Fundamentals of Public Budgeting and Finance

That is the title of a recent e-book through Springer-Link by Aman Khan (Texas Tech University). If you are at a university with the right subscription, you might be able to access it for free, but is $25 otherwise.

If I was teaching an undergraduate public budgeting and finance introductory course, I would likely adopt it as the main textbook.  It is budget heavy by design and therefore lighter on the tax side, but it has a chapter on evaluating a tax system and another that covers the different means of raising revenue through alternative instruments. Depending on the course and its role in the curriculum, I might also find it light on federalism and accounting, but those are hardly necessary additions so I think it is overall an excellent textbook for undergraduates that is easy on student budgets.

Disclaimer: I came across the book by Google Scholar recommendation. There was no contact with the author or publisher, and so no undue influence for the preparation of this post.

*Political Budget Cycles and the Civil Service*

One of my internal motivations for starting this blog was to have a commitment device for staying current and broad in the public finance literature. One of the surprises that has come of this venture is the amount of good research on political budget cycles, a subject that I thought was basically dead. A year ago, I would have thought political budget cycle research was basically non-existent and what remained likely to be uninteresting.

The July issue of JPubE posses another example of how wrong I was in “Political Budget Cycles and the Civil Service: Evidence from Highway Spending in US States” by David Bostashvili (Amazon) and Gergely Ujhelyi (University of Houston). Here is the abstract

We study political budget cycles in infrastructure spending that are conditional on bureaucratic organization. Bureaucrats can facilitate or hinder politicians’ ability to engage in voter-friendly spending around elections. To test this idea, we use civil service reforms undertaken by US states in the second half of the 20th century to study political budget cycles in highway spending under civil service and patronage. We find that under patronage, highway spending is 12% higher in election years and 9% higher in the year before an election. By contrast, under civil service highway spending is essentially smooth over the electoral cycle. These findings provide a novel way through which civil service rules can stabilize government activity.

Of course if you’re still with me, you’re wondering how the authors define and identify “patronage” and “merit” systems in the states. The answer is that the authors are actually studying  the adoption of merit system adopted throughout the 20th century that mimicked legislation at the state level. These acts included a competitive civil service exam, prohibited mandatory political services from employees, and established a bipartisan civil service commission. Therefore, “patronage” systems are states that did not adopt those laws. Here is a neat preliminary figure the presents per capita highway spending over the state electoral cycle from 1960-1995 in the 44 states with 4-year election cycles:


And if you compare the 11 states that switch during their study period from patronage to merit, here is how they compare before and after:


The rest of the paper goes on to show that this analysis holds up when you use a regression to control for other factors so that you get these graphs but with confidence intervals.

Score one for the Deep State.

Informal Norms in the Federal Budget Process

Confronted with the threat of another impending federal government shut-down over the budget, much has been made of recent trends in the dissolution of norms in both politics and civility.

For a longer run perspective on the role of norms, I thought it useful to visit an interesting paper (ungated) in the Journal of Institutional Economics by Peter Calcagno (College of Charleston) and Edward Lopez (Western Carolina University) on the role of informal norms in the federal budget process. The argument is in the title with “Informal Norms Trump Formal Constraints: The Evolution of Fiscal Policy Institutions in the United States.” Here is the abstract:

Two shifts of informal rules occurred in the decades around the turn of the 20th century that continue to shape U.S. fiscal policy outcomes. Spending norms in the electorate shifted to expand the scope of the government budget to promote economic security and macroeconomic stability. Simultaneously, norms for elected office shifted to careerism. Both norms were later codified into formal rules as legislation creating entitlement programs, macroeconomic responsibility, and organizational changes to the fiscal policy process. This institutional evolution increased demand for federal expenditures while creating budgetary commons, thus imparting strong motivations to spend through deficit finance in normal times. Despite the last four decades of legislative attempts to constrain spending relative to taxes, the informal norms have trumped the formal constraints. While the empirical literature on deficits has examined the constraining effects of informal rules, this paper offers a novel treatment of shifting norms as having expansionary effects on deficits.

Here is some more:

Our historical investigation traces today’s U.S. fiscal policy challenges to two shifts of fiscal norms from about 1880 to 1930. First, there emerged new demands on federal spending to support economic security at the household level and economic stability at the macro level. Second, the industrial organization of supplying federal spending became professionalized and competitive, as elected office transformed from a temporary public service to a pursuit of a career ambition. We describe the combination of these two shifts–the demand side spending norm and the supply-side professionalization norm–as the American polity’s shift away from a balanced-budget norm in favor of a deficit-as-policy norm.

See also a recent blog post here on a paper in Public Choice on the influence of formal rules in state constitutions.  It is tempting to see those two as opposing views, but I would be inclined to read it as Calcagno and Lopez arguing that informal rules carry more explanatory power, not that formal rules are irrelevant at the margin.

Can Understanding Cognitive Bias Improve the Federal Budget Process?

