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How States Budget for Capital

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Commission to Study Capital Budgetting
Staff Paper Prepared for the President's Commission to Study Capital Budgeting

October 22, 1998

Most States have a capital budget, which consists of capital spending that is planned, analyzed, presented, enacted , or financed separately to some degree from other State spending. The nature of the capital planning process, the form of the Governor's capital budget proposal, the way legislatures enact capital spending, the coverage of the capital budget, and the method of financing vary widely among States.

Although there is no standard definition of a State capital budget, the following may be a good working definition:

    A State capital budget is the prioritized list of capital improvement projects, adopted by the governing body along with the operating budget for the next fiscal year. It includes projects financed by various revenue sources.(1) 
Based on studies done since the early 1960s, the number of States with separate capital budgets has increased.

Capital is defined by many States to be construction, major renovation, land, and major equipment above a minimum threshold. In many States, however, significant amounts of capital expenditures, such as those for transportation (mainly highways) or special authorities (e.g., university systems, hospitals, or toll roads), or aid to localities, are not included in the State capital budget, or perhaps even in the State budget generally.

An important part of many State capital budgets is a long term planning process, or capital improvement program. This plan prioritizes projects over a multi-year period, such as five years, and as projects move closer to the budget year they must undergo increasing scrutiny in order to be funded.

Capital projects can be financed by general purpose revenues, dedicated revenues, Federal grants, or borrowing. If financed by borrowing, the borrowing is usually designated for specific projects or groups of projects, and the amount, type, and purpose of borrowing is constrained by the State's laws or constitution and the credit market's assessment of the risk associated with the debt.

No State records depreciation in its budget. In addition, States do not record depreciation in their financial accounting statements for governmental funds.

Current information about State capital budgets is available in a publication by the National Association of State Budget Officers, Capital Budgeting in the States, published most recently in September 1997.

The following sections provide more information on State capital budgets. The sections discuss:

  • a history of State capital budgets;
  • an overview of State budgeting in general, and budgeting by funds;
  • the number and variety of State capital budgets; and
  • a description of State capital budgets, including coverage, planning, budgeting, and financing.
A History of State Capital Budgets

Comprehensive State and local budgetary processes appeared in the early part of this century as the result of encouragement by civic reformers, businessmen, and public administration scholars. In the early 1920s some cities began a comprehensive approach to capital planning with the development of local Master Plans, and by the end of the decade capital budgets emerged to link the planning process to realistic assessments of the community's willingness to pay for what was being planned. This process continued into the 1930s. Bozeman(2) identifies four factors that led to the development of public sector capital budgets:

    1) The emergence of official planning commissions in the 1920s resulted in Master Plans for physical development of communities.

    2) In the field of public administration increased attention was paid to budgeting in general and the improvement of administrative practices and their policy implications.

    3) The Great Depression caused communities to learn that massive public works projects could lead to fiscal crises and bankruptcies if the limits to resources were not recognized.

    4) World War II caused communities to plan for the return of soldiers and the need for new roads, schools, water and sewer lines, and other infrastructure.

By the late 1940s capital planning and capital budgets were in place in many communities and States, and since that time budget reform efforts have focused on other ways to improve budgeting, including performance budgeting; program planning budgeting systems (PPBS), which focused on benefit-cost analysis; management by objectives; and zero-based budgeting. These latter efforts focused primarily on operating expenditures and less so on capital budgets. More recent efforts have focused on a longer range outlook for capital planning, increased automation in the planning process, greater emphasis on analyzing life-cycle costs, linking capital acquisitions to program performance measures, and ensuring that all expenditures, including capital expenditures, help achieve established long range goals.(3) (4) 

Overview of State Budgeting: Budgeting by Funds

All States budget differently. Their budgeting systems are the result of traditions and preferences that have developed, for some States, over more than 200 years. There are differences in the relative authority of the governor and the legislature, in the frequency in which the legislature meets, in the State's relations to local governments, in traditions about borrowing, and many other aspects of budgeting, including budgeting for capital. As a result, it is difficult to identify a typical State budgeting system.

