Chapter 6: Public Budgeting and Finance

#1 Accountability

Responsibility for public funds is a fundamental aspect of public financial management. Essentially, this principle dictates that individuals entrusted with the task of managing public finances must be held responsible for them. These individuals overseeing the utilization of public funds also need to provide a comprehensive account of how these funds are used. The establishment of accountability can be achieved by means of audits and assessments carried out by legislative bodies.

#2 Probity

Probity, or integrity, is another cornerstone within the framework of public financial management. It is crucial for all lawmakers and administrators to bear in mind that although these funds are under their control, they are not meant for personal enrichment. Consequently, the utilization of public funds must be characterized by the highest standards of honesty and integrity. This principle of financial management seeks to emphasize precisely this message.

#3 Prudence

Individuals who have been entrusted with the responsibility of managing these funds must never utilize these public funds to engage in unnecessary or unjustifiable risks. Whether the motivation behind such actions is their personal gain or the supposed benefit of the public, it remains unacceptable. These funds are explicitly designated for the betterment of the public’s welfare.

In their work “Public Finance in Theory and Practice,” Economists Richard and Peggy Musgrave offer a fundamental insight into comprehending the objectives underlying public financial management. They suggest that the process of taxing and spending is driven by one of four main objectives:

• Allocation: Ensuring that adequate funds are directed towards sectors of the economy where they are most needed.
• Distribution: Guaranteeing that the distribution of public funding among regions, societal classes, public and private sectors, and government and business aligns with public policy objectives.
• Stabilization: Utilizing public expenditure to stabilize the broader economy or specific segments, in line with Keynesian principles.
• Growth: Harnessing government spending as a tool to foster economic expansion and the creation of wealth.

When we analyze the budget of a national, state, or local government, we can use this framework. Does the budget primarily focus on promoting economic growth? If so, what strategies are employed? Perhaps it involves lower taxes on businesses and reduced government regulations. Is the budget designed to achieve distributional goals? It might seek to assist urban areas or provide support for the long-term unemployed. Alternatively, the budget might aim to stabilize the economic cycle, either by boosting demand during a downturn or tempering it during an upswing.

Disagreements often arise concerning the methods used to attain these stated objectives. Advocates of supply-side economics, for instance, believe that reducing tax rates encourages fresh capital inflow, leading to job creation, economic growth, and ultimately increased tax revenues. This concept, associated with the Reagan administration, is colloquially referred to as Reaganomics, even though Reagan’s economic policies were not solely supply-side.

Keynes argued that during economic downturns, traditional market forces might not be sufficient to restore economic equilibrium. In response, he proposed that governments should step in to stimulate demand through increased public spending, even if it meant running budget deficits. This concept of deficit spending during economic slumps became a cornerstone of Keynesian economics and found its way into American budgeting practices.

During the mid-20th century, particularly after World War II, Keynesian principles guided American economic policy and public budgeting. The idea that government expenditure could effectively combat unemployment and stimulate economic activity gained prominence. This perspective was notably embraced by President Franklin D. Roosevelt’s New Deal policies, which aimed to alleviate the effects of the Great Depression through massive public works projects, job creation, and social welfare programs. The New Deal’s expansionary budgeting approach aligned with Keynesian thinking and played a vital role in the recovery of the American economy.

Keynesian influence persisted beyond the New Deal era. In the 1960s, President Lyndon B. Johnson’s Great Society programs, including initiatives to combat poverty and promote civil rights, exemplified the integration of Keynesian principles into public budgeting. These programs involved increased government spending on social services, education, and healthcare, aimed at improving the well-being of citizens and stimulating overall economic growth.

Hayek’s most notable work, “The Road to Serfdom,” warned against the dangers of government intervention and central planning, arguing that such interventions could lead to a loss of individual freedom and a slide towards authoritarianism. His views on the importance of limited government and the spontaneous order of markets resonated with many American policymakers and thinkers, especially those aligned with conservative and libertarian ideologies.

Hayek’s influence on American public budgeting can be observed in the promotion of fiscal conservatism and efforts to restrain government spending. His emphasis on the potential negative consequences of deficit spending and the accumulation of public debt has informed debates about the sustainability of expansive government budgets. Advocates of Hayekian principles argue that excessive government spending can lead to distortions in the market, crowding out private investment and impeding economic growth.

Throughout American history, policymakers who share Hayek’s concerns about government intervention have sought to limit the scope and size of government expenditures. This perspective gained prominence during the Reagan administration in the 1980s. President Ronald Reagan, influenced by Hayek’s ideas, championed tax cuts, deregulation, and reductions in government spending as a means to promote economic growth and individual liberty. These policies were in line with Hayek’s belief in the power of market forces to allocate resources efficiently and drive innovation.

Fiscal pertains to matters related to taxation, public income, or public debt.

The annual federal budget process doesn’t exist due to a single piece of legislation. Instead, Congress shapes spending and tax determinations through an array of legislative actions, a practice that has developed over more than two centuries. The Constitution explicitly vests Congress with control over financial matters, bestowing it with the authority “to lay and collect Taxes, Duties, Imposts and Excises.” It also stipulates that “No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by law.” In essence, federal taxation and expenditure necessitate legislative enactment to become legally binding.

