Mitchell’s Musings 4-11-16: What is the Point? – Part 2

09 Apr 2016 6:45 AM | Daniel Mitchell (Administrator)

Mitchell’s Musings 4-11-16: What is the Point? – Part 2


Daniel J.B. Mitchell


Last week’s musings dealt with a lecture I gave in my course California Policy Issues on state economic policy. Basically, after watching that lecture, it seemed (to me at least) that there were a few key points in the presentation and that those points were in fact made clear. Earlier in the same course, however, I gave a lecture on fiscal policy which has some obvious overlaps with the later one. See https://archive.org/details/10bfiscal2016pt1. After watching that fiscal presentation, I am less confident that all the key points that should have been made actually were made or were made clearly enough.


In that earlier lecture the topic is really budgeting. There was a time, back when I was an undergraduate in the 1960s, in which courses were offered which dealt with that topic in economics departments under the heading of “Public Finance.”  Since that time, Public Finance has become “Public Economics” and the name change signified that the topic is now a whole lot more theoretical than in olden times. So the nuts and bolts of state and local fiscal affairs are not likely to receive much attention.


Undergraduate students can still take courses in accounting, as I did. But such courses tend to be focused on corporate, i.e., private sector, accounting and not the kind of accounts routinely found at the state and local level. That’s a definite gap in the curriculum, particularly for students who might be considering careers in the public sector. Nonetheless, there is one benefit that a student with an accounting background would have and that benefit is a recognition of a key point in the lecture: the distinction between stocks and flows and the related notion that flows have to be defined over a unit of time (such as a fiscal year).


The lecture does make it clear (I think) that notions of surplus and deficit should be defined as flows (and thus linked to a specified time period). In corporate accounting, for example, flows are reflected in income statements. And the profits and losses shown on those statements are roughly analogous to surpluses and deficits in government budgets.


Similarly, the balance sheet in corporate accounting is a stock measure since it shows assets vs. liabilities at a point in time, e.g., the end of the fiscal year. But the analogy somewhat breaks down since balance sheets for governments typically value only cash as assets and omit physical assets that governments own (office buildings, roads, bridges, schools, equipment, etc.). Balance sheets for government do show debt although there are issues about what debts are to be reflected. (Should unfunded retirement-related liabilities be listed along with bond-type debt, for example?)


What I think is not clear is that, although the lecture notes that the budget is the most complete piece of legislation establishing priorities, the budget doesn’t directly tell you much about judgment or good administration. Fiscal prudence, i.e., managing the budget so that bills can be paid both in good times and bad, doesn’t mean that budgetary priorities are the “right” ones. Right and wrong in that case are individual political preferences, not matters of accounting. And even if your priorities match those of the legislature and the budget, fiscal prudence doesn’t tell you whether the priorities are being accomplished efficiently or effectively.


Although the budget lecture focuses on California and provides some of that state’s recent budgetary history (including the fiscal crisis surrounding the Great Recession), it omits an important observation. It doesn’t note that popular opinion judges whether fiscal affairs in Sacramento are being managed correctly by the absence of crisis. That is, if there are no dark headlines, things must be OK.


For many years, until voters changed the rules through a ballot proposition in 2010, a budget could not be passed without a two-thirds vote of the legislature (in both houses). That requirement rarely caused significant delay in good times. In bad times, however, budgets were late – sometimes by months – creating a crisis. Bills couldn’t be paid without budgetary authorization, even if cash was on hand to do so. Thus, delay and crisis in Sacramento was a signal to the voters that something was wrong and that fiscal affairs were being mishandled. Typically, pollsters would detect a sharp drop in favorability ratings of the governor and legislature when budget delays occurred.


Crisis via delay was a crude public signal, but it was a highly visible signal. Delays in budget enactment at least gave an indication of a problem before fiscal affairs reached a point – as occurred in 2009 – that cash couldn’t be found to pay all bills and IOUs had to be issued instead. Now that the delay signal is gone (thanks to the end of the supermajority requirement), the need for consistent budget definitions of concepts such as deficits is heightened.


Yes, Governor Jerry Brown got voters to approve a “rainy day” fund that is supposed to (help) avert future fiscal crises. But the rainy day fund itself tends to obscure the issue of whether there is a deficit so long as a crisp definition of that concept is not mandated. The flows into and out of the General Fund now have to be added to the flows into and out of the rainy day fund to calculate deficits and surpluses properly.


You can find the elements of such a conclusion in the lecture. But after a replay, I have to conclude that the implication may not be apparent. Next year, I will have to clarify. In the meantime, all that can be said is that such policy reforms as removing the two-thirds budget rule or creating a rainy day fund have unintended consequences. Perhaps that is another point that also needs to be made next year.


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