Business & Finance Homework

INSTRUCTIONS

In an evaluation, discuss how the role and function of budgeting has been utilized to correct externalities and other market failures. Additionally, justify the use of taxpayer resources to correct externalities and other market failures.

1-Summarize  the role of the government in the budget process.

2-Analyze  the role of the government in correcting externalities and other market failures.

3- Justify  the use of taxpayer resources to correct externalities and other market failures.

Support the assertions using scholarly and/or Biblical citations in current APA format. Each reply must use scholarly and/or Biblical citations in current APA format. Any sources cited must have been published within the last five years.

NOTE: Externalities are a consequence of a governmental activity that affects other parties without this being reflected in the cost of the goods or services involved. Externalities by nature often are environmental . Some examples of negative externalities include:

Air pollution, water and noise pollution, farm animal production, passive smoking and traffic congestion.

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Source number One

Part 1 What is a Public Budget? Origins and Purposes

The first essay describes what public budgeting is and how it differs from individual and family budgeting; the second describes the origins of public budgeting in the United States. The next two pieces deal with what budgeting is designed to do, and how it accomplishes those goals. Together, the pieces in this part introduce several themes that are echoed throughout the book. The first is that government budgeting is necessarily and appropriately different from private sector budgeting; the second is that waves of budget reform are aimed at adapting public budgeting to the problems of the day, such as departmental overspending, mobilizing resources to solve societal problems such as health care, or cutting back spending to reduce taxes and the scope of government. Budgeting changes because the problems budgets confront change.

Most people approach public budgeting from the nearest thing that they know, either business budgeting or family budgeting. Joseph White’s essay contends that both comparisons are flawed. White argues that economic theories based on modeling individuals’ behavior miss their mark because they pay inadequate attention to the actual structure of budgeting, which provides any number of constraints. Far from being the expansionary enterprise envisioned by those describing “the budget maximizing bureaucrat,” in the United States, budgeting is a process marked by competition among committees and branches of government and limited by revenue ceilings and spending caps. Budgeting implies both the articulation of demands and needs and prioritizing those demands and needs to keep totals in some kind of discipline.

The second selection, “Who Invented Public Budgeting in the United States?” tracks the origin of modern governmental budgeting to the early 1900s. This essay argues that business did not develop budgeting but rather that government, borrowing from the social services, came up with a model that was later imposed on businesses. This history was obscured by reformers who were funded by the business community and sought its approval by touting the excellence of business. The essay reinforces the idea that business and government are different, and that the level of accountability required from government is much higher. Using the budget and accounting data to achieve public accountability was a major concern of early budget reformers.

The third essay introduces the idea that budgeting and its key functions change over time, depending on which problems are dominant at the moment. Allen Schick argues that budgets differentially emphasize spending controls, management improvements, or planning, while still performing all three functions. He describes a succession of reforms, from line-item budgets geared to spending controls, to program budgeting that facilitates productivity and management improvement, to complex integrated planning and management documents advocated by PPBS, planning program budgeting systems. Each reform addressed the dominant problems of the era.

Chapter 1 Making “Common Sense” of Federal Budgeting

Joseph White

DOI: 10.4324/9781315701431-2

Budgeting is a ubiquitous, frequently controversial, and almost always dissatisfying aspect of government. Because it influences so many decisions and provokes so much debate, budgeting attracts study from a wide variety of perspectives, ranging from welfare economics to public choice, public administration, political science, and political anthropology. Federal budgeting has been especially controversial over the past two decades of partisan war over the unbalanced budget. These battles have provoked a great deal of explanation (Drew, 1996; Gilmour, 1990; Haas, 1990; Hager and Pianin, 1997; Makin and Ornstein, 1994; Maraniss and Weisskopf, 1996; Penner and Abramson, 1988; Schick, 1990; Steuerle, 1991; White and Wildavsky, 1991; Woodward 1994). As a participant in the explanatory effort, I have been struck by the extent to which public debate and attitudes seem to proceed not from the insights of academic fields but from a different set of perspectives.

