The Budget Process
In almost every state, there are two basic steps in the budget process: the proposal, and the approval. In most states, the Office of Management and Budget (OMB), or similarly-named agency, is responsible for writing budget proposals and studying state spending. Since most OMBs are run by an appointee of the Governor (in some states, they’re actually under the direct authority of the Governor’s office), the Chief Executive usually has a lot of influence over what comes out of these agencies. In many states, there's often an annual (or biennial) "Governor's Budget address", where the Governor actually goes to the Legislature, in person, and gives a speech laying out his/her proposal and budget priorities. These speeches often get a fair amount of statewide and local press coverage, and the media often portray this as THE budget for the next year or two. However, what often gets lost in this process is that it's actually the Legislature that has to ultimately approve that budget. They can (almost always DO) modify that budget (and many do so in quite a radical way) before state agencies can actually spend any money.
When these Executive agencies study potential state budgets, and try to predict the effects of increased or decreased public spending on certain things, they are engaging in “Cost-Benefit Analysis”. The principle behind CBA is very simple: “If I spend X number of dollars on this program, the community, government, society, and citizens will derive Y number of dollars in benefits.” The trick, of course, is in trying to calculate benefits to all of those different sectors. For example, if a block of homes is razed to pay for a new interstate highway, the individual home owners might suffer a loss (not only monetarily, but emotionally as well), whereas several business owners a few blocks away might experience an upsurge in their businesses due to increased traffic, which then means increased sales tax revenue for the city. Therefore, some individuals will experience a gain, and others a loss, and it is left up to the policy makers to decide which losses they are willing to accept in exchange for certain types of gains. In many cases, this sort of thing really becomes an exercise in “educated guessing”. For example, think about the widely varying claims that one reads about the “benefits” of publicly funding sports stadiums. Proponents of these projects will always claim that building a stadium will produce “X” millions of dollars in payroll construction and “Y” millions of dollars in permanent sales taxes from increased traffic and retail activities, whereas opponents will point to numerous historical examples where a new stadium only resulted in a shifting of entertainment spending from one type to activity to another, resulting in little or no net gain to the city, county, or state. Even though these competing studies are looking at the same projects, they often come to very different conclusions about their "costs" and "benefits", because they're looking at the numbers in very different ways.
The other thing that one must take into consideration is the relative “value” of certain types of gains and losses: is an emotional cost (like the loss of a family home) something that can be given a monetary value? If so, how does that “value” compare to other economic costs or benefits? Should one type be favored other another? These are the sorts of policy questions that elected officials need to make: one probably can’t presume that the accountants and fiscal analysts that work for the Executive-branch OMB or the Legislative Fiscal Office are equipped to make these kinds of judgment calls.
Another concept to understand is the difference between operating budgets and capital budgets. Think of an operating budget as similar to your household budget. You have your monthly income, and then you also have expenses. Your income has to be greater or equal to your expenses; if not, then you’ll likely have to declare bankruptcy sooner or later. A good amount of your operating budget probably goes to “consumables”: food, gas, clothing, utilities, and other goods which, once they are used, cannot be re-used (at least not at the same original value – if you consider clothing a consumable good). Part of your budget probably also goes to pay off your mortgage (if you own your own home), or your car loan, or credit cards. Those first two expenses are “capital” expenses (or they would be in the context of state budgets), because (1) you probably didn’t have the cash necessary to buy those items outright, which is why you borrowed money in the first place to pay for them; and (2) those items have an actual value which can be re-gained in the future (by selling them to somebody else). In every state but one, there is a requirement (either in the Constitution, or in the law, or by State Supreme Court ruling), that the operating budget be balanced at the end of the fiscal cycle. In other words, states cannot spend more than they bring in in revenue, at least when it comes to day-to-day expenses. The only debt that states can incur is for “capital” expenses: the building of roads, buildings, dams, water treatment plants, and any other physical space or improvement. If you follow the news about state politics in Minnesota, you might have heard of the “bonding” bill. What that refers to is an amount of money that is borrowed by the state to build college buildings, road expansions, flood control, state parks, and a host of other physical expenditures. Because the state will actually gain a physical asset (which it could, at least theoretically, later re-sell), it’s OK to borrow for that, although the payments (think of them as car payments, or mortgage payments) need to then be figured as part of the regular operating budget.
The one exception in this case is Vermont, which is the only one of the 50 states that can, like the federal government, engage in deficit spending. As mentioned in a previous unit, many of our Presidents in the last 30 years have been current or former state Governors, and a common theme that one hears from Governors running for President is something along the lines of “Well, in my state, we never ran a deficit, so I’m the guy (or gal) who can fix the deficit problem in Washington.” I used to scream at my television when these candidates came on “Of course you did, idiot, you had to!”, or something like that. When Howard Dean (former Governor of Vermont) was running for President in 2004, and made that claim, I refrained from screaming at my TV, because Dean was the one candidate who could actually point to a balanced budget as a real accomplishment (because he didn’t have to balance the state budget).
