Budgeting processes on the local level are highly diverse, but most follow the same structure just as state and federal processes do. Public choice theory advocates are quick to note that reasons exist for why government intervention does not achieve its desired effects and that to solve the problems associated with government intervention, as much government action as possible should take place at the local level.