The distinction is most evident in attitudes towards budget balance. Although there are mac-roeconomic arguments for balancing the federal budget, the discipline of economics provides no basis for saying that the different between balance and, say, a deficit of one half of one percent of the gross domestic product is very significant. Yet “balance” per se has great political meaning. James D. Savage (1988) has described the roots of the balanced budget ideal in American politics. His argument about the political values and interests the ideal has served can explain who chooses to manipulate the appeal, but it cannot fully explain the attraction of the balanced budget ideal for apolitical, inattentive citizens. Instead, budget balance and other values tend to be based on simple principles, such as, “I have to balance my budget so the government should, too.” This is a commonsense understanding: it operates by considering government budgeting as if it were something closer to everyday experience for most people (thus, common and sensible).

Unfortunately, application of what passes for commonsense about federal budgeting almost inevitably leads to disappointment. Governments do not budget the way citizens think individuals or families or business firms do or should.

Ironically, only part of the misunderstanding is because government is different; the rest is because the standards applied to government budgeting are not followed in everyday life, either. This essay will highlight some points about budgeting, especially federal budgeting, that are revealed by making the comparison with financial planning for individuals or households carefully, rather than casually. Both causal explanations and normative conclusions follow from the analysis. My goals are to show that federal budgeting is less alien than it may often seem, to offer a new perspective on some common arguments in academic as well as citizen discourse, and to provide an example that may be used for further discussion of both budgeting and other subjects in public administration. The first section compares budgeting for an individual (or any unit with only one relevant decision maker) and a representative government.1 One theme involves how individuals’ interests aggregate into collective decisions. The common argument that intense minorities force excessive spending by demanding it at the expense of inattentive majorities is basically wrong. But a less common argument about the natural inconsistency of collective as opposed to individual choice provides a basic explanation of the difficulty of deficit reduction. A second theme involves whether standards based on the experience of individuals either make sense for government or can convince individuals to support government action. I will show why the common argument that people must sacrifice for deficit reduction for “our grandchildren” should not be expected to convince rational individuals to pay. And what should be obvious but is usually ignored, deficit reduction is almost inevitably unequal, rather than the “equal sacrifice” demanded by political rhetoric.

The second section then emphasizes the human relations aspects of budgeting, comparing budgeting for households (especially families) and for governments. This comparison shows how common critiques of budgeting depend on particular assumptions about the nature of the community, rather than on obvious standards of rationality and fairness. For instance, the virtue of budget balance itself, as a form of responsibility, must be balanced against the virtue of keeping promises within a community.

Government Versus Individual Budgeting

“Other Peoples' Money”

Begin with the commonly made contrast between government and individual decision making. In private life individuals who consider spending also bear the costs. In government, those who campaign for spending of some sort of bear very little of the cost. Thus, government supposedly spends too much because of demands to spend “other peoples’ money.” In the words of a former economics professor at Texas A&M:

the average spending bill we voted on in the last Congress cost about $50 million. The average beneficiary got between $500 and $700. There are 100 million taxpayers, so the average taxpayer paid 50 cents. You don’t need a lot of economics to understand that somebody getting $700 is willing to do a lot more than somebody who is paying 50 cents. So every time you vote on every issue, all the people who want the program are looking over your right shoulder and nobody’s looking over your left shoulder (Gramm, 1982, 37).

Nothing could be more commonsensical. This critique recurs in other forms with other protagonists. Thus William Niskanen (1971) emphasizes the incentives of “budget-maximizing bureaucrats” who get benefits (agency budgets) without having to worry about costs at all. Rational choice political theorists, such as Ken Shepsle and Barry Weingast (1984), or Emerson Niou and Peter Ordeshook (1985), emphasize the legislative side of the story. The analogy is correct as far as it goes: the participants identified do have different incentives in competing for government budgets than the incentives individuals have in spending their own money. The analogy does not explain growing federal spending because it ignores the actual decision-making processes and the presence of other constraints. Thus, Senator Gramm is describing authorizations bills, which do not in fact spend the money. Programs compete with each other in appropriations bills that average $40 billion apiece, not $50 million. The appropriations committees are working to fit their bills into totals defined (formally or informally) outside the committees. Once the total came from the president’s budget, after 1974 it came from the Congressional Budget Resolution, and since 1990 it has come from multi-year caps, or annual totals, negotiated in various budget summit agreements. But the process since the 1920s has been organized to keep spending within some total (White, 1995).