Within this framework, some tax and spending laws maintain permanence until modified, which frequently occurs. Other statutes span multi-year intervals, prompting the need for periodic renewal. Moreover, numerous budget choices are made on an annual basis through the enactment of yearly appropriations bills. Furthermore, the Congressional Budget Act of 1974 establishes an internal procedure known as a congressional budget resolution. This process is designed for Congress to devise and uphold an annual comprehensive plan for addressing budget-related legislation, though Congress has increasingly opted to disregard this procedure.

The fiscal year is a 12-month accounting period not tied to the regular calendar year. Historically, the fiscal year for the federal government commenced on July 1 and concluded on June 30, extending back to fiscal year 1976. However, due in part to increased activity in Washington during the summer months facilitated by air conditioning, Congress shifted the fiscal year’s commencement to the end of summer. Thus, since fiscal year 1977, the federal government’s fiscal year starts on October 1 and concludes on September 30. The fiscal year is identified by the calendar year in which it ends (e.g., fiscal year 2010 concluded on September 30, 2010). Not all state and local governments mirror the federal model. While most states start their fiscal year on July 1, a few adopt the first day of April, September, or October.

President

Traditionally commencing the annual federal budget process, the President presents an exhaustive budget request for the upcoming fiscal year, set to commence on October 1. (While this request should be submitted by the first Monday of February, occasional delays arise, particularly during new administrations or when prior year’s budget-related congressional actions have been postponed.) This budget request, shaped through an interactive collaboration between federal agencies and the President’s Office of Management and Budget, a process that usually initiates the preceding spring or earlier, holds three vital roles.

Firstly, it serves as the conduit for the President’s recommendations regarding the broader federal fiscal strategy, encompassing: (a) the proposed federal spending for public objectives; (b) the envisaged tax revenue to be amassed; and (c) the targeted deficit (or surplus), denoting the disparity between (a) and (b). Most years witness federal expenditures exceeding tax income, with resulting deficits predominantly financed through borrowing (as indicated in the chart).

Secondly, the President’s budget outlines the administration’s comparative priorities for federal programs, delineating allocations for defense, agriculture, education, healthcare, and other domains. The budget assumes a notably detailed stance, presenting funding levels for individual “budget accounts,” which encompass federal programs or smaller clusters of programs. It typically charts fiscal policy and budget preferences not just for the ensuing year, but also for the ensuing nine years. Accompanying this budget are supplementary volumes, including historical tables detailing past budgetary outcomes.

Lastly, the President’s budget often incorporates proposals to modify certain mandatory programs and specific facets of revenue regulations, even if Congress is unlikely to deliberate upon these suggestions. Furthermore, the budget provides updated projections of predicted expenditures for ongoing mandatory programs and revenues, even in instances where no adjustments to these programs are advocated. This ensures that the cumulative budget figures, signifying overall fiscal policy, are grounded in more recent data.

Typically, Congress holds hearings to question administration officials regarding their requests, however because of how the Constitution divvies up responsibilities, they are under no obligation to adhere to the President’s budget. Congress tends to use it as a guideline, and certainly important information about the cost of running departments and programs are included in the President’s budget, but when it comes down to it the President does not have the authority to set taxing and spending levels.

Congress

After a review of the President’s proposed budget, Congress constructs its own financial blueprint, called a “budget resolution.” The responsibility of formulating and enforcing the congressional budget resolution rests with the House and Senate Budget Committees. Following their approval, these resolutions are presented to the House and Senate chambers, where they remain open to amendments. The budget resolution for the year gains approval when both the House and Senate adopt the same version, either following negotiations on a conference agreement or by one chamber endorsing the resolution adopted by the other.

The congressional budget resolution is a “concurrent” resolution, which unlike most other bills, is exempt from being presented to the President for signing or vetoing. Additionally, it is one of the rare measures not susceptible to filibustering in the Senate, thus necessitating only a majority vote for passage or amendment. As it doesn’t proceed to the President, the budget resolution lacks the capacity to establish spending or tax law. Instead, it sets objectives for congressional committees to propose legislation directly related to funding allocation or modifications to spending and tax statutes. Furthermore, it can institute an expedited process termed “reconciliation” for addressing changes in mandatory spending and tax matters.

The aim is for Congress to endorse the budget resolution by April 15, giving them 5½ months to work before the end of the fiscal year, however, this timeline is often extended. In recent years, it has also become common for Congress to forgo passing a budget resolution entirely. Instead, an alternative approach involves the House and Senate agreeing upon “deeming resolutions” or statutory provisions to supplant the budget resolution.

In contrast to the extensively detailed President’s budget, the congressional budget resolution adopts a more straightforward format. It comprises a series of figures that outline the suggested expenditure amounts for 19 distinct spending classifications, referred to as budget “functions,” alongside the projected aggregate government revenue for each of the upcoming five years or beyond. The disparity between these two cumulative sums — the upper spending limit and the lower revenue threshold — signifies the anticipated annual deficit (or surplus).

