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SOME FUNDAMENTAL CONCEPTS AND PRINCIPLES
OF PUBLIC FINANCE
BUDGET
 
A budget is a financial plan for a specified period of time that matches planned revenues and expenditures to municipal services, goals and objectives. A budget is thus a spending plan based on expected revenues. It includes revenue and expenditure forecasts and allocates appropriated funds for funding of existing and new projects. It also lays out the procedure for covering revenue shortfalls or deficits as well as allocating any anticipated surplus. State and local governments and the federal government usually plan annual budgets.
 
OFF-BUDGET FUNDS
 
Some revenue and expenditures, however, are not included in an annual budget. These are included in off-budget accounts that are not subject to the legislative process. Federal off-budget accounts include Social Security, while state off-budget accounts include state employee retirement systems.
 
UNIFIED BUDGET
 
A unified budget is the total of the annual budget and the off-budget fund taken together. For the purposes of fiscal policy, the unified budget is the relevant budget. The deficit and surplus reported annually refers to the status of the unified budget.
 
BALANCED BUDGETS AND DEBT
 
State and local governments usually have separate budgets for operating expenditures and for capital expenditures to distinguish between annual recurring expenditures for providing services and the periodic acquisition of public assets.
 
States and local governments also have to balance their operating budgets. Capital budgets for capital projects, however, are often financed by issuing debt. The most common method is by issuing municipal bonds, which may be general obligation bonds or revenue bonds. The interest on interest on such municipal bonds is exempt from federal income taxes and thus constitutes a federal subsidy for state and local capital expenditures. The operating budget may include appropriations for debt service for acquiring or developing public sector capital.
 
The three main purposes for state and local governments to borrow are:
  • Capital financing
  • Short-term needs
  • Emergencies
The federal budget is not constrained by the principle of a balanced budget. There seems to be no rationale behind this absence of a division between operating and capital budgets at the federal level. This lack of a budget constraint can lead to large federal deficits that are covered with borrowing. Federal borrowing has significant impacts on relevant stakeholders both in the public and the private sector. High levels of federal borrowing can drive up interests rates, which in turn makes borrowing more expensive for households, private firms and state and local governments. Conversely, a federal surplus usually reduces federal borrowing and drives down interest rates and borrowing costs for households, private firms and state and local governments.
 
STATE AND LOCAL REVENUE AND SPENDING
 
The composition of state and local revenue sources and spending obligations is very different than that of the federal government.
 
The main revenue sources for state and local governments are income taxes, retail sales taxes and property taxes. A significant share of revenues may also be generated from fees and charges of various kinds. State and local governments, like the federal government, also derive some revenue from corporate income taxes and excise taxes.
 
There are three categories of state revenues:
  • Total revenues include the earnings of state-operated entities such as public utilities.
  • General revenues include revenues from other levels of government or intergovernmental revenues.
  • Own-source revenues include revenues earned from imposing fees, taxes and other charges.
State spending obligations include education, social services, health, highways, law enforcement and corrections. Intergovernmental transfers and interest on debt are also major components of state expenditures.
 
Revenues for local government are generated primarily from intergovernmental funds, property taxes and fees and charges. Spending obligations for local governments are similar to state expenditures and include intergovernmental expenditures, education, social services, public safety, transportation and other direct spending and interest on debt.
 
FEDERAL REVENUE AND SPENDING
 
Individual income taxes, corporate income taxes, social insurance and retirement receipts and excise taxes (on gasoline, cigarettes and other items) comprise the four primary sources of federal revenues accounting for 95 percent of on-budget items.
 
Federal spending can be categorized in a number of ways but the three major items accounting for over 85 percent of spending are national defense, human services (including Social Security benefits) and net interest. Net interest is determined by government debt levels and the prevailing market rate of interest. 
 
The composition of federal spending has changed dramatically in the last half century compared to the revenue mix, which has been relatively stable.


Updated: June 2004

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