More powerful legislators may gain electoral advantage from using their power to direct disproportionate shares of federal projects back home. But such power shapes shares, not totals. The programs being described by Senator Gramm, by Shepsle and Weingast, and by other analysts as subject to the intense interest/small costs phenomenon would be distributive, discretionary spending programs. As Charles L. Schultze (1984), John Ellwood (1984), and many others have shown, such programs have long been a shrinking share of the economy, dwarfed as sources of budget growth by the major entitlement programs, such as Social Security and Medicare, which have strong support from majorities of voters.

Niskanen’s description of bureaucratic influence exaggerates or misstates both bureaucrats’ interests and their power. His hypothesis was carefully assessed in a volume edited by Andre Blais and Stephane Dion (1991), which shows that many of Niskanen’s underlying assumptions are highly questionable. Niskanen never specified which officials should be the agents of the theory. A theory that relies on bureaucrats’ information advantages should emphasize top civil servants. Yet many of them do not display the hypothesized values, in part because their economic interest in larger budgets is ambiguous in a civil service system that does not automatically turn larger budgets into higher salaries. Public-sector unionism may provide a force for higher spending, but that has little to do with higher civil servants and “bureaucratic” power per se and should be important only where the members are a big enough interest group to have serious power (e.g. teachers and police in cities, not the employees of the Food and Drug Administration in federal budgeting). The direct power of bureaucrats of other sorts relative to other contestants in the battle to shape federal budget totals does not seem great. All other things being equal, people in agencies surely want higher budgets and ask for them. But all sorts of people in politics want things they don’t get. Niskanen’s errors in stating his protagonists’ interests and power leave only a cliché behind.

In common applications, the “other peoples’ money” argument seeks explanation from analogy alone without sufficient attention to how government itself works. Many other factors, such as alternative sources of constraint, counter the logic that Senator Gramm and so many others emphasize.

That the most common comparison between individual and government decision making does not explain spending totals or imbalance, however, only shows that the comparison is poorly made, not that it could not be useful. Consider an alternative version. Aggregating Individual Preferences into Collective Preference. Both the public as revealed by polls and elites as revealed by the tone and content of news reports have long supported a balanced budget—in principle. Majority coalitions endorsing any particular method to balance the budget have been much rarer. After 17 years of budget balance wars, Congress and the president enacted legislation in 1997 that promises a balanced federal budget by 2002, 33 years since the last one in 1969. That was possible mainly because good economic news allowed a much smaller package of deficit reductions than had been achieved in previous efforts (especially efforts in 1990 and 1993). Plain old ignorance is one reason that support for budget balance is not accompanied by support for the practical means to achieve it. Many voters believe the federal government spends much more of its budget on unpopular programs like welfare and foreign aid than it does. Individuals should know more (on average) about their own budgets. But what about the elites that supposedly know better? Are they simply constrained by the public’s ignorance?

As Kenneth Arrow (1951) argued long ago, consistent personal preferences can aggregate into inconsistent social preferences. In the budgeting case, if each citizen can think of the spending that he or she would cut to balance the budget, and the distribution of preferences about cuts is wide enough, it is possible for individuals to know they would balance the budget, and for the large majorities to oppose any particular measure. Imagine that ten people contribute $9,000 each to a community with $100,000 in expenses, leaving a deficit of $10,000. The expenses are divided into ten activities, costing $10,000 each. Each person supports nine of the activities, and each opposes a different one. Each contributor has a consistent position about how to balance the budget (cut the program he or she dislikes) but 90 percent of the group would oppose cutting any specific program. Nobody would see a need to raise taxes, since each individual’s spending preferences would fit available revenue. Everybody would oppose an across-the-board cut of $1,000 from each program because each would see such a cut as eliminating $9,000 in the wrong places in order to cut $1,000 in the right place. Everybody in the community wants a balanced budget, and knows it is possible, but it would not occur.

