(Written for Prof. Casciotti’s Public Budgeting/Finance [GOVT356] class at George Mason University.)
Balancing a budget is, arguably, one of the most important things that any fiscal body can do. Whether it be within a household, a small business, a worldwide corporation, a government agency, or an entire government it’s always a good thing to spend within your means and bring in as much money as you spend, if not more.
Methods of balancing a budget fall roughly into three categories. The first broad genre of budget-balancing methods is to cut your expenditures. The second broad method is to increase revenues. The third, and most curious, is to change the rules of the game by redefining timelines or other frameworks of the budgeting process.
When a governmental body finds itself teetering on the brink of deficit (or, in the Federal case, deep in the deficit range), applying one or more of these three generalized methods of balancing a budget can help ensure that the government’s fiscal house remains in order. In this paper, I will explore in more detail these three budget-balancing methods and their effect on current and future budget cycles.
The Nature of the Budget
A budget, by definition, is simply a plan of action. Based on expected revenue, a government (or anything else) simply marks down what they plan to do with that money and slaps a budget label on the front of it. The process forces budget makers—typically elected representatives—to enumerate their priorities and assign them all dollar values.
One of the difficulties in a budget, however, is that it relies on the environment. Revenues are effected by the current economic climate in the populace the government serves, as revenue is brought in basically through taxes linked to incomes, purchases, sales, etc. Furthermore, the expenditures can also be influenced by environment. A snow storm or other natural disaster might require an unexpected or higher-than-projected cost on emergency services, road repair, etc. Even worse, higher governments can pass un-funded mandates that effect the budgets of smaller governments, or cut back on funding through the intergovernmental revenue system.
That nature and society are so unpredictable, budgeting is almost entirely unlikely to ever perfectly represent the actual revenue and expenses of a government for the upcoming year. That is why balancing the budget can be so difficult. One the first day of the fiscal year, you may start off with a balanced budget—but as soon as reality throws in a hurricane or terrorist attack, the balance gets tilted and you find yourself about to fall into deficit.
I surely don’t mean to make the prospect sound hopeless, but when discussing budgeting and balancing of budgets, its necessary to understand how a budget operates and what can act on it to throw it out-of-whack.
The first major method of bringing a deficit budget into balance is to cut costs. By cutting programs, improving efficiency, or otherwise lowering the cost of running a government you can bring the income-in/income-out equation back into balance.
Improving efficiency is the most positive of the spending-decrease methods, although at times it can involve cutting duplicative positions (firing people) and other unpleasantness. But generally, efficiency can be improved drastically by the one-time costs of replacing outdated systems, improving internal processes, and things along those lines.
Improving efficiency can have long term positive impact on a government or other organizations, permitting the entity to effectively “do more with less.” By increasing productivity without changing costs, a government can go a long way toward budget balance and help keep its costs under control in future budget cycles.
The most controversial (and popular) method of cost-cutting is to simply cut back money to programs or, in some cases, cut those programs entirely. This method is almost painful to the government, the public, and mostly to the people directly effected by those cuts, but is unarguably more effective than improving efficiency.
The budget benefit of cutting programs or seriously cutting back programs is as large as the government is willing to cut, while there are limits to improving efficiency. But while the benefits can be huge, so can the cost—not in money, but in public opinion. Cutting funding to programs considered by the public to be important can land a budgeting body in hot water fast.
Future budget cycles can be adversely effected by these kinds of cuts as well. For example, if a government decides to cut 20 percent of the budget for its road maintenance there is a good chance that the roads will still be passable in a year. But if that government keeps road maintenance funding at the new, low rate the roads will begin to degrade. While cutting the budget seemed great in the short term—service level remained the same and the government spent less on it—the government ends up having to drastically increase funding to compensate and rebuild the roads later, at what will likely be a higher cost.
In the political world, these kinds of drastic cuts placed in areas of government that don’t have immediate urgency allow a political administration to pass-off the cost of such programs onto a future administration.