The primary mechanism ensuring compliance with the budget resolution’s terms and preventing the passage of legislation that violates them is the authority of a single member from either the House or Senate to raise a budget-related “point of order” on the floor, effectively blocking such legislation. In recent times, this point of order has held less significance in the House due to its potential waiver within the “rule” that outlines the conditions governing the consideration of each bill on the floor. These rules, established through resolutions that the House can adopt with a simple majority vote, are formulated by the Rules Committee, a body appointed by the leadership. On the other hand, the budget point of order carries substantial weight within the Senate. In this chamber, any legislation surpassing a committee’s assigned spending allocation or reducing taxes below the level allowed in the budget resolution (revenue floor) is susceptible to a budget point of order on the Senate floor. To overcome this point of order, a waiver necessitates a 60-vote majority. Failing to secure a waiver leads to the termination of the bill’s consideration on the Senate floor.

What if there is no budget resolution?

Congress has rarely managed to finalize action on the budget resolution by the specified April 15 deadline outlined in the Congressional Budget Act of 1974. Additionally, although Congress endorsed a budget resolution for the initial 23 years after the enactment of the Budget Act (from 1976 to 1998), it encountered difficulty in passing a resolution for the majority of years spanning between 1999 and 2023. In the absence of a new budget resolution, the spending limitations and revenue baseline from the prior resolution automatically extend to cover the remaining years of that resolution.

However, as the prior budget resolution exclusively set an allocation for the Appropriations Committees for the previous year, these committees lack an official funding objective for the upcoming year. This absence of a funding target renders each of the 12 appropriations bills vulnerable to a point of order. To circumvent this and other potential procedural challenges arising due to the absence of a new budget resolution, the House and Senate might come to an agreement on distinct budget targets, often with significant delays. These targets are “deemed” to substitute the budget resolution. These deeming resolutions could concentrate solely on a new appropriations target or they could introduce new revenue floors and targets for the other committees.

At times, Congress has adopted a divergent approach, instituting a “Congressional Budget” via legislation as an alternative to the concurrent budget resolution. This approach involves setting fresh appropriations targets for discretionary programs. For instance, this was observed in a series of “bipartisan budget acts” (enacted in 2013, 2015, 2018, and 2019) that reflected outcomes from negotiations aimed at elevating the funding limits on defense and non-defense appropriations established by the 2011 Budget Control Act. Since both deeming resolutions and the statutory course followed in the bipartisan budget acts serve as substitutes for regular budget resolutions, they trigger the same budgetary points of order.

Should Congress fail to finalize action on an appropriations bill before the onset of the fiscal year on October 1—a scenario observed in every fiscal year since 1997 and in 40 out of the last 43 years—a contingency measure called a continuing resolution (CR) must be sanctioned by Congress and subsequently signed by the President. This CR offers interim funding for agencies and programs affected by the situation. In instances where Congress doesn’t endorse the CR or the President withholds their signature (due to disputes concerning its content), agencies and programs dependent on annual appropriations but not yet allocated funding must, to a large extent, halt their operations.

For instance, a disagreement between President Trump and congressional Democrats regarding border wall funding resulted in a federal agency shutdown across nine distinct departments for 35 days, starting from December 22, 2018. Similarly, a clash between President Obama and congressional Republicans over the funding of health reform legislation caused a 16-day cessation of regular government activities beginning October 1, 2013. In the winter of 1995-96, a disagreement between President Clinton and congressional Republicans prompted a 21-day shutdown of substantial segments of the federal government.

Budget Reconciliation

The budget “reconciliation” process, as established in the Congressional Budget Act, is a specialized procedure that expedites the deliberation of spending and tax legislation. Initially conceived as a tool for reducing deficits, this procedure compelled committees to generate spending cuts or tax hikes as stipulated in the budget resolution. Sixteen deficit-reduction reconciliation bills have been enacted, including the Inflation Reduction Act of 2022. Nevertheless, this process has also been used to elevate deficits, such as enacting tax cuts during the George W. Bush Administration and under the Trump Administration in 2017, along with passing a COVID-19 relief bill during the Biden Administration in 2021. Despite its optional nature, the procedural benefits it offers have prompted Congress to increasingly utilize it for major spending and tax adjustments. Presently, the most common trigger for a budget resolution is to initiate the reconciliation process.

While reconciliation allows Congress to modify spending and tax legislation with a majority vote, it encounters a significant restriction—the “Byrd Rule,” named after the late Senator Robert Byrd of West Virginia. This Senate rule enforces a point of order against any provision in a reconciliation bill (or its amendment) that is deemed “extraneous” to the purpose of amending spending or tax law. If a point of order is raised under the Byrd Rule, the contested provision is automatically removed from the bill unless at least 60 senators vote to waive the rule. This hinders the inclusion of policy changes in a reconciliation bill unless they bear direct fiscal implications— and these fiscal effects must surpass being “merely incidental” to the non-budgetary aspects of the provision. This rule also disallows modifications to discretionary appropriations authorizations, which will be financed in later appropriations bills rather than the reconciliation bill. Likewise, alterations to civil rights, employment law, or even the budget process are restricted by the Byrd Rule. Changes to Social Security are also barred, even if they pertain to budgetary matters. Additionally, the Byrd Rule prohibits any spending increments or tax reductions that incur costs beyond the timeframe covered by the reconciliation directive—five (or typically ten) years—unless other provisions in the bill fully offset these “outside-the-window” expenses.

