Choosing a Budget Method - Essay Example

1. A. The word “budget” attracts a lot of attention, loathed and loved by turns depending on where one might sit on the financial table. In truth, “A budget is nothing more than a written estimate of how an organization – or a particular project, department, or business unit – will perform financially. If you can accurately predict your company’s performance, you can be certain that resources such as money, people, equipment, manufacturing plants, and the like are deployed appropriately” (“Choosing a Budget Method www.allbusiness.com). It is not the private sector alone that has a need to budget; governments, which control huge sums of money, are under perennial pressure to budget. As important as budgeting is, it is hardly surprising that there are a number of methods available for those who must budget. One of the more traditional budgeting methods is the bottom up budgetary process, which involved having line ministries present their budget requests to those at the top, such as the finance ministry. This often happened at the beginning of the budgetary period because it was taken for granted that the various ministries would request more than they expected to get or indeed more than they really needed. As those at the top considered all the various requests in light of the money available to them, they would decide how much should go to which ministry. Actually, in between, there were a lot of negotiations but the bottom line is that this method “conferred centralized authority for resource allocation on the finance ministry, which managed public finance by controlling individual appropriations and budget items of lien ministries” (Kim and Park 2006 87). As the report entitled “Fundamentals of Sound State Budgeting Practices,” points out, traditionally, budgets at the state level in the United States “have focused on controlling expenditures. Control is expressed in written budgets through “line items” – statements allocating so much money for a specific expense: computers for the tax collectors, acquisitions for the state library, salaries for prison guards” (www.ncsl.org/programs/fiscal/fpfssbp.htm). As governments using the bottom up approach became beset with problems, in the 1990s top-down budgeting emerged as a possible improvement. This was supposed to be an improvement of the traditional method and involved having the finance ministry present a ceiling on expenditure. This was based on the finance ministry’s study of economic indicators and a consideration of available funding and revenues. “Sub ceilings, such as sectoral expenditure ceilings, were set according to policy priorities. These ceilings were confirmed in the cabinet meeting at an early stage in the budget process. Detailed resource allocation decisions to individual appropriations were then made by line ministries within their expenditure ceilings. In other words, the authority over resource allocation which the finance ministry had retained in the bottom-up approach was delegated to line ministries” (Kim and Park 2006 87). The ceiling expenditures decided upon are considered binding, which forces those at the bottom rungs to tighten their belts, thus helping the government to keep a lid on spending and thus avoid criticism from the public. Benefits of the top-down approach includes a reduction in time involved in the budgeting process, a reduction in the practice of inflating actual budget needs. Kim and Park (2006) also believe that the top-down approach allows for more “disciplined, sustainable public finances” (Kim and Park 2006). For some, however, being able to control costs is not necessarily the best use of a budgeting system. Rather, budgeting is seen as a possible planning tool that can help a government or business achieve goals that it might not otherwise be able to achieve under the top-down or bottom-up approaches. As line-item budgeting has come under increasing criticism regarding the lack of results attached to the budgeting process a number of other efforts at reform have emerged. These reforms usually focus on outcomes. One such is the so-called performance-based budgeting approach which stresses the setting of goals and creating specific strategies that will help meet the goals. Furthermore, performance-based budgeting includes measuring the extent to which goals have been met. In this regard, “Future funding decisions should focus on program effectiveness, not on the preservation of existing programs and levels of spending. This approach requires that budgeting be directed at program rather than at specific line items, that the goals of those programs be laid out in measurable terms, and that performance review becomes central to budget decisions” (www.ncsl.org/programs/fiscal/fpfssbp.htm). As the name suggests, Zero-based budgeting, has as its starting point the assumption that no project should continue automatically and that each year every project should be given a fresh review as though starting from point zero. Originally, ZBB was based on the notion of continual review. State governments have not been able to follow this apparently radical form of ZBB. As implemented by states ZBB requires prioritization of projects. In fact, in those states where ZBB is practiced, it makes it possible for policy makers to avoid the traditional practice of increasing budgets year after year even if there was no real reason to do so. “To the extent that ZBB has encouraged governors and legislators to take a hard look at the impact of incremental changes in state spending, it produced a significant improvement in state budgeting. But in its classic form – begin all budget evaluations from zero—ZBB is as unworkable as it ever was” (www.ncsl.org/programs/fiscal/fpfssbp.htm). B. While fudging on budgets is a common problem around the world, for a more topical example, it is better to go north of the U.S. border to Canada where the government has enjoyed record surpluses over the past