While governmental entities must strive to serve the public good to the best of their abilities, public administrators must navigate an environment of extreme complexity in which the allocated capital funds are put to their best use. The administration of the capital budgeting process can be extremely time consuming, confusing, and expensive. This research will discuss capital budgeting policies and procedures in the states of New York as well as Pennsylvania for the fiscal years of 2009 and 2010. These governmental entities generate funds through taxes, public debt, inter-governmental transfers and various businesses owned by the government and capital projects represent a significant portion of the state's responsibilities. With the use of a prepared financial analysis, this paper will describe current practices and examine how debt ratio affects borrowing and investment opportunities for the two governmental entities.
Much of public spending on capital projects is geared at making investments for the future. Examples of this include education, transportation infrastructure, and environmental protection measures. However, some capital expenditures are also geared to social causes such as low-income housing and creating public goods such as parks and other recreational facilities. In addition, capital expenditures can have positive impacts on the state's economy because they can act to spur growth and economic development. However, too much public funding of capital projects can also crowd out private investments (Aschauer, 1989). Therefore it is up to the public officials to try to find the right balance between public and private capital projects to find the optimal point for social and economic benefit; which adds another layer of complexity to the equation.
Overview of Capital Expenditures
Capital expenditures serve many goals within state governments. They can be used as a fiscal policy that improves the economic infrastructure and facilitates economic development. They can also be used in a redistributive manner that can address certain social causes or provide public goods. Various forms of capital expenditures have shown a positive correlation with productivity in governments and are an important long-term policy tool (Bronzini, 2009). Capital expenditures often have a greater reliance on debt than more conventional methods of financing through state revenues. Capital budgets can also be used to reduce deficits by shifting short-term debt into long-term debt.
This often makes it challenging for a public official to find the right balance between current and capital expenditures (Borio & Zhu, 2011). Many public officials are not qualified to properly evaluate the nuances involved in achieving such a balance and as a result it is not uncommon for capital budgets to run a deficit due to poor management and performance of capital expenditures. However, many of these poor results often could have been mitigated with proper capital budgeting techniques. Given their immense value to society as well as their tendency to run amuck, it is important for policy makers to properly allocate and account for their capital resource investments.
Capital Expenditures are generally financed through either debt or equity financing. The most common form of financing capital expenditures is through the issuance of state governmental bonds. State bonds often offer investors a fairly low risk investment while also offering some amount of tax advantages in many cases. Municipal bonds, for example, are generally exempt from all income taxes on both the state and federal level (Chan, 2012). Therefore investors are attracted to the bonds because they generally have higher rates than treasury bills while at the same time being virtually risk free and also providing the tax advantages.
As portions of the debt from bonds to maturity, the state governments do not necessarily cut expenditures, or raise taxes to provide the funds required. Rather, the governments can also choose to refinance the debt by selling new bonds, and using the proceeds to pay off holders of the maturing (Moldogaziev, 2012). Refinancing of the bonds has the same incentives for investors as the previous bonds and this can also be used as a tool to reduce deficits without too much work on the state governments' behalf. However, that being the case, eventually the states must deal with their principle obligations without continually rolling over the interest payments. If states choose this path then they can find themselves in a position in which a large percentage of their revenues are dedicated to making interest payments on large capital expenditures.
The risks associated with the issuance of bonds is generally ranked by one of the major bond rating agencies; Moody's Investor Service, Fitch, and Standard & Poor's Corporation (S&P) represent some of the largest credit ranking agencies (Schmidt, 2012). The higher the ratings that state governments receive from these rating agencies, the lower the required interest payments to find investors in the market. The concept of rating a government's ability to repay debt is at the core of the ability of the governmental entity to acquire funding for capital improvements. The more risk that is associated with a bond, the higher the interest payment will have to be to attract potential investors.
Studies have demonstrated that public officials may use the depreciation schedules to determine when a deteriorating capital asset needs to be replaced with new capital expenditures (Colasse, 1983). However, given the fact that many states have crumbling infrastructures, including roads, highways, and bridges, using the depreciation schedule for guidance is most likely not the right model to base such decisions off of (Sledge, 2012). Furthermore, there have also been allegations that state corruption and political connections have strong effects on municipal bond sales and the underwriting of these bonds (Butler, 2009). For example, in some cases a certain financial institution may make financial contributions to a candidate's campaign while later on receiving a large contract to manage the states bonds. The private financial institutions may issue fees that are higher than the market price and the public ultimately must pay the price for such questionable practices.
Analysis of Two State's Capital Expenditures
Two states were selected and the ratios of their capital expenditures to their total revenues were calculated. In New York, the ratio was 8.36% in 2009 and then fell to 7.61% in 2010. In Pennsylvania, the state's ratio of capital expenditures to revenue was 19.32% in 2009 and then fell to 16.19% in 2010. Further analysis revealed that the capital accounts had actually increased in both cases by substantial amounts. This is likely due to the fact that the states' did not commit to as high of a rate capital expenditures in the 2010 fiscal year and as a result there were more funds left in this account.
In Pennsylvania the total amount of funds allocated to unreserved capital projects decreased significantly. However, since the unreserved capital account in this case was running a deficit, this translates into the fact that the state must have added funding to the unreserved account to cut its deficit. By contrast, the deficit in the unreserved account in New York continued to grow by over nine percent. Thus while Pennsylvania was able to stem the deficit in this account, New York continued to grow their deficit. Neither state implemented any significant changes to their existing tax policies' and the calculated changes in the ratio of capital expenditures between the years are based on the differences in the capital allocations. Given the fact that it was identified that capital expenditures could be used as a fiscal stimulus and the country was still in a recession, it is likely that the capital expenditures were inadequate to stimulate the state's economy; especially since both states reduced their capital expenditures. However, given the fact that the state official were more focused on total debt amounts than instituting stimulus policies, the reduction in capital expenditures is in line with this political position.
New York also uses a much smaller percentage of its total revenues for capital projects. However, at the same it time it spends nearly twice as much as Pennsylvania on capital improvements. This is due to the fact that New York's general revenue collections greatly exceed that of Pennsylvania's. Since Pennsylvania does not have the same revenues as the state of New York, they must use a much higher percentage of their total revenues to invest in items such as infrastructure projects as well as maintenance. However, Pennsylvania has also been noted as being one of the most responsible states in regards to their capital budgeting allocations. Governor Rendell of Pennsylvania has been praised for using capital expenditures to lower the state's unemployment rate, which has beat the national average 86 out of 89 months (Rendell, 2010).
How and where would you reduce expenditures so they match governmental fund revenues, and why?
If I were in a leadership position, I would consider increasing expenditures in New York as a form of a fiscal stimulus. This would not add a significant burden to the budget since most of the financing activity would be conducted through the issuance of municipal bonds. The benefits would…