The second major method of bringing a deficit budget into balance is to bring in more money. In the government world, this translates loosely to getting more tax money from the people your government serves.
At a glance, it would seem that you accomplish a revenue increase by increasing the tax burden. For example, if you currently tax the populace at 15 percent of their income, simply increase their tax rate to 20 percent. Theoretically, tax revenue would increase about 5 percent in such an example. While this would indeed help balance a budget in deficit, it also has some undesired consequences that will effect future budget cycles.
Most directly, people don’t like tax increases and in a post-tax-increase election it is possible that the unhappy public will bring an anti-tax administration and legislature to power, which would then reverse the tax increase and possibly bring those future budgets back into the deficit range.
But it’s less of a stretch to say that adjustments in tax rates often have an opposite long-term effect than the intended short-term effect. Much government revenue in the United States is generated by income taxes, and an increase in the income tax rate logically diminishes the amount of money available to consumers for personal spending. The consumers then buy less, companies make less, and pay their workers less in upcoming budget cycles. This lower income is taxed at the higher percentage rate, and the government brings in about as much as they might have leaving the tax rate unchanged (while people and companies end up poorer).
On the other hand, a decrease in the income tax level would increase short-term deficits while increasing government revenue in the long term. Similarly to the scenario put forth above, the lowered tax rates increase the amount of money available for personal spending. Consumers then buy more, companies make more, and pay their workers more. That higher total income across the jurisdiction brings in more revenue for the government.
In both cases, changing the income tax rate has different effects on the current budget cycle and on future budget cycles. A short term fix—raising taxes—could solve your budget-balancing troubles today, while saddling future administrations with diminishing tax revenues.
In a pinch, governments do have limited other options aside from raising taxes. Funding reserves can be created during good times, and used to offset deficits in the not-so-good times. Also, governments can transfer monies between the general fund and other funds. Both of these methods leave future budget years with less leeway, as reserves can run out and so can those other funds.
Playing Around the Rules
The third major method of bringing a deficit budget into balance is to change, skirt, or entirely break the budgeting rules. While these methods can be effective in the short term, a government can only function so long when it’s in a true deficit (regardless of how it looks on paper). These rule-bending procedures can trick people for a while, but almost exclusively they lead to further troubles.
One of the simplest rule-changes that can help in balancing a budget is to change the window of time with which the budget deals. For example, jurisdictions can switch to a multi-year budgeting system that gives them more leeway to run a deficit in a particular year. They can adjust individual budgeting periods to capture an additional month or two of revenue. While this method works out great for the budgeting body, it does not bode well for anybody interested in following the government’s finances from the outside who may find these non-standard budget periods extremely confusing. While a longer budget period may encourage planning, it also gives the government so much wiggle-room that they could get away with almost anything—including sticking future administrations with a disordered financial house.
More underhandedly, however, governments can also simply overstate their projected revenue. After all, a budget is just a document and numbers can be easily misrepresented. Governments can also engage in bad accounting practices—Enron style—and obscure the data to the point that nobody can tell how much money is coming in or where it is all going. Projects can be postponed, transactions can be done off-the-books, and a million other little tricks that make the evidence of deficit all-but-disappear. But all of these methods force future administrations in future budgets to compensate, often at a higher cost.
While there are several ways to balance a budget, the best way is to completely avoid a deficit situation in the first place. By following good financial management practices, properly projecting both income and expenses, building up reserves when possible, and monitoring expenditures throughout the year (and re-balancing the budget if necessary) a government can make sure that its finances stay in the black.
While doing these things takes a lot of effort, the benefits are almost incomprehensibly huge. The government can afford to do what it needs to do, without the unpleasantness of raised taxes or cut programs, and hopefully have a little bit of money left over to maybe try something new. By putting all the political rhetoric aside and examining a government’s financial situation with cool eyes and good intentions, any governmental body can move from year to year with its revenue matching its expenses—its budget balanced.