The numbers are different in federal budgeting, but the basic principle is the same. Informed liberal Democrats could sincerely endorse a balanced budget if it were achieved with defense cuts and higher taxes. Conservative Republicans would cut lots of programs for liberal constituencies. Rural legislators would cut urban programs, and vice versa. Investment bankers and the editors of the Washington Post would slash entitlements for the (affluent?) elderly. As a result, over the nearly two decades of effort to balance the budget almost everyone could view the failure to do so as unnecessary, while large majorities opposed any particular plan. That helps to explain not only the difficulty of balancing the budget, but one of the most peculiar aspects of the budget debate—the fact that compromise on achieving this goal, unlike many others, has been widely viewed as illegitimate. Since everybody knew it “could” be done, failure to do so seemed unnecessary. Setting an overall budget constraint impedes aggressive minorities from exploiting majorities. It does not provide a way to assemble majorities to cut existing programs. So, the “commonsense” understanding of the difference between individual and collective decision making is less instructive than the version based on Arrow’s (1951) insights.

Chapter 2 Who Invented Budgeting in the United States?

Irene S. Rubin

DOI: 10.4324/9781315701431-3

It has often been argued that the business community was the origin and model of improved public financial practices in the United States, including budgeting, in the early 20th century. This point of view is not the only one in the literature, but it has been around for a long time. Early budget reformers often attributed their proposals to businessmen. Henry Bruere, one of the directors of the New York Bureau of Municipal Research, attributed some of the bureau’s budget innovations to railroad financier E. H. Harriman; Frederick Cleveland, one of the most important founders and promoters of executive budgeting in the United States, claimed the methods of accounting he wanted to introduce to the public sector were already established in the management of private corporations (Cleveland, 1980). The adoption of the city manager form of government, promoted by businessmen, often involved the advocacy and adoption of business techniques, furthering the impression that business practices were superior to those in the public sector. For example, a description of Dayton, Ohio, before and after the adoption of the city manager system includes the following:

The finance department revised traditional city purchasing and accounting practices to conform with private business practices. Purchasing was centralized and specs drawn up for all purchases. Prior to 1914, the accounting system was a check on cash receipts and disbursements only, there were no cost records for city repairs and construction work. There was no way to assure that people receiving city pay were actually doing city work. All city workers received their pay in cash, there was no definite city payroll, and property records did not exist. A central account office was created; accounting was made accrual based, with the ability to monitor appropriations, accounts receivable and accounts payable (Sealander, 1988, pp. 119–120).

Such descriptions strongly suggested that improved business practices predated improved public financial practices and constituted a model for government. Groups of businessmen have frequently pressed government to adopt business efficiency in government (Shuman, 1992, p. 31). The first director of the Bureau of the Budget, Charles G. Dawes, was one of a number of businessmen trying to set up business practices in government in 1921; part of the thrust of that effort was to import business accounting and especially balance sheets to government. Dawes advocated accrual budgeting as a way of making reporting uniform throughout the federal government and between government and business. Business used balance sheets and accruals of assets and liabilities, so government should too. Dawes stated his opinion forcefully: Every habit, every custom, personal or administrative, which has arisen out of a decentralized status quo of the present 43 departments and independent establishments of government … which militated against the recognition in governmental business of those principles of business organization incident to successful private administration, we have fought from the beginning and succeeded, in my judgment, in largely eliminating (Dawes, 1923, p. 229). The clear assumption was the superiority of business methods. More recent innovations such as zero-based budgeting were invented for business and then touted for the public sector. Similar origins can be cited for management-by-objectives, which some governments integrated into budget formats or the budget process.