Alongside the parameters established during the annual budget process under the Congressional Budget Act, Congress has frequently operated within statutory budget-control mechanisms designed to prevent tax and mandatory spending changes from escalating the deficit, or to restrict discretionary spending.

One example of this is PAYGO. Enacted in 2010, the Statutory Pay-As-You Go (PAYGO) Act mandates that any legislative adjustments to taxes or mandatory spending that amplify projected deficits must be counterbalanced or funded by other alterations to taxes or mandatory spending that diminish deficits by an equivalent magnitude. Similarly, the 1990 Budget Enforcement Act (BEA) and the 2011 Budget Control Act (BCA) each imposed temporary, legally enforceable thresholds or “caps” on the level of discretionary appropriations. The BEA limits lapsed after 2002, while the BCA limits terminated after 2021. Both PAYGO and discretionary funding caps are enforced through “sequestration” — broad-based reductions in specified programs. In the case of PAYGO violations, across-the-board cuts in designated mandatory programs would be triggered at the conclusion of each Congress session to restore the equilibrium between the expenses and savings stemming from previously enacted mandatory spending or revenue changes. However, Congress frequently bypasses the Statutory PAYGO Act by exempting certain expenses from its sequestration stipulations, resulting in no sequestration under Statutory PAYGO thus far. Similarly, appropriations surpassing the discretionary funding caps would activate across-the-board reductions in appropriated programs to eliminate the excess. The sole significant sequestration transpired in 2013 to adhere to the funding limits outlined by the 2011 Budget Control Act.

The budgetary process at the state level in the United States is somewhat similar to the federal process but varies quite a bit from state to state. Generally, the process begins with the governor proposing a budget to the state legislature, which includes estimates of revenue and spending, as well as proposed funding for various government agencies and programs.

There are two fundamental categories of budgets. The most prevalent, and the one that immediately comes to mind for most individuals when discussing budgets, is referred to as the operating budget. This constitutes a short-term strategy for effectively managing the resources required to execute a program. The term “short-term” can encompass a span ranging from several weeks to a few years. Typically, an operating budget is formulated for each fiscal year, subject to adjustments as circumstances dictate.

Incrementalism is a budgeting approach characterized by its gradual and incremental adjustments to existing financial allocations. In this method, budget decisions are based on historical patterns and precedents, where the current year’s budget serves as the starting point for the next budget cycle. Adjustments are typically made by adding or subtracting a certain percentage to each line item or department’s previous allocation. This approach is often favored for its simplicity and stability, as it avoids significant deviations from established spending levels.

One of the key advantages of incremental budgeting is its ability to provide a sense of stability and predictability in financial planning. Organizations that utilize incrementalism can maintain continuity in their operations, as they build upon prior budget allocations and avoid abrupt shifts in resource distribution. This stability can be particularly useful in government agencies and large organizations, where sudden budget changes could disrupt essential services or programs. Additionally, incrementalism simplifies the budgeting process by reducing the need for extensive reevaluation of every expenditure each budget cycle, which can save time and resources

However, critics of incrementalism argue that this approach may lead to inefficiencies and suboptimal resource allocation. The reliance on historical data and past practices might prevent organizations from adapting to changing circumstances or shifting priorities. It can perpetuate ineffective or outdated programs simply because they have been funded in the past. Critics also contend that incremental budgeting might discourage innovation and the pursuit of new initiatives, as resources are primarily allocated based on what has been done before rather than what might yield the greatest impact in the future. As a result, many organizations opt for a combination of incremental budgeting and other approaches, such as performance-based budgeting, to strike a balance between stability and strategic resource allocation.

Line-Item Budgets

Line-item budgeting is a traditional and widely utilized method of budgeting that breaks down financial allocations into distinct line items, each representing a specific expense category. In this approach, the budget is structured with detailed lists of individual expenses, typically categorized by department, program, or activity. Each line item is associated with a specific monetary value, providing a clear breakdown of how funds will be allocated across various components of an organization’s operations.

One of the key characteristics of line-item budgeting is its emphasis on simplicity and transparency. By categorizing expenditures into easily identifiable line items, decision- makers can readily discern where funds are allocated and how resources are distributed within an organization. This level of clarity makes line-item budgeting particularly well- suited for tracking expenses and facilitating accountability. Moreover, since line-item budgets provide a historical record of spending patterns, they can aid in making informed decisions during subsequent budget cycles.

While line-item budgeting offers simplicity and transparency, it does have limitations. Critics argue that this method might lack strategic focus, as it prioritizes tracking individual expenses rather than evaluating the alignment of budget allocations with overarching goals and priorities. It can potentially hinder innovation and flexibility, as it may be challenging to reallocate funds between line items to respond to changing needs. Additionally, the granularity of line-item budgets can make it difficult to ascertain the impact of funding decisions on broader organizational objectives. As a result, some organizations have transitioned to more modern budgeting approaches that offer greater strategic alignment and performance evaluation while still retaining the transparency aspects of line-item budgeting.