decade and more. The Liberal government had declared that it was important to balance the budget and that the government could not go into a deficit. As Andrew Coyne explains in the article, “Truth in budgeting,” “By insisting that deficits must be absolutely prohibited at all times…the government had given the budget process a built-in-bias toward surplus: risk-averse bureaucrats were encouraged to add an extra layer of fudge to their forecasts, over and above the formally declared margins for “contingency” and “prudence” (Coyne 2005 8). Another strategy is for newly elected governments to declare that the “cupboards are bare,” even though not long before there had been a surplus. By concealing that there are huge amounts of money in the coffers the governments are able to keep would be money hounds at bay. In some cases, politicians have been very brazen about fudging the books as was the case in British Columbia in the mid-1990s “where politicians ordered bureaucrats to doctor (read: misreport) numbers” (Robinson 2003 8). In this particular case, an auditor-general’s report called the report “inappropriate,” “inadequate” and of having taken a “disproportionate risk” (Robinson 2003 8). 2. Next to democracy itself, the federal system is seen by many as a tool that allows power to devolve to the grassroots so that people with local knowledge can take the decisions that most matter to their own lives. As Alexis de Tocqueville wrote: “No one can appreciate the advantages of a federal system more than I. I hold it to be one of the most powerful combinations favoring human prosperity and freedom. I envy the lot of the nations that have been allowed to adopt it” (Rodden 2005 www.cambridge.org). In the case of finance, for example, it is unlikely that the powerful people in Washington, D.C., who have access to tax dollars may know exactly what the needs of the people of Peoria, Illinois, are. How much better to make the funds available to those in that area so that they can make appropriate decisions regarding their needs, but theory is one thing and reality is another. In the book, Decentralization and Corruptions: Evidence from U.S. Federal Transfer Programs, we learn that when the federal government makes large amounts of money available to local areas, often, the result is misuse of the funds as local politicians line their pockets (Fisher and Gatti 2004). Another disadvantage of federalism is that different regions become too obsessed with their own needs. The historian and critic Alexander Hamilton was one of the individuals who saw through the dangers of federalism at a time when this system was being lauded by scholars and laymen alike. Hamilton feared that the states “would used taxing and borrowing powers to weaken the center..more specifically, that they would spend and borrow excessively, attempting to shift their burdens onto the central government and one another” (Rodden 2005). 1. According to the principle of subsidiarity, which suggests that matters should be handled by the smallest competent authority, the Tenn-Tom, which stretches along Mississippi and Alabama should have been a matter for these states. The reality, however, is that goods shipped through this waterway could benefit companies from other states. While local management and oversight might be a good idea, the scale of the project, and its potential benefit beyond those of Mississippi, Alabama, and Tennessee suggests that the use of federal funds is appropriate. 2. If principles of subsidiarity, which requires the smallest governmental entity to handle a matter if it can, and correspondence, which supposes that the geographical extent of a project should determine the jurisdiction of the government involved, had been followed, it would mean that those at the local level, be it cities or towns across the Tenn-Tom river, and perhaps the states, should have financed the project. At the local or state level, however, the necessary funds might simply not have been available, thus leaving such a project only a dream. 3. The Tenn-Tom is certainly a good use of public funds. The project was on such a scale that local or state governments could not afford to build them. While cost-benefit issues are important, it must be remembered that economic benefits are not the only reason for embarking on public works projects. The thousands of parks that have been preserved in the United States, along with museums and monuments that dot the land, do not necessarily yield profits for the government or the local areas but they do satisfy a national craving for places of sanctuary and beauty, in the case of parks, and of pride, in the case of monuments. If the Tenn-Tom waterway is seen in this light, then the cost factor is not really all that relevant. This is not to say that the government should not ensure that it is not throwing money away after useless projects. The Tenn-Tom waterway has great potential. Good management can certainly make the project far more profitable than it is now. If anything, government should be more careful in choosing contractors for projects and in demanding accountability. The unbelievable increase in the cost of construction, for example, may be seen as a case where the contractors involved did all they could to milk the federal government, knowing that there was always more money in government coffers to be had. Alternatively, right from the start, the government might have sought some private partners with whom to develop the project, thus avoiding the problem of having to put up all the necessary funds. 