The argument that business financial practices were better earlier and provided a model for government is especially important today, because the superiority of business is again being touted, and used as a reason for contracting out and for reducing the scope of government services. What if it turned out on examination, that the source of government financial improvements was not business, but government officials and university professors? In fact, government officials and academics did play a larger role in introducing public budgeting and accounting in the United States than did business. Businessmen pressed for reform, but the proposals for change were usually generated by reformers in government, universities, and social service agencies. The role of business techniques as a model has been greatly exaggerated. The history of early public budgeting in the United States suggests that the public should have more confidence in the public sector’s capacity for experimentation, evaluation, and reform. This early budget history also suggests that the public should be skeptical and demand evidence for continuing claims about the superiority of business management. The evidence that government officials and university professors played a major role introducing public budgeting and financial management reform is of three types. First, the quality of financial management in the private sector in the early 20th century was generally poor. Moreover, many of the much-touted improvements in business accounting were invented by public officials in an effort to facilitate regulation of railroads and utilities. Those improvements were later held up to government officials in an effort to pressure them to adopt the new techniques. Second, much of the development of the reform agenda in budgeting came from the experience of practitioners, who were experimenting and sharing innovations, and academics who were examining the experience of public organizations around the world and helping to formulate reform proposals. Many of the reformers went back and forth between government and universities.

Third, the development of budget reform proposals by government officials preceded in the main the development of bureaus of municipal research. The research bureaus, whose functions included surveys of existing administrative practices and recommendations for reform, were dominated by businesspeople. The bureaus’ professional staff, in efforts to keep themselves funded, generally deferred to business ideologies and preferences. Business was widely respected after the Progressive era, and the research bureaus could not go against the dominant belief in the excellence of business over government without losing their reason for existing as well as their funding sources. It was primarily the staff of these bureaus who wrote the history of efforts to reform budgeting. They carried their particular bias into historical narratives later treated as neutral.1

Business Management Was Poor

Improvements in accounting generally preceded improvements in budget process. Reformers felt that improved management could not take place unless the quality of financial information fed to reformed administrators improved. Moreover, better financial reporting provided the possibility of greater public accountability. Better accounting was associated with better budgeting, and many of the reformers who worked in accounting made recommendations for budgetary improvements after improvements in accounting were in place. The quality of business accounting was generally considered poor before the beginning of public budgeting, even in the railroads, which were considered the precursors of modern corporate management. The poor recordkeeping of the railroads was of particular public concern because the railroads were large, borrowed heavily from citizens and governments, and were often subsidized by governments. When they went under, they took a heavy toll on public finance. The railroads were also important to commerce; their ability to set rates threatened large segments of the population, setting in motion early efforts to regulate them. These regulatory efforts confronted poor and highly disparate bookkeeping, making it difficult if not impossible to see what the rates should be, and whether the companies were making profits or losses. Frederick Cleveland was a long-time student of railroad finances. He argued that railroad accounting was poor and in some cases corrupt. He saw the independent auditor as the necessary protector of the railroad investor, to make corporate information public (Cleveland, 1905). In Railroad Finances (co-authored with Fred Powell), published in 1912, he summarized some of the poor practices that characterized railroad management until the early 1900s. He noted, for example, that some unscrupulous railroad managers overstated net profits by underfunding purchases of capital stock and charging some equipment purchases to capital that should have been charged to operating expenses. He reported that this practice was brought to an end in 1906 by the Hepburn act, in which the Interstate Commerce Commission (ICC) promulgated uniform accounting principles for the railroads. The railroads were required to set up formal depreciation accounts for all equipment (pp. 91–92). Cleveland and Powell also noted that the railroads generally did not provide informative reports (p. 213):