Performance Budgets

Performance budgeting is a budgeting approach that focuses on linking financial allocations to the outcomes and results that an organization aims to achieve. Unlike traditional budgeting methods that emphasize inputs and expenditures, performance budgeting places a strong emphasis on the effectiveness and efficiency of programs and projects. In this approach, budget decisions are based on the anticipated performance metrics, goals, and targets, aligning funding with the achievement of specific outcomes.

One of the key features of performance budgeting is its emphasis on measuring and evaluating the impact of budget allocations. Organizations that adopt performance budgeting establish clear performance indicators and benchmarks for each program or project. These indicators enable decision-makers to assess the success of initiatives based on their ability to meet predetermined objectives. By holding programs accountable for their performance, this approach promotes transparency and accountability in resource allocation, as well as the optimization of resources toward the most effective activities.

However, implementing performance budgeting can be complex and challenging. Establishing accurate performance metrics, measuring outcomes, and attributing results solely to budget decisions can be difficult, especially for programs with long-term or indirect impacts. Additionally, performance budgeting requires a shift in organizational culture, as it encourages a results-oriented mindset and necessitates the collection and analysis of performance data. Despite these challenges, many organizations, including government agencies, non-profits, and businesses, have embraced performance budgeting as a way to enhance their decision-making, ensure resource efficiency, and achieve their intended outcomes more effectively.

Zero-Based Budgets

Zero-based budgeting (ZBB) is a budgeting methodology that stands in contrast to traditional budgeting approaches. In ZBB, every budget cycle starts from scratch, requiring managers and departments to justify all expenses as if they were starting anew, regardless of whether they were previously approved. This approach challenges the assumption that previous budgets are automatically valid for the upcoming period, encouraging a thorough review of each expenditure and activity. ZBB emphasizes the need for a clear rationale for spending and allocates resources based on the merits and priorities of each program.

One of the primary advantages of zero-based budgeting is its ability to promote efficiency and resource optimization. By requiring each expenditure to be justified and evaluated, ZBB helps identify redundancies, inefficiencies, and outdated practices that might have been perpetuated through traditional incremental budgeting. This encourages managers to critically assess the necessity of each program or activity and prioritize those that offer the greatest value and impact. ZBB also provides a platform for reallocating resources from underperforming or less relevant areas to initiatives that are more aligned with organizational objectives.

During the medieval period, feudal systems emerged in Europe, where peasants paid a portion of their agricultural produce to feudal lords in exchange for protection and use of land. However, the establishment of more centralized nation-states marked a turning point in taxation. In the 17th and 18th centuries, monarchs and governments began to assert more control over taxation to finance wars and build modern bureaucracies. This period saw the emergence of concepts like the social contract, where citizens consented to taxation in exchange for the protection and services provided by the state.

The Industrial Revolution brought about significant economic changes, leading to the implementation of new forms of taxation to support the growing needs of modern societies. Income taxes became more prominent, as governments sought to generate revenue from the increasingly urban and diverse workforce. The 20th century saw further developments, including the introduction of progressive taxation to address income inequality, as well as the establishment of social welfare programs funded through taxation. Today, taxation continues to play a vital role in shaping economies and societies, funding public services, infrastructure, and addressing various social and economic challenges.

Significant developments in the history of taxation in the United States:

1765: The Stamp Act is enacted by the British Parliament, imposing taxes on various paper goods and legal documents in the American colonies. This sparks widespread protests and resistance from colonists who argue against “taxation without representation.”

1773: The Boston Tea Party takes place as American colonists, in protest of the British-imposed tea tax, throw chests of tea into Boston Harbor.

1787: The U.S. Constitution is ratified, granting Congress the power to “lay and collect Taxes, Duties, Imposts, and Excises.”

1791: The first federal excise tax is levied on distilled spirits, sparking the Whiskey Rebellion in western Pennsylvania in protest against the tax.

1861-1865: The Civil War prompts the implementation of various taxes, including the first federal income tax in 1861, to fund the war effort. The income tax is repealed in 1872.

1913: The 16th Amendment to the Constitution is ratified, establishing the federal income tax as a permanent part of the U.S. tax system.

1935: The Social Security Act is passed, introducing the payroll tax to fund social welfare programs.

1942: The Revenue Act of 1942 introduces automatic payroll withholding for income taxes, making tax collection more efficient.

1965: Medicare and Medicaid are established, leading to payroll tax increases to support these healthcare programs.

1981: The Economic Recovery Tax Act is enacted, implementing significant tax cuts under President Ronald Reagan.

1986: The Tax Reform Act is passed, simplifying the tax code and eliminating many deductions while reducing tax rates.

1990: President George H.W. Bush signs a budget deal that includes tax increases, going against his “Read my lips, no new taxes” pledge.

2001: The Economic Growth and Tax Relief Reconciliation Act is signed into law, introducing tax cuts under President George W. Bush.

