The budgetary process

Although the major budgetary decisions that affect the performance of the economy and the national debt are usually made by the central government, most countries have local or state governments that are responsible for the provision of various services and have the authority to raise revenues through taxation or to borrow on their own account. This devolution of authority is greatest in the United States, where the majority of provision of civilian services is carried out at state or local levels and where states have a tradition of being individual decision-making units. In the United Kingdom, by contrast, local-authority spending is constrained by rules set by the central government. Local authorities are also limited in their ability to borrow and to raise taxes, which are set by the central government. The budget of the European Union is an example where authority for major spending, particularly for agricultural support, has devolved to a transnational body.

Expenditures by state and local governments grew rapidly in the United States after World War II, particularly in the areas of education, health, and welfare services. Rising expenditures have been coupled with an expansion of the number of taxes used at this level and a widening of the traditional tax base from property. Although some local activity is financed by federal grants or by taxes that are shared between the federal and state level, the majority of expenditure at state and local levels is raised by locally determined taxes. Most federal grants are specific, for particular and limited purposes. The majority of such grants concern education, income security (e.g., public aid, housing assistance), and health programs such as Medicaid. The appropriate balance both of public provision and of revenue sources between federal, state, and local levels is the subject of continuing and vigorous debate.

The individual states pioneered the use of income taxation before World War I, but today the federal government is the major user of this form of revenue, with only limited scope for state income taxes. The decline of income taxes as a source of local finance at the state level was also hastened by problems with the definition of income and rising collection and compliance costs.

Diminishing taxation of income, coupled with congressional rejection of a general sales tax in the 1930s, led to a growth in the use of the retail sales tax; in the late 20th century most states have adopted this as their major source of finance. Taxation of business income at the state level has also run into problems, not least because of its damaging effects on interstate trade; accordingly, although most states have tried such taxes, their importance remains limited. Property taxes, which once were the major source of state revenue, have, during the 20th century become largely a local tax.

The 20th century has witnessed a large shift in expenditures on civil functions. In 1902 more than 70 percent of such functions were supported by local governments out of revenue raised predominantly from property taxes. But through the following decades, the proportion provided by local governments shrank to less than one-half, with the states taking on a larger share of the funding and the federal provision also increasing. During the period since World War II, the balance of state and local expenditure has shifted somewhat, with education increasing in importance (today it accounts for more than one-third of the state and local budget), while highways have increasingly become a federal function, carried out with either direct federal funding or grants-in-aid to state and local governments.

Relations between the federal and state governments have been through a number of cycles in the postwar period. In 1948 grants to state and local governments were small, but they increased so dramatically during the 1960s that only the most dynamic local administrations could keep up. The allocation of resources came to depend more on the efficiency and wit of local administrators than on any particular need. A backlash to this situation took place during the 1970s, with a strong movement toward grants allocated by formula (loosely based on need) rather than application from the states. In 1972 Congress passed the State and Local Fiscal Assistance Act, which over a five-year period allocated some $30,000,000,000, one-third to state governments and two-thirds to local governments. This act, called general revenue sharing, continued into the 1980s although the amounts it allocated generally diminished after 1980. Only a fraction of the total amount of federal aid to state and local governments, estimated to exceed $100,000,000,000 per year by the mid-1980s, was provided by the act.

The United Kingdom has a number of different levels of government, ranging from local parishes to the central government and including districts (town, borough, or city), counties, and metropolitan counties. All these levels have different traditional roles and are responsible for the provision of particular services. Historically, apart from direct contributions to finance the activities of parish councils and charges for local services, the only source of local revenue was a property tax called rates.

Rates are levied, at levels determined by county and district authorities, on both households and businesses in proportion to the ratable value of the property they occupy. This ratable value, in principle revised periodically, is supposed to reflect the rental value of the property in a base year; increases in revenue are caused not by changes in ratable values but by steady increases in rate poundage (tax rate).

The domestic rates system of collecting revenue for local government was replaced in Scotland in 1989 and in England and Wales in 1990 by a community charge, or poll tax, determined by each community and payable by nearly every adult resident. (The rates system remains in use in Northern Ireland.) The flat-rate poll tax proved highly unpopular, leading to large-scale demonstrations and the worst riot in the city of London in the 20th century. In April 1993 the controversial poll tax was replaced with a council tax, under which each household pays a single bill based on the market value of its property and on the number of adults living in it. Rebates and discounts are available for low-income households.

Local taxes do not raise sufficient funds to cover expenditure, so that local authorities are very dependent on grants from the central government. These are determined according to complex formulas that relate them to needs and resources in each local area. The central government now tries to limit local expenditure by imposing penalties on high-spending authorities through the grant system.

