WHY WE BUDGET

INTRODUCTION

Rethinking Budgeting will show us how to optimize how local governments’ approach budgeting and be more responsive to our dynamic environment.

Finding the best way to develop a local government budget starts with knowing why local governments create budgets in the first place. Each government is required by law to adopt a budget. Yet, many local governments use budget processes that go beyond what the law requires. This shows us there is value to the budget beyond mere legal compliance.

Local governments provide infrastructure and public services that enable us to live together in communities. Revenue must be collected to pay for these services and spent on public employees, contractors, and capital assets. Public consent is essential, and local governments must justify the money collected, demonstrate that it is spent wisely, and ensure that the spending plan is balanced with available revenues for the short and long-term, while providing flexibility to deal with the unexpected. The budget is how we do this.

Funding choices and priorities must be visible to the public and reflective of the public’s preferences. Critically, the budget needs to change as the public’s preferences and needs change. This requires gaining insight into what the public wants. At the same time, the budget needs flexibility to deal with unplanned, unavoidable events. This could be as dramatic as a natural catastrophe that impacts the community or it could be as simple as an opportunity that emerges after the budget was adopted.

These are the main reasons why we budget. Rethinking Budgeting will show us how to optimize how local governments’ approach budgeting and be more responsive to our dynamic environment. The rest of this document will examine in more detail key themes of why we budget and highlight implications for Rethinking Budgeting. You can explore these details or move on to the next part of Rethinking Budgeting, which is A Guide to Designing a Local Government Budget.

1. PROVIDE PUBLIC GOODS AND SERVICES

The main reason for a local government budget is to allocate funds for the government to purchase goods and services on behalf of the community it serves. Why can’t communities simply rely on private firms for these goods and services? Government spending is necessary because markets are imperfect, sometimes leading to . The most salient type of market failure for a local government budget is the A public good differs from a private good (i.e., goods of the type typically purchased from private firms) in two ways:

  • Nonexcludable. A service is nonexcludable if nonpaying customers cannot be prevented from benefiting from it. For example, a downtown beautification program improves the aesthetic experience for everyone who visits downtown. In another example, a professional police force makes the community safer for everyone.
  • Nonrivalrous. The use of a service by one person does not reduce its value for another person. Using our examples above, two people can enjoy a beautiful downtown and a safe community at the same time, without diminishing each other’s benefit.

These features of public goods (or services) make it difficult to charge a fee to the user, as one would for private goods or services. For example, what would be the basis for a charge for enjoying the aesthetics of a downtown or experiencing a safe community?

Instead, local governments levy taxes. The budget then allocates those revenues to provide public goods like safety, health, education, and quality of life. Public goods are the most prominent type of market failure that requires government spending, but that is not the only type that results in the underprovision of services by the private economy. A good example is trash collection. Trash collection is excludable and rivalrous, so individual residents could contract with their own waste haulers. However, this would strain local roadway infrastructure, and some residents might find less sanitary ways to dispose of their trash (i.e., “fly dumping”), thereby creating public health problems. Hence, local governments often provide this service and charge a fee for it because of the public health benefits universal waste removal service provides and to limit strain on local roadways.

The budget is the vehicle for funding services needed for a thriving economy—services that the private sector is unlikely to provide on its own or will underprovide because market failures make achieving a profit through a conventional fee-for-service approach too difficult or impossible.

Further, the local government budget is the vehicle for producing public goods at scale. Public goods are produced more efficiently when produced at a certain volume. A local government does not have to be huge to achieve these efficiencies. Research shows that economies of scale are largely achieved for most (but not all) public services for municipalities with a population of 20,000 to 40,000 Even a local government of 20,000 people is larger than a city block or some other more “natural” size of human organization, which is thought to be around 200 people Thus, the local government budget coordinates the preferences and financial contributions across large numbers of people to produce public goods and to coordinate the financial, human, and capital resources needed for their production.