2010: The Affordable Care Act is passed, introducing various taxes to fund healthcare reforms, including the Net Investment Income Tax and the Additional Medicare Tax.

2017: The Tax Cuts and Jobs Act is enacted, implementing significant tax cuts and changes to the tax code under President Donald Trump.

Please note that this timeline highlights key developments, and there are many more nuanced changes and legislative actions related to taxation in the U.S. throughout its history.

Taxation stands as one of the most volatile subjects in the realm of politics. A poignant example of its influence is found in Walter Mondale’s acceptance of the Democratic Party’s presidential nomination back in 1984. During his address, Mondale candidly stated, “Taxes will experience an increase, and anyone asserting otherwise is not being truthful.” Despite his forthrightness, he suffered a resounding defeat. In stark contrast, George Bush, upon embracing the Republican Party’s presidential nomination in 1988, emphatically declared, “Read my words, no novel taxes!” His triumph was decisive. Nonetheless, Bush’s assurances turned out to be far from accurate, as he ultimately implemented tax hikes. This decision significantly contributed to his electoral struggles during his unsuccessful reelection bid in 1992. The tale serves as a notable lesson in the intricate dynamics of political pledges and the ramifications they can bear.

Progressive, Regressive and Flat Taxes

Progressive taxation is a fundamental concept in the realm of taxation that involves imposing higher tax rates on individuals or entities with higher incomes or wealth. The principle behind progressive taxation is rooted in the idea of income redistribution and social equity. Under this system, as a person’s income rises, the proportion of their income paid in taxes also increases. This approach is often seen as a way to address income inequality by placing a heavier burden on those who can afford it more, while providing relief to lower-income individuals.

One of the key benefits of progressive taxation is its potential to reduce economic disparities within a society. By taxing higher income earners at higher rates, governments can generate revenue that can be used to fund social programs, infrastructure, and public services that benefit a broader segment of the population. This approach aligns with the principle of addressing the needs of marginalized and vulnerable individuals, as it directs resources toward initiatives that improve overall societal well-being.

However, progressive taxation is not without its critics. Opponents argue that excessively high tax rates on the wealthy can discourage investment, innovation, and economic growth. Detractors also raise concerns about potential tax evasion strategies that could emerge as a response to steeply progressive tax systems. Striking the right balance between revenue generation, social equity, and economic growth is a complex challenge that requires careful consideration of a country’s economic conditions and policy objectives. Despite the ongoing debate, progressive taxation remains a central component of many countries’ tax systems as they seek to create a fairer and more inclusive society.

Regressive taxation is a taxation model where the tax burden disproportionately affects individuals or entities with lower incomes or fewer resources. Unlike progressive taxation, where tax rates increase as income rises, regressive taxation involves a higher proportion of income being taken as taxes from those with lower earnings. This can result in a more significant impact on individuals who are already economically disadvantaged. Progressive taxation is implemented on purpose–people with more money will have more left over, even if they pay higher tax rates. Conversely, regressive taxation is something that tends to happen more as a side effect. One common example of a regressive tax is sales tax. Imagine this, you are a broke college student with $20 to your name and you head into a coffee shop to buy a $5 coffee. Say the sales tax where you are (for nice, round numbers) is 10%. You pay $5.50 for your coffee and you have $14.50 left over. That $.50 was 2.5% of the money you’d had. Now imagine that Warren Buffet also goes to buy coffee. He chooses the same coffee and spends the same $5.50 you did. Because Mr. Buffett is worth around $120B today, that $.50 represents about .000000000417% of the money he has. That sales tax was a larger burden on you than it was on him.

One notable characteristic of regressive taxation is its potential to exacerbate income inequality. As lower-income individuals spend a larger portion of their income on goods and services subject to regressive taxes, these taxes effectively take a greater share of their available resources. This dynamic contrasts with progressive taxation, which seeks to distribute the tax burden more equitably based on income levels. Critics argue that regressive taxation can perpetuate cycles of poverty and hinder social mobility by placing a heavier financial strain on those who are least able to bear it.

While regressive taxes can be seen as inequitable, proponents argue that certain consumption-based taxes are simple to administer and can encourage responsible spending. In some cases, regressive taxes may be combined with targeted social programs to mitigate their regressive effects, such as providing subsidies or exemptions for essential goods and services. Balancing the revenue needs of governments with the goal of reducing income inequality is a central challenge in designing tax systems that promote economic fairness and societal well-being.

Because of how some see the benefits of things like consumption taxes, within certain political circles there are frequent calls to institute a “flat tax.” The flat tax, often referred to as a proportional tax, is a taxation system in which all individuals or entities are taxed at the same fixed percentage rate, regardless of their income level. This system aims to simplify the tax code by applying a uniform tax rate to all taxpayers. Proponents of the flat tax argue that it eliminates the complexity and loopholes associated with progressive tax systems, leading to increased transparency and ease of compliance. Additionally, they believe that a flat tax can encourage economic growth by providing individuals and businesses with greater certainty and predictability regarding their tax liabilities.

