Introduction: Capital Budgeting in the States After the Great Recession

Operating and Capital Budgets

It is important to remember to distinguish between operating and capital budgets which are used for different purposes. Operating budgets administer and spend revenues to buy goods and services that are immediately or nearly so paid for, delivered, and consumed. Capital budgets manage revenues which often are not just spent, but invested both purchasing things and getting them and the benefits from them less immediately. Decisions about budgets that pay for and structure investments, capital budgets, call for a distinctly different point of view than that of operating budgets that pay for the day-to-day business of state and local governments. Spending decisions encapsulated in capital budgets are about investment, which is a longer term, and higher priced expenditure usually to buy longer lasting more durable things that produce future term, often imprecisely calculated, benefits, and pay offs that are called returns. The capital process seeks to answer three basic questions:

In the operating budget case (e.g., the law enforcement personnel spending mentioned above), expenditures go to purchase immediate actions and directly delivered benefits that are closely linked in time (all transactions occur somewhat immediately): answering citizen calls for service, protection of property, pursuit of criminal activity, and preservation of order. In case of capital budgeting, however, authorized and budgeted expenditures may immediately and directly purchase or pay for physical infrastructure like the parking garage mentioned above or they may be used to service bonds that are sold to finance the purchase which may occur over many years and may come from sources directly used to pay for the parking garage like user fees; likewise, the benefits may only fully accrue in the future when the infrastructure is built, in full use, and the benefits are fully realized: the parking garage is finally constructed over a period of years; initial use is down and parking fees are low; the jurisdiction has to subsidize the bond repayment; and finally demand for the garage parking rates are sufficient to have the revenue stream from it pay off the bonds. Of course, there is no guarantee that it will work out this way.

Difference in Perspectives

It is this longer term and thus less certain perspective about expenditures as well as their relative size that make capital budgets so important to state and local jurisdictions. Because the amount of money they have to invest is limited and even more limited during an economic downturn, decisions about investments must be made with great care. These decisions may lock up revenues for a long time or require a large initial expenditure. Also, because benefits accrue in the future they are not only discounted but may not be fully realized in the future at all due to predictions that are off or unforeseen circumstances. During economic downturns, when many capital investments are made or justified because of their expected impact on the economy (e.g., roads, stadiums, convention centers, spaceports, trains), the ability to predict return on the capital investment, durability or life cycle of the capital investment, and costs of the investment are of paramount importance. In this regard, it is important to consider the impact of capital expenditures on the operating budget: every bit of infrastructure requires operation, maintenance, repair, renovation, and replacement: all of these capital support functions are operating expenditures all.

It is worth noting too that capital expenditures are important not only from an administrative standpoint of good government but from a political one as well. In this journal, one author has found that an influence as important as good government on the tenure of Mayors is the construction of physical infrastructure in their jurisdictions (McNitt 2010). Mostly, this is due to some of the reasons mentioned above like the size of expenditures and their role in the economy of the jurisdiction which creates political backing from the political class. One can easily see that this could be true for state officials as well.

Varieties of Capital Budgeting

Fittingly, the essay presented in this issue of State and Local Government Review’s Governance Matters section looks at capital budgeting practices and processes in the states. It lays out the findings from a survey and accompanying interviews about how forty state respondents organize and structure their budgeting processes, plan for and execute capital expenditures, and the influences on the evolution of these practices. In short, as the title implies, it looks and describes the varieties of capital budgeting in the states.

The survey and initial follow-up interviews were conducted during a seven-month period in 2011 by its author, Natalia Ermasova, from Governors State University. Accordingly, some of her findings speak directly to capital budgeting practices and thinking in the states after the Great Recession and thus are not only an important descriptive contribution to the understanding of current behavior in capital processes but inform both thinking and speculation about the effects of the economic downturn on that behavior.

For these reasons, this article should be of interest to academics and practitioners alike. It gives an overview to those interested in studying the process and raises questions that need to be addressed by research. In addition, it presents variations in capital budgeting behavior that may spark ideas for change in existing capital budget processes and administration. Thus, it has the possibility of stimulating study, debate, and innovation. Moreover, it provides a taxonomy and classification scheme that may make some of these questions both easier to discuss and better analyzed in the future.