Forthcoming in Public Budgeting & Finance is an interesting essay by Marvin Phaup (Trachtenberg School – George Washington University) on “Budgeting for Mandatory Spending: Prologue to Reform.” Phaup points out that many features of the federal budget process currently plays into well known human biases:

Specifically, use of cash‐basis accounting, on‐budget payment accounts, and a narrow definition of debt defers recognition of the cost of mandatory spending until benefits are payable and politically unavoidable. Acting to control “future” costs is cognitively more difficult for decision‐makers than addressing cost now as obligated.


From an accounting perspective, the current process fails to support budgeting for mandatory spending because of the failure to recognize cost when it is controllable at the decision to incur it. Instead current accounting recognizes cost only when payments are made to or on behalf of beneficiaries, that is, when non‐payment would be a grievous breach of acceptable norms of behavior. Simply, current accounting gives prominence in the budget process to a politically sunk, unavoidable measure of cost.

Phaup works through several examples in detail from several mandatory programs, then  in my favorite section reassesses the defense of the current practice with several sharply worded observations. E.g.:

Current budgetary accounting for mandatory spending is often defended on grounds of consistency with the absence of a constitutionally protected right to benefits, if current law were to be changed. That is, elected policymakers could change the law at any time and terminate benefits, including for those already receiving payments. A Supreme Court decision upholding a legislative revocation of benefits is frequently cited to support this position. According to this view, the budget properly delays recognition of current law mandatory obligations until government forgoes exercise of its option to terminate and makes payment.

However, for most budget purposes, for example, baselines, cost estimates, the maintained assumption is the precise opposite: that current law spending continues indefinitely. Only when the law is changed is this assumption extended to the new statute.

Phaup argues that the long term costs of these program should be made more salient by substituting existing arbitrary assumptions (e.g. that the government will pay no future benefits) to arbitrary-but-more-politically-realistic assumptions (e.g. benefits accumulated prior to a change in current law will still be paid). He proposes a few of these plausible assumptions and depicts how they would be scored or provided to policy makers under the three programs examined. Generally the fiscal sustainability of these programs is more alarming than under current policy [see Table 3].

The essay concludes with some anticipated critiques and how they might be accommodated. For instance, if the goal is to eliminate on previously promised benefits (contra previous norms and practices), then this accounting change would make that more difficult. But of course there is no obvious neutral way to do this, a default must be chosen, and we consequently can’t avoid some implicit policy setting with our accounting rules.

I think another reaction one might have is that the budget process is in some sense purposefully myopic because that is what the political equilibrium selects on. But that is probably an overattribution of human will to something of human design. The current approach probably has arbitrary features that continue to survive because there is nothing in the political competition to attack the bias. In the private sector, poor accounting methods can lead to business exit via poor prices and misallocated inputs; I’ve never seen a candidate try to win voters with changes to accounting practices in the federal budget. While our budget deficit inclinations are probably mostly determined by politics, if simple reforms like these improved our long-term standing by even a small percentage then they’d probably be worth trying out.

The Effect of Inherited Fiscal Rules

Many budgeting scholars are currently interested in whether a rule-based system could be used for improving fiscal sustainability. In the US, congress’s own dismissive treatment of the rules governing the budget process are supportive anecdotes of the view that self-imposed rules do not bind. Furthermore, there is little doubt that adopting rules (e.g. like Balanced Budget Amendments) is at least partially just signalling what you intend to do regardless of the rules. Nevertheless you’d expect that it is possible to raise the political cost of certain actions.

In this spirit is an interesting article forthcoming in Public Choice by Csaba Toth (Central Bank of Hugary) on “Valuable Legacy? The Effect of Inherited Fiscal Rules.” Here is the abstract:

The working mechanism of national fiscal rules depends strongly on whether a government must comply with its own rules or inherited ones. In the former case, a government usually introduces fiscal rules to show its commitment to a disciplined fiscal policy (the signaling function). In the latter context, however, inherited rules constitute external obstacles to budgetary policymaking (the limiting function). This study mainly is concerned with the limiting function and therefore bases its empirical analysis on periods when the ruling government inherited fiscal rules introduced by a previous government. The results of a panel-data econometric study indicate that national fiscal rules do contribute to disciplined fiscal policy after a change in government in times of an economic upturn. That finding, however, does not mean that the signaling function is ineffective: quite the contrary. My results, in line with the literature, indicate that the double functions of rules may complement one another. A government that introduces such rules is often already committed to a disciplined policy and wishes to signal such commitment in the short term. With the appearance of new government, however, the function of rules changes, and they efficiently promote disciplined fiscal policy in the long term.

That abstract is a nice summary of the paper’s main points. The empirical work is based on 27 EU members states from 1995 to 2008. Section 3 (Databases and New Methods) is a section not to be skipped, and it is a credit to the author that such a detailed description of where the reader might want to be skeptical of the data’s coding and other limitations. For instance, this has the potential to be a big drawback.

Before delving into the details, however, I need to emphasize that my definition of budgetary rules is limited in several ways. On the one hand, this study concerns only the numerical values of the procedural rules in effect during the compilation and enforcement of the general public budget. In doing so, I concentrate exclusively on the rules contained in national legal systems and thus ignore supranational provisions. Third, budget rules are in place worldwide; this study focuses on European practice and more precisely on the EU member states.

It is an impressive paper, and if you teach a doctoral level course on budgeting it is worth consideration for syllabus space.