Critics, however, highlight the same potential fairness concerns with the flat tax as discussed above with the regressive taxes. Since everyone pays the same percentage of their income, regardless of whether they’re low, middle, or high-income earners, critics argue that this approach places a heavier burden on lower-income individuals. The regressive nature of the flat tax can exacerbate income inequality by disproportionately affecting those with less disposable income. Critics also raise concerns about potential revenue shortfalls, as the wealthy may pay lower effective tax rates compared to progressive systems where higher earners are taxed at higher rates.

Implementing a flat tax system involves careful consideration of both economic and social implications. While proponents emphasize its simplicity and potential economic benefits, critics underline the potential for increased inequality. Finding a balance between maintaining revenue levels, promoting fairness, and stimulating economic growth remains a key challenge in shaping tax policy decisions related to the flat tax.

User Fees and Charges

Governments raise money through user fees by charging individuals or entities for specific government services or facilities they directly use or benefit from. User fees are a form of revenue generation that allows governments to recover some of the costs associated with providing these services without relying solely on general taxation. This approach is often seen as equitable since it ensures that those who directly benefit from a particular service or resource contribute to its upkeep and maintenance. User fees can cover a wide range of services, such as tolls for using highways, entrance fees for national parks, tuition fees for public universities, and charges for government-provided licenses or permits.
The implementation of user fees requires careful consideration of various factors. Governments need to strike a balance between ensuring that essential services remain accessible to all citizens while also generating sufficient revenue to cover costs. There is also the challenge of avoiding potential inequities, as user fees can disproportionately affect lower-income individuals who may find it difficult to afford these additional expenses. Striking the right balance often involves providing exemptions, discounts, or subsidies to vulnerable populations to mitigate these regressive effects. Overall, user fees can offer a valuable revenue stream for governments while allowing for a more direct connection between the cost of services and the individuals benefiting from them.

Grants

Governments raise money by obtaining grants, which are financial contributions provided by external entities, such as other governments, international organizations, foundations, or private corporations. Grants serve as a means for governments to secure additional funds without resorting to traditional forms of taxation or borrowing. These funds can be directed towards specific projects, programs, or initiatives aligned with the objectives of the grant-giving organization. Grants are often used to support diverse areas such as infrastructure development, healthcare initiatives, education programs, research projects, and social welfare programs.

Obtaining grants requires governments to present well-structured proposals that outline the intended use of funds, the projected outcomes, and the alignment with the grantor’s goals. The process can be competitive, with governments competing against other applicants for limited funding opportunities. Successful grant applications often highlight the potential impact of the proposed project on the community or society as a whole.

While grants provide a valuable source of additional revenue, governments must also consider the conditions and requirements attached to the funds. These conditions can range from strict reporting and accountability measures to mandates regarding the use of funds for specific purposes. Balancing the benefits of grant funding with the need to maintain sovereignty and address local priorities remains a critical aspect of government grant-seeking strategies.

Profits

Governments can generate profits from certain enterprises by engaging in activities that yield revenue beyond the costs of operation. These government-owned or operated ventures, often referred to as public enterprises or state-owned enterprises (SOEs), can encompass a wide range of sectors, including energy, telecommunications, transportation, and more. By effectively managing and strategically investing in these enterprises, governments can not only provide essential services to citizens but also generate income that can be channeled back into public programs and infrastructure development.

To make a profit from public enterprises, governments must adopt effective management practices, ensure operational efficiency, and consider market dynamics. Competing in sectors with private businesses requires governments to maintain high standards of service and innovation to attract customers and clients. However, it’s crucial to strike a balance between profitability and the broader public interest. Some governments choose to subsidize certain enterprises, such as public transportation, to ensure affordability and accessibility for citizens while focusing on profit generation in areas where market dynamics allow. Careful monitoring, transparent governance, and accountability mechanisms are essential to prevent inefficiencies and maintain public trust in these profit-generating government enterprises.

Borrowing

Governments can raise money through borrowing by issuing debt securities in the form of government bonds. When a government needs to finance a budget deficit or fund specific projects, it can borrow funds from investors by selling these bonds. Investors purchase government bonds with the expectation of receiving the principal amount plus interest over a predetermined period. This borrowing mechanism allows governments to access capital without immediately increasing taxes or cutting spending, and the borrowed funds can be used for various purposes such as infrastructure development, public services, or economic stimulus.

The process of government borrowing involves careful consideration of factors such as interest rates, maturity periods, and investor confidence. The government’s creditworthiness and ability to repay debt play a crucial role in determining the terms of borrowing. Governments with strong fiscal discipline and stable economies tend to enjoy lower borrowing costs, as investors perceive them as less risky. Additionally, the central bank’s monetary policy can impact interest rates, affecting the government’s cost of borrowing. While borrowing can provide necessary funds, governments must also be vigilant about managing their debt levels to avoid excessive interest payments and potential negative effects on economic stability.

Governments have several options when issuing debt, including short-term and long- term bonds, as well as bonds with fixed or variable interest rates. By effectively managing their borrowing strategies and adhering to responsible fiscal policies, governments can leverage borrowing as a tool for financing critical initiatives and addressing economic challenges. However, excessive reliance on borrowing can lead to unsustainable debt levels and potential economic instability, underscoring the importance of prudent debt management and long-term financial planning.