4. In terms of budget strategies it appears that the Tenn-Tom waterway project had some major champions who had the power to influence to some extent the release of the funds. There is a lot of wheeling and dealing in Congress so it was possible for Jamie Whitten of Mississippi, who was chairman of the House of Appropriations Committee to get the support he needed to channel funds towards the project. Likewise, Tom Bevill of Alabama, who knew that people in his district could benefit took the initiative to be one of the champions of the project. Often, in such cases, without someone to make a strong case and to twist a few arms it is difficult to get the necessary funds. So, the budgeting process is not always straightforward. Sometimes, it takes a lot of negotiating or leveraging what power one might have to get funds where one wants them. 3. The municipal bond market allows municipalities to issue bonds at fair market rates as a way to finance projects at the municipal level. These bonds are very attractive to investors not only because of the rates but also because they usually attract less tax. In fact, municipal bonds are issued by a wide spectrum of municipalities, including states, countries, cities and even school districts. As an article in the Lowell, Masachusetts newspaper, The Sun, notes, “The most attractive feature of municipal bonds is that the interest received is exempt from federal income taxes to encourage individuals to invest in such projects” (“For a less taxing way to invest, consider municipal bonds” 2006). While individuals could benefit greatly from investing in municipal bonds, the big players in the municipal bond market are institutional investors who also are able to supply the huge funds that issuers need to improve their communities. The three main elements that characterize a bond are its par value, which refers to how much money an investor will get when the bond matures. This means, for example, how much a municipality will give to the person who bears the bond. The par value may be for example $1000, which is the principal, so the investor can be sure of getting this amount back. Beyond the par value, however, the investor will also receive an extra amount known as the coupon rate. This is essentially the interest rate at which the municipality “borrowed” the money from the investor. Third is the maturity date which refers to the date when the issuer of the bond has to pay back the lender (“Characteristics of a Bond” www.foolcom). Governments at all levels appear to be constantly in need of money to improve their areas. Rather than always turning to the taxpayer for money there is an attempt to make investors feel that they are getting something in return. In other words, instead of depending solely on taxes, which might not please citizens, the use of bond markets invites willing individuals and institutions to benefit themselves while benefit the issuer and their communities at the same time. Public pension funds and bonds can provide an opportunity for governments to have access to funds that they can use to fund capital intensive projects. The unfunded pension liability refers to money that a government does not have but that it needs to have to pay current employees in the future. Currently in the United States, “Unfunded pension liabilities for private companies have skyrocketed from $26 billion last year to a staggering $111 billion this year” (Chronology of Unfunded Pension Liability 2002). There are worries about the future not only for the individuals who are expecting money that does not exist but also for the viability of the companies themselves and some future expectations that might be placed upon tax payers. Among the problems that have contributed to the debacle are “deceptive ad slipshod accounting, dumping of company stock by executives holding inside information, runaway golden parachutes for executive retirees, and corrupt investment banking practices – all at the expense of hard-working families who have lost their jobs, and had their life-savings decimated” (Miller http://edworkforce.house.gov/democrats/pvtpensionliability.html#oversight). It seems that there is not enough accountability in both government and the private sector. If companies were required to make periodic reports that might help. Companies may be reluctant to pay money for employees when those funds could be used for other projects. Unfortunately, not all products are successful so companies may simply not have the money to invest even if they wished they did. Greater oversight on companies and government institutions and agencies are of paramount importance in this regard. Bibliography “Characteristics of a bond.” http://www.fool.com/bonds/bonds03.htm (December 17, 2006) Coyne, Andrew. “Truth in budgeting.” National Post, (Aug 10, 2005):A14. Banham, Russ. “Better budgets.” Journal of Accountancy, Vol. 189 Issue 2 (Feb 2000):37. “Choosing a Budget Method.” www.allbusiness.com (December 16, 2006) Fishman, Raymond & Gatti, Roberta. Decentralization and Corruption: Evidence from U.S. Federal Transfer Programs. Vol. 113 No 2 (Oct, 2002). “For a less taxing way to invest, consider municipal bonds” The Sun, (Dec 10, 2006):1. “Fundamentals of Sound State Budgeting Practices.” National Conference of State Legislatures, www.ncsl.org/programs/fiscal/fpfssbp.htm (December 16, 2006) Glassman, Cynthia A. “The Continuing Evolution of the Bond Market and Other Observations: Remarks before the Bond Market Association’s 30th Annual Conference.” http://www.sec.gov/news/speech/2006/spch051906cag.htm (December 17, 2006). Kim, John M. & Park, Chung-Keun. “Top-down Budgeting as a Tool for Central Resource Management.” OECD Journal on Budgeting, Vol. 6 Issue 1 (2006):87. Miller, George. “Chronology of Unfunded Pension Liability Concerns Raised by Represenative George Miller (D-CA) Senior Democrat, Committee on Education and the workforce. (July 25, 2002) “http://edworkforce.house.gov/democrats/pvtpensionliability.html#oversight (December 17, 2006). Robinson, Walter. “Don’t post a fake surplus, go directly to jail! Whitehorse Star, (Nov 17, 2003):8. Rodden, Jonathan A. “Hamilton’s Paradox: The Promise and Peril of Fiscal Federalism.” www.cambridge.org (2005). Taylor, Audrey G. “Strategic Budgeting: A Case Study and Proposed Framework.” Management Accounting Quarterly, Vol. 5 Issue 1 (Fall 2003):1. Read More