Capital budgeting policies and procedures in New York and Pennsylvania

Expenditure Revenue Analysis

NY PA Expenditure

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.

Literature Review

Bond Rates

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).

Case Questions

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 be rewarding as the economy pulls out of the recession. The deteriorating infrastructure could be addressed and since the ratio for capital projects is fairly low in New York, it is reasonable to suspect that these activities could be increased. However, in Pennsylvania the ratio is much higher, and as a consequence it should be maintained at its current rate rather than be increased.

Write your analysis and recommendation explaining your recommended course of action. Analyze the percentage of the major category of expenditure compared to the total net operating expenditures.

Since New York's capital expenditure ratio is well under ten percent, I would consider raising the ratio by five percent to make the total roughly thirteen percent. This would allow the state to address infrastructure and education issues while simultaneously stimulating the state's economy. Since the capital expenditure rate in Pennsylvania is closer to twenty percent, I would focus on making the best use of the funds to attract private investment to the state.

Can any increase be explained by the addition of a new service?

No. Since both states reduced their capital expenditures there was not an increase that could be explained by the addition of a new service.

Compare the change to the previous year?

In New York, the capital expenditures fell from 8.36% in 2009 to 7.61% in 2010. This represents roughly a nine percent reduction in capital expenditures. In Pennsylvania, capital expenditures fell from 19.32% in 2009 to 16.19% in 2010 which represents over a twelve percent reduction in capital expenditures.

Is the financing formula adequate?

I don't believe that during a recession that a reduction in capital expenditures is the right course of action. Capital expenditures are a valuable tool that can be used to stimulate the state's economy and get people back to work. Although these projects do undoubtedly add to the total liabilities of the state's budget, a majority of capital projects can also be considered an investment that offers the state positive returns. For example, if the infrastructure in a state is crumbling then repairing roads and bridges will not only make transportations safe but also more efficient which will stimulate economic development beyond the costs of conducting such projects.

Have there been recent tax redesign efforts?

There was no tax redesign efforts identified in this analysis that was relevant to capital expenditures.

How does the jurisdictions expenditures compare to other similar jurisdictions?

The PEW center both analyzed the trends regarding all fifty states in regards to their spending and maintaining their state's infrastructure and developing new infrastructure to meet the challenges faced in the twenty first century (The Pew Center on the States, 2009). This indicates that both states are in the middle of the pack in regards to their capital expenditures and thus could stand room for improvement.

Figure 1 - Pew Analysis of Capital Performance (The Pew Center on the States, 2009)

Conclusion

There were several limitations that were faced in trying to compare the capital expenditures of these two states. One major limitation was the fact that both states, while they use similar accounting methods, use different accounts to represent different activities. For example, Pennsylvania did not list in federal funding that was allocated for capital projects in their capital expenditures statement, while New York did. Such instances were prevalent and made a direct comparison of the capital budgeting process very difficult. It was also difficult to compare the states to other regions because of these accounting limitations.

As a result of analyzing the ratios, it was determined that both states experienced a reduction in capital expenditures over the period between the fiscal year 2009 and 2010. Many arguments have been made that the effects of a recession can be somewhat mitigated through capital expenditure projects. Given this was not the case in either state, it is likely that the individual states were more concerned with the total deficit amount rather than trying to implement a fiscal stimulus to their state's economies. This is also representative of the ideological differences that reside in the current political divides between the two main political parties in the U.S.

Table 1 - Capital Expenditure Ratio

NY 2010

NY 2009

Total Revenues

125879000

110716000

3528613

2901521

Capital Expenditures

9574000

9261000

571220

560546

Ratio

7.61%

8.36%

16.19%

19.32%

Note. Data collected from the Office of the State Comptroller in New York and the Office of the Budget in Pennsylvania for the Fiscal Years 2009 and 2010

Table 2 - Capital Expenditure Balance Sheet Information

NY 2010

NY 2009

Cash and investments

$3,188,000

$1,958,000

$1,015,945

$649,758

Receivables

$14,628

$21,790

Taxes

$61,000

$67,000

Federal Funds

$184,000

$203,000

Other

$163,000

$203,000

$16,858

$42,111

Due from other funds

$171,000

$92,000

$11,688

$2,949

Total

$3,830,000

$2,771,000

$1,059,119

$716,608

Tax Refunds Payable

$18,000

$20,000

Accounts Payable

$555,000

$381,000

$192,760

$213,617

Accrued Liabilities

$66,000

$85,000

Local Gov. Payables

$215,000

$187,000

Other Funds

$611,000

$778,000

$119,244

$115,156

Deferred Revenues

$12,000

$28,000

Total

$1,477,000

$1,479,000

$312,004

$328,773

Reserved

$7,632,000

$6,090,000

$1,238,701

$1,075,673

Unreserved

-$5,279,000

-$4,798,000

-$524,465

-$698,838

Total

$2,353,000

$1,292,000

$1,059,119

$387,835

Note. Data collected from the Office of the State Comptroller in New York and the Office of the Budget in Pennsylvania for the Fiscal Years 2009 and 2010

Table 3 - Changes in Balance Sheet Comparison

Capital Project Funds

(in thousands)

% Change 2010-2009 NY

% Change 2010-2009 PA

Assets

Cash and investments

38.58%

36.04%

Receivables

-48.96%

Taxes

-9.84%

Federal Funds

-10.33%

Other

-24.54%

-149.80%

Due from other funds

46.20%

74.77%

Total

27.65%

32.34%

Liabilities

Tax Refunds Payable

-11.11%

Accounts Payable

31.35%

-10.82%

Accrued Liabilities

-28.79%

Local Gov. Payables

13.02%

Other Funds

-27.33%

3.43%

Deferred Revenues

-133.33%

Total

-0.14%

-5.37%

Fund Balances

Reserved

20.20%

13.16%

Unreserved

9.11%

-33.25%

Total

45.09%

63.38%

Note. Data collected from the Office of the State Comptroller in New York and the Office of the Budget in Pennsylvania for the Fiscal Years 2009 and 2010