Public-Private Partnerships

Public-private partnerships (PPPs) are collaborative arrangements between government entities and private sector companies to jointly plan, develop, and operate projects or services that serve the public interest. These partnerships leverage the strengths of both sectors, combining the public sector’s regulatory and financing capacities with the private sector’s expertise in project management, innovation, and operational efficiency. PPPs can encompass a wide range of initiatives, including infrastructure projects like roads, bridges, and airports, as well as public services like healthcare, education, and utilities. The primary goal of PPPs is to deliver improved services or infrastructure while optimizing resource allocation and risk sharing.

In a PPP, the roles and responsibilities of each partner are defined in a contractual agreement. The government typically outlines the project’s goals, quality standards, and regulatory framework, while the private sector contributes funding, technological know- how, and operational expertise. PPPs can offer several benefits, including enhanced efficiency, reduced financial burden on the public sector, and improved service quality. However, they also come with challenges, such as the potential for conflicts of interest, the complexity of contractual arrangements, and the need for robust regulatory oversight to ensure public welfare is safeguarded. Striking the right balance between public interests and private sector profit motives remains a critical consideration in the successful implementation of PPPs.

Monetary Policy

Monetary policy is a fundamental tool employed by central banks to regulate a nation’s money supply, interest rates, and overall financial conditions with the goal of achieving macroeconomic stability and promoting economic growth. Through various mechanisms, central banks influence borrowing costs, spending patterns, and investment decisions within an economy. By effectively managing the money supply and interest rates, monetary policy seeks to control inflation, maintain stable prices, and support full employment.

Central banks enact monetary policy primarily through open market operations, reserve requirements, and the setting of key interest rates, such as the federal funds rate in the United States. In open market operations, central banks buy or sell government securities to increase or decrease the amount of money in circulation, respectively. Adjusting reserve requirements mandates how much financial institutions must hold in reserves, affecting their lending capacity. Moreover, central banks can directly influence short-term interest rates, which ripple through the economy, by setting policy rates. Lowering interest rates encourages borrowing and spending, fostering economic activity, while raising rates can curb inflationary pressures.

Monetary policy’s effectiveness, however, can be influenced by various factors, including global economic conditions, financial market dynamics, and the velocity of money circulation. In a globally interconnected world, changes in interest rates and money supply can impact exchange rates and capital flows, affecting trade and investment flows. Additionally, the effectiveness of monetary policy hinges on public expectations; if people anticipate that central banks will take certain actions, their behaviors may shift accordingly. The complexity of these interactions highlights the need for central banks to carefully analyze economic data, forecast trends, and communicate their intentions transparently to achieve desired economic outcomes.

Summary

Budgeting stands as the preeminent decision-making procedure within public institutions. Budgets are increasingly complex and lengthy and encapsulate a multitude of functions; they document policy decisions, highlight priorities, clarify program objectives, and outline the entirety of a government’s service endeavors.

Two fundamental types of budgets exist. The prevalent one is the operating budget, a near-term strategy delineating the resource management needed to execute a program. Ordinarily, each fiscal year witnesses the creation of an operating budget. The second variety, the capital budget, addresses extensive expenditures such as infrastructure and edifices. Capital budgets generally extend across periods of 5 to 10 years.

An executive budget embodies both a procedural and material essence. First, it constitutes the process through which agency funding requests are formulated and sent to a central budget office for assessment, adjustments, and compilation. Next, it takes on a tangible form as the official budgetary document for a government’s executive branch, presented by the chief executive to a legislative body for appraisal, amendments, and approval.

Traditional public service financing is predominantly achieved through general taxation. Distinct dissimilarities exist between federal and state-local revenue systems. The federal sphere has witnessed a trend towards reduced variation in personnel, with most of its revenue originating from the federal income tax and the insurance funds like Social Security. In comparison, state and local revenue systems rely on a more diverse array of revenue streams encompassing property taxes, income taxes, sales taxes, user fees, lotteries, and federal grants. While local governments often hinge primarily on property taxes, states—apart from a few exceptions—largely lean on state personal income taxes.

Deficit financing denotes a scenario where a government’s expenditures surpass its receipts within a given period, primarily funded through borrowing from the public.

Politicians often perceive borrowing as a politically preferable alternative to imposing higher taxes, given its discreet nature from the electorate’s perspective. Borrowing’s effects remain virtually unobservable to the public, especially when the outcomes it generates are impressive. Consequently, politicians might view it as a seemingly effortless method to garner favor, particularly when the repercussions only manifest during subsequent administrations.

Economic policy, as the mechanism through which a nation navigates its trade, commerce, and finances, typically comprises three dimensions: (1) fiscal policy, (2) monetary policy, and (3) other public policy aspects that bear economic implications, such as energy policy, agricultural policy, and labor union policy. While monetary policy chiefly governs the quantity and cost (interest rates) of money and credit in the economy, fiscal policy handles the sizes of budgets, deficits, and taxes.

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