Staff Paper Prepared for the President's Commission to Study Capital
Budgeting
October 22, 1998
HOW STATES BUDGET FOR CAPITAL
Summary
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:
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a history of State capital budgets;
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an overview of State budgeting in general, and budgeting by funds;
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the number and variety of State capital budgets; and
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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:
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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;
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emerging needs of the Commonwealth, assessing such issues as the age of
the current assets, demographic changes, and environmental standards; and
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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.
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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.
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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.
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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.
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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.
Footnotes:
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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