Despite these differences, an understanding of State budgets, and especially State capital budgets, requires an understanding of budgeting by funds, because most States budget by the use of different funds. Most States have most of their spending in a general fund. Receipts to the general fund can come from general purpose and miscellaneous taxes. Spending in this fund can be for State operations, aid to localities, capital projects not in the capital fund, debt service (principal and interest) on general obligations bonds, and transfers to other funds. For most States, spending in the general fund cannot exceed annual revenues plus beginning year balances, although the stringency of this requirement to balance the general fund differs widely.(5)  Borrowing is not permitted except for short-term purposes to smooth out seasonality in tax collections.

In addition to the general fund, most States also have special revenue funds, although different States give this category different names, such as special funds, or non general funds. Spending in these funds is generally financed by earmarked revenues, such as highway taxes (if not in the capital fund); grants from the Federal Government; State lottery receipts; or fees for motor vehicle licenses, parks and recreation, fish and game licenses, or business regulation. Some of these funds can be very small, and some States may have a large number of special revenue funds. As with the general fund, spending in special funds generally cannot exceed annual revenues plus the beginning year balance.

Many States also have a capital projects fund, which is often called the "capital budget." In some States the fund may cover only capital projects financed by borrowing, while in other States it may include projects financed by Federal grants, earmarked revenues from a State's own sources, or transfers from the general fund. The method of appropriation for these projects also differs among the States. In some States this fund may have a separate capital appropriations bill, in some it may have several capital appropriations bills, and in other States capital projects may be appropriated in bills that include operating expenditures, with the amounts for the capital projects fund identified separately in the bill.

States that borrow may also have a debt service fund, which receives payments from the general fund to pay interest and principal on bonds sold to finance capital projects. The bonds are generally linked to a specific project or group of projects, and the maturity of the bonds may in some cases match roughly the expected life of the projects. The timing of payments from the general fund to the debt service fund can vary.

In addition to these funds, some States may have other funds, such as an exchange stabilization fund, highway fund, Federal grants fund, bond fund, public enterprise funds, or retirement funds.

The Number and Variety of State Capital Budgets

Because there is no standard definition of what is and is not a State capital budget, it is difficult to identify how many States have a separate capital budget. The National Association of State Budget Officers (NASBO) publishes a survey of good practices in capital budgeting, which focuses on how States plan, budget for, and finance capital. This survey indicates that only South Dakota does not have a capital budget.(6)  Other efforts to count the number of State capital budgets using different criteria indicate that 29 States had a capital budget (c. 1962) (7), 31 States had a capital budget (1963) (8) ; 42 States had a capital budget (1986) (9) ; and 37 States (of the 45 that responded to a GAO survey) had a capital budget (1986) (10) . This suggests that since the early 1960s an increasing number of States have developed separate capital budgets.

A Description of State Capital Budgets

Coverage of State capital budgets and definition of capital.--Capital is defined by many States to be construction, major renovation, land, and major equipment above a minimum threshold. In many States, however, significant amounts of capital expenditures, such as those for transportation (mainly highways) or special authorities (e.g., university systems, hospitals, or toll roads), are not included in the State capital budget, or even in the State budget generally. In addition, State grants to localities for certain capital projects may also not be in the State capital budget.

Planning for capital.-Capital projects that are candidates for the capital budget are often part of an extensive planning process that takes place prior to the inclusion of a project in the list of projects that is the State capital budget. This planning process is often called a capital improvement program (CIP) and ranks projects over a 5-10 year period.(1)  As projects move closer to the budget year, the required degree of analysis and justification increases before they can appear in the Governor's budget and be approved for funding by the legislature. For many States, an important part of this plan is an inventory and assessment of the condition of existing capital assets.

In Virginia (11) the capital outlay plan is for six years, and the current plan for 1998-2004 covers three bienniums (1998-2000, 2000-2002, and 2002-2004). The six-year plan addresses three major areas:

  • how projects would be financed, focusing largely on the relative use of current revenues (pay-as-you-go) and debt financing (pay-as-you-use), and the Commonwealth's debt capacity;
  • emerging needs of the Commonwealth, assessing such issues as the age of the current assets, demographic changes, and environmental standards; and
  • recommendations for specific capital projects for each of the three bienniums.
Budgeting for capital.--The nature of the Governor's budget proposal and its enactment in the legislature vary widely among the States.

The Governor's capital budget proposal to the legislature normally begins with the State budget office preparing guidelines for State agencies to submit proposals. Some States permit nonprofit agencies, boards and commissions, public authorities, and elected officials to make requests for capital projects. About half the States have a separate capital budget document and about half combine capital and operating expenditures in one document.