It is important to understand these market failures because the goods and services local governments provide often pose distinct funding challenges that prevent the private sector from efficiently providing these services on its own. Thus, without a well-functioning local government, communities will find it difficult to thrive. A leading challenge for public budgets is that groups of people must agree on a course of action, rather than individual consumers making independent choices. It would be best for the whole community if the public budget were financially sustainable and provided a level of service that most people agreed with. However, individual participants in the budgeting process are often incentivized to maximize their own benefits from the budget. If too many people pursue this approach, the budget may become overused, leading to financial stress. We will delve deeper into this issue later. For now, we will note that Rethinking Budgeting must contend with the production of public goods and the challenges of group decision-making with public funds.

2. MAKE WISE CHOICES WITH PUBLIC MONEY

There are many kinds and amounts of public goods and services that a local government could produce. A budget must allocate the community’s resources to the best uses among the available options. The budget process makes clear what services are being funded and the amount of funding they are getting.

Among the services funded, the budget has a role in defining what constitutes “value” for the money that government spends and then generating the best value for each dollar spent. For example, if the local government is going to provide a given service, the budget could be used to fund one of many options for that service. Perhaps local government staff are the best providers of services; perhaps a private contractor would be better; or a local community nonprofit. Rethinking Budgeting shows how the budget process can be used to assess the value of public spending options.

Local governments are meant to be enduring institutions. They have a responsibility to chart a sustainable financial trajectory and build resiliency or the capacity to bounce back from setbacks. The budget process should ensure that today’s choices do not compromise the ability of future generations to provide good public services to the community. Thus, the budget process must help government spend within its means, add resources to address new or expanding responsibilities, while also preserving or creating capacity to respond to the unexpected. At the same time, the local government budget must not underprovide services if the resources are available to do so. Rethinking Budgeting shows how the budget can find the balance between: A) spending today versus investing in the future; and B) public spending versus leaving money in the private economy.

3. BUILD PUBLIC CONFIDENCE

A local government needs the support of its This requires that constituents have confidence that the local government is providing them with reasonable value and that public money is being used wisely. To some extent, this purpose of local government budgeting is a function of the first two, but it is different in one important way—the need for open communication, fairness, and trust with the public. Let’s imagine that a local government is making wise choices with public money and investing in public goods and services. If the public has a tough time seeing this or believing it, the investments are not distributed fairly, or the process used to make those choices appears suspect then the local government’s good work will not build the public’s confidence. The budget must communicate to the public what is being done, in a way that the public can understand it and that is fair, if trust in government is to be rebuilt. Rethinking Budgeting shows how outcomes that the public wants or needs are addressed in the budget, the resources used and created to achieve those outcomes, and how results can be demonstrated.

Local government is also an institution of representative democracy led by elected officials. Elected officials can gain the support of the community by doing good in the community and showing their constituents that good is being done. Rethinking Budgeting shows how the budget is a tool for gaining public support.

4. ADDRESS COMPLEX COMMUNITY PROBLEMS

Local governments are expected to address complex community problems, like affordable housing, public health and safety problems, This requires long-term planning, flexibility to adapt to changing circumstances, and more resources. Local governments will need partners like other governments, private firms, nonprofit organizations, and more. Local governments will also need to work closely with community members and engage them in decision-making. Rethinking Budgeting addresses how the budget and planning process can help organize the people and resources needed to take on complex problems and big goals.

Endnotes

  1. Our example of trash collection illustrates two types of market failures.

    “Natural monopolies” or services where high infrastructure costs and other factors create a situation where the efficient way to produce the service is through a single provider. Local governments often are the providers of natural monopolies, like water and sewer utilities and spaces for on-street parking. Trash collection’s strain on roadways is an example of a natural monopoly.

    “Merit goods” include services like education, which might be underconsumed in a pure market economy because the benefits do not accrue to the consumer in the short-term and/or because there are positive benefits to society beyond the benefit to the individual consumer. The public health benefits of trash collection are a merit good. There are other market failures governments might need to address. For example, some researchers feel that poverty or income inequality constitute a market failure, which makes the case for local governments getting involved in problems like homelessness or affordable housing. Though private firms can provide public goods, the private sector is likely to underprovide public goods relative to the demand. This is because it is difficult to price public goods and assign prices to users, and because users are often able to enjoy the benefits of public goods without paying.