Each year, European countries that are part of the European Union agree on a budget for the EU. This covers expenditure on agricultural support, on regional and social development, and on the financing of various transnational agencies. The budget is presented in a series of drafts that are substantially revised following discussion among ministers from the various countries. Finance for the budget of the EU is provided by the common external tariff levied on all imports from outside the EU and by a national contribution that is set, in most cases, as a fixed percentage of the “value-added base” (roughly the national income) of each member state.

Studies of the governmental budget include Jesse Burkhead, Government Budgeting (1956); E.S. Kirschen et al., Economic Policy in Our Time, 3 vol. (1964); J.R. Hicks, The Social Framework: An Introduction to Economics, 4th ed. (1971); United States. Congress, Planning, Programming, Budgeting: Inquiry (1970); David J. Ott and Attiat F. Ott, Federal Budget Policy, 3rd ed. (1977); Peter C. Sarant, Zero-Based Budgeting in the Public Sector: A Pragmatic Approach (1978); and Wilfred Beckerman, An Introduction to National Income Analysis, 3rd ed. (1980). Survey of Current Business (monthy), published by the Bureau of Economic Analysis of the United States Department of Commerce, together with its supplement, The National Income and Product Accounts of the United States: Statistical Tables (irregular), provides practical analyses. The Brookings Institution annual Setting National Priorities explores U.S. budgetary developments; and the London Institute for Fiscal Studies does the same for the United Kingdom in its IFS Report Series.

Components of the budget and their interrelation are explored in Richard A. Musgrave, Fiscal Systems (1969, reprinted 1981); Hugh Heclo and Aaron Wildavsky, The Private Government of Public Money, 2nd ed. (1981); Alan T. Peacock and Jack Wiseman, The Growth of Public Expenditure in the United Kingdom, 2nd rev. ed. (1967); Leo Pliatzky, Getting and Spending: Public Expenditure, Employment, and Inflation, rev. ed. (1984); Carl S. Shoup, Public Finance (1969); Harold F. Williamson (ed.), The Growth of the American Economy, 2nd ed. (1951); Alan S. Blinder et al., The Economics of Public Finance (1974); Charles L. Schultze, The Politics and Economics of Public Spending (1968); J.A. Kay and M.A. King, The British Tax System, 3rd ed. (1983); Carolyn Webber and Aaron Wildavsky, A History of Taxation and Expenditure in the Western World (1986); Mervyn A. King and Don Fullerton (eds.), The Taxation of Income from Capital: A Comparative Study in the United States, the United Kingdom, Sweden, and West Germany (1984); John F. Due and John L. Mikesell, Sales Taxation: State and Local Structure and Administration (1983); Charles E. Walker and Mark A. Bloomfield (eds.), New Directions in Federal Tax Policy for the 1980s (1983); Mark Ashworth, John Hills, and Nick Morris, Public Finances in Perspective (1984); Henry C. Adams, Public Debts: An Essay in the Science of Finance (1887, reprinted 1975); John Maynard Keynes, How to Pay for the War (1940); Tilford C. Gaines, Techniques of Treasury Debt Management (1962); Warren L. Smith, Debt Management in the United States (1960); Edward Nevin, The Problem of the National Debt (1954); Henry C. Murphy, The National Debt in War and Transition (1950); A. James Heins, Constitutional Restrictions Against State Debt (1963); James M. Buchanan, Public Principles of Public Debt (1958); and James M. Ferguson (ed.), Public Debt and Future Generations (1964, reprinted 1982).

The budgetary process at both national and local levels is discussed in Richard A. Musgrave and Peggy B. Musgrave, Public Finance in Theory and Practice, 4th ed. (1984); Arthur Smithies, The Budgetary Process in the United States (1955); Aaron Wildavsky, The Politics of the Budgetary Process, 4th ed. (1984); Sir Herbert Brittain, The British Budgetary System (1959); Samuel Brittan, Steering the Economy: The British Experiment (1971); R.W. Davies, The Development of the Soviet Budgetary System (1958, reprinted 1979); David Novick (ed.), Program Budgeting: Program Analysis and the Federal Budget, 2nd ed. (1969); Richard A. Musgrave (ed.), Essays in Fiscal Federalism (1965, reprinted 1977); Wallace E. Oates, Fiscal Federalism (1972); C.D. Foster, R.A. Jackman, and M. Perlman, Local Government Finance in a Unitary State (1980); and J. Richard Aronson and John Hilley, Financing State and Local Governments, 4th ed. (1986).