Many States have joint boards that include executive and legislative officials that inform the budgeting process in the legislature. In some cases the capital budget is a separate capital appropriations bill, in some cases it is several bills, and in others the capital projects are parts of appropriations bills that include operating expenditures.

No State records depreciation in its budget. In addition, States do not record depreciation in their financial accounting statements for governmental funds. They record it only for proprietary funds (commercial-type funds that sell goods or services to the public or other units of the government) and for nonexpendable trust funds (those trust funds where net income, expense, or capital maintenance is measured).(12)  Under a proposed change in financial reporting standards, however, depreciation on general capital assets would be recognized as an expense in entity-wide financial statements.(13)  This would not affect the State budget.

Financing capital projects.--Capital projects can be financed by transfers from the general fund, dedicated revenues, Federal grants, or borrowing.

  • The availability of general funds for capital projects depends in part on other demands from the general fund and on the economic condition of the State. When growth in revenues is strong there is more likely to be general revenues available to finance capital projects.
  • The most prevalent example of a State dedicated revenue is the State gasoline tax. Other examples can include tolls or fees from bridges or other facilities, or dedicated revenues for construction of higher education facilities.
  • Federal grants to States make a significant contribution to State capital spending. The largest grant of this type is for highway construction, financed by the Federal tax on gasoline.
  • State borrowing can be in the form of general obligation bonds or revenue bonds, and is subject to constitutional or legal restrictions on the State debt limit, the judgment of the financial markets regarding the risk associated with the debt, the desire of the State to maintain its credit rating, and other factors. Revenue bonds are bonds backed by a dedicated revenue stream, such as tolls or other fees.
1/  Linda Hollis, AICP, Tischler and Associates, Inc, on behalf of the American Planning Association, in testimony before the Subcommittee on Economic Development, Committee on Public Works and Transportation, House of Representatives, June 16, 1993. It should be understood that capital improvements would not include routine maintenance. It should also be understood that capital budgets are not always enacted with the operating budget, and a capital budget is often for mutli-year projects, not just for spending for the next fiscal year.

2/  J. Lisle Bozeman, "The Capital Budget: History and Future Directions," Public Budgeting & Finance 4 (Autumn 1984).

3/  National Association of State Budget Officers, Capital Budgeting in the States, September 1997, p. 10.

4/  National Advisory Council on State and Local Budgeting, "A Framework for Improved State and Local Government Budgeting and Recommended Budget Practices" (December 15, 1997).

5/  Steven D. Gold, "State Government Experience with Balanced Budget Requirements: Relevance to Federal Proposals," Statement to the Budget Committee, U.S. House of Representatives, May 13, 1992; and Richard Briffault, Balancing Acts: The Reality Behind State Balanced Budget Requirements, New York: Twentieth Century Fund, 1996.

6/  National Association of State Budget Officers, Capital Budgeting in the States, September 1997, Table 6: Organization of the Capital Budget. Massachusetts and Nevada did not respond to the survey.

7/  James M. Poterba, "Capital Budgets, Borrowing Rules, and State Capital Spending," National Bureau of Economic Research, Inc. Working Paper No. 4235, December 1992.

8/  Albert M. Hillhouse and S. Kenneth Howard, State Capital Budgeting, Chicago: Council of State Governments, 1963, p. 4.

9/  Lawrence W. Hush and Kathleen Peroff, "The Variety of State Capital Budgets: A Survey," Public Budgeting and Finance (Summer 1988), pp 67-79.

10/  General Accounting Office, "Budget Issues: Capital Budgeting Practices in the States," GAO/AFMD-86-63FS, July 1986.

11/  Ronald L. Tillett, Secretary of Finance, Commonwealth of Virginia, testimony before the President's Commission to Study Capital Budgeting, May 8, 1998; and "Six-Year Capital Outlay Plan: 1998-2004" for the Commonwealth of Virginia.

12/  Governmental Accounting Standards Board (GASB), Codification of Governmental Accounting and Financial Reporting Standards as of June 30, 1996, sections 1100.107 and 1400.114-1400.118.

13/  Governmental Accounting Standard Board, Exposure Draft, Basic Financial Statements -- and Management's Discussion and Analysis -- for State and Local Governments (January 31, 1997), paragraphs 33-37 and 273-81.

President's Commission to Study Capital Budgeting

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How States Budget for Capital

A Matrix of Capital Budgeting