… in most railroad financial statements, there has been no attempt to distinguish capital resources from current resources, and there has been no regard for the truth even in the statement of the amounts and sources of capital actually obtained by the corporation … In many instances, shareholders are as uninformed after reading a published balance sheet as if none had been rendered. Dividends have been declared out of capital; corporate estates have been wasted; railroads have been reduced to bankruptcy by their officers without any suggestion either in accounts or reports as to the facts. And while this was being done, shareholders and creditors have been led to believe that the corporation was in a sound financial condition. Corporate estates have been managed for the benefit of trustees; published statements have been used for the manipulation of the stock market and the enhancement of private fortunes through stock deals; in fact, the whole purpose of one transportation enterprise after another has been subverted to the private interests of those who were in possession and who alone knew the facts. Even directors have been so ignorant of the true state of affairs that the officers have been permitted to act in open defiance of public law and business morality for years without even arousing a suspicion (pp. 120–121). Railroads were considered to be among the largest, most complex, and most sophisticated of private corporations. Cleveland’s description of railroad finances, however, did not make them sound as if they had much to offer government in the way of a model. On the contrary, according to Cleveland, federal regulations helped eliminate some of the worst railroad abuses. One of the major stimuli for the improvement of accounting and reporting in railroads was the creation of the federal Interstate Commerce Commission (ICC) in 1887. This agency represented the then new Progressive era image of activist government as a potential counterweight to business. The new agency was in the position of regulating the rates of the railroads but found that it could not judge the profits of the companies, and began to develop better accounting tools in consultation with the railroads. Having designed such improved accounting and imposed it on businesses, government officials were pressured to make similar improvements in their own operations. One of the leading reformers in accounting at this time was Henry Carter Adams. After a stint as an academic, he served as chief statistician of the ICC from 1887 to 1911 (Rosenberry, 1948). His first report was on railway statistics. He argued with state regulators on the need for uniformity and helped persuade the railroads to go along by asking them for suggestions on forms for collecting standardized information (Rosenberry, 1948, p. 37). In 1906, Adams secured the adoption by Congress of an amendment to the act to regulate commerce that required railway companies to make uniform reports in accordance with regulations set by the commission, with heavy penalties for failure to comply. Once the enabling legislation was in place, Adams found he could not recruit trained staff, so he started his own course in railway administration at the University of Michigan in 1910. The accounting system that Adams set up was later extended to other utilities and other jurisdictions (Rosenberry, 1948, p. 39). The ICC was credited with helping modernize all corporate accounting because of its emphasis on debt and stock as claims on total assets, and its emphasis on income measurement (Dusenbury, 1985, p. 5).

Once the ICC set up accounting systems and imposed them on private sector organizations, the federal government was pressured to adopt analogous measures for itself. Frederick Cleveland, an accountant, a professor, a director of the New York Bureau of Municipal Research, and then Director of Taft’s Economy and Efficiency Commission, argued in 1912 that if the government could impose major accounting changes on business, it better impose similar changes on itself. He called for an educational campaign that would make it dangerous for anyone to “stand in the way of the demand for the same kind of a reorganization and reformation of methods in the Government as has been demanded for life insurance, banking, and railroad companies.” He further argued; The Government is spending $1,500,000 each year regulating the business methods of railroads in the interest of the public; it is spending about $200,000 each year in supervision of national banking; it is spending over $200,000 each year regulating interstate corporations, through the Bureau of Corporations, besides carrying on prosecutions at very high cost through the Department of Justice. What the Government does with $1,000,000,000 of revenues raised each year; how it conducts its own business, what is the element of waste and inefficiency in carrying on activities that reach the home and vital interests of every citizen, is of vastly greater importance to the average man than is the manner in which a railroad company keeps its accounts (Goodnow, c. 1912, quoting from Cleveland, p. 15).

W.F. Willoughby, another key budget reformer, was a former government official, first a statistician for the Department of Labor, and later a treasurer and budget reformer in Puerto Rico. He was also a member of Taft’s Efficiency and Economy Commission. After the commission was dissolved, he became director of the Institute for Government Research, which was later incorporated into The Brookings Institution. The early mission of that institute was to lobby for the adoption of federal budget reforms. Like Cleveland, Willoughby argued that if the federal government was going to regulate business procedures, it had better put it own house in order. It is inconsistent to the last degree that governments should insist that corporations controlled by them should have systems of accounting and reporting corresponding to the most approved principles of modern accountancy while not providing for equally efficient systems for the management of their own financial affairs. The demand for improved methods of public administration has thus inevitably centered primarily upon the demand for improved methods of financial administration and, in order that this may be secured, upon the specific demand for the adoption of a budgetary system as the central feature of such improved system (Willoughby, 1918, pp. 4–5).Both Cleveland and Willoughby referred to the role that the federal government played in introducing high standards of accounting and reporting to private sector organizations. It was not the details of these private sector accounting systems that these reformers advocated; it was the improvement of financial management. If the government could force improved financial management on business, then it could put its own house in order.

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