Another concept which comes into play when Governors and executive agencies are putting together their budgets is the question of whether they will use an “incremental” (or “baseline”) approach or a “zero-based” approach. The traditional method of governmental budgeting has been based upon the assumption that as costs go up from one budget cycle to the next, then the amount of money needed to perform that same work needs to go up as well. Think about this in the context of your personal budget: if you spent $100 a week on food last year, is it reasonable to assume that, because the cost of food went up (let’s say 5%) in the last twelve months, that you’ll need $105 a week to buy the same amount of food this year? “Incremental” budgeting in the governmental sector works under the same assumption: if the State Department of Transportation spent $100 million (the “baseline”) last year, and inflation is 4%, then there’s an assumption that they’ll need $104 million this coming year to do exactly the same things they did in the previous year. Add to that new programs that the department might want to add to their existing list of projects and programs, and you have the basic concept behind incremental budgeting: costs go up (because inflation does), and governmental agencies tend to add additional programs in each budgeting cycle.
“Zero-based” budgeting starts with a very different assumption. There’s no reference to historical or previous spending; the expectation here is that each department has to justify, in each budget cycle, every program that it wants to administer in that coming fiscal year. In other words, under the “pure” form of zero-based budgeting, each governmental agency starts with nothing, and has to explain to the OMB, the Governor, and/or the Legislature why it should have the authority to spend public dollars on its programs. As you might imagine, agency and department heads don’t particularly like this approach, since it creates a lot of work for them to continuously monitor and re-justify existing programs. No state government has ever fully implemented this; however, some modified versions of it have existed in various incarnations over the years. In the 1970’s, Jimmy Carter, then the Governor of Georgia, tried to implement a form of ZBB in that state, and then when he became President later that decade, in the federal government as well. However, this system wasn’t “pure” ZBB; it really took the form instead of a ‘sunset’ process, where some programs (but not major spending areas) were tried as a “pilot”, with a short timeframe (a couple of years, usually), and then discontinued if they didn’t meet expectations. The State of Montana, in the 1980s and early 90s, tried a process where each agency was automatically given 80% of it’s previous year’s budget at the beginning of the OMB review process, and then any additional spending had to be justified by the department heads. In North Dakota, in the early 1990’s, Governor Schafer tried a similar approach: he asked each agency head to give him three budget proposals: one would be 95% of the previous year’s spending, one would be 100% plus inflation, and the third would have no limit. Then, when he put together the Executive Budget proposal to give to the Legislature, he and the OMB could identify which programs were an absolute priority (presumably the items included in the smallest budget), and which could be cut back in an era of lower tax collections (which was the situation in that state in the early 1990s).
Sources of Revenue (aka "Taxes")
So, where does the government GET its revenue to pay for these programs? As you probably have figured out by now, they get it from taxes (and sometimes fees). The textbook talks about various types of taxes. I won't focus on ALL of the possible types, but will talk about the major ones here.
Individual Income: Hopefully, this is self-explanatory. You pay based on how much money you make. Every April 15 (or thereabouts), you file a 1040, 1040A, or 1040EZ with the IRS, telling them how much you made, and how much you owe in federal income taxes. Most states also assess income taxes; when you file your federal form, you usually have to mail the state Tax Department a separate state form as well. Almost all states use a "graduated income tax", meaning that the RATE goes up as the level of personal income goes up. So, if I make $100,000 a year, and you make $25,000 a year, in most states, not only would I pay more, but the actual tax RATE (what percentage I pay) would probably be higher for me than it would for you. In the next section, I'll talk about theories of "progressive" and "regressive" taxation, and we'll come back to this example. There are some local governments (usually cities) that also impose personal income taxes. Many states don't allow this, but as the Tax Policy Foundation reading indicates, these exist in about a dozen states.
Sales: Most states have these. You pay them when you buy something at the retail level. Some states exempt certain items. For example, Minnesota doesn’t charge sales tax on most types of clothing; North Dakota does. North Dakota doesn't tax groceries; South Dakota charges sales tax on both groceries and clothing. However, South Dakota doesn’t have an income tax, so they have to get revenue more from the sales tax (hence why they don't have as many exemptions). Many local governments (usually cities) also tack on an extra percentage point or two. You might remember the distinction (in the unit on Local Government) between "General Law" cities and "Home Rule" cities. In some states that allow local governments to charge sales taxes, the rate that "General Law" cities can charge might be universal across the entire state, whereas Home Rule cities can charge more (remember that in Home Rule cities, the voters can pass amendments to their city charters; in almost all cases, those cities are able to charge higher sales taxes because the voters in that city voted to allow that).
Real Property: These are almost always assessed by local governments, and they are assessed on the value of real estate (land and buildings, including houses). When you hear people talk about “property taxes”, this is usually what they’re talking about. If you’ve ever seen a “property tax bill”, they usually include an “assessed value” of the land and/or buildings, and then a list of the “mill rates” (the rate charged as a percentage of the value of the property) by the local governments (county, city, school district, township, etc) that are charging real property tax in that area.
Personal Property: These are assessed by both local and state governments. They are also a form of "property tax", but depending on where you live, you might not actually have these. They are taxes on movable property of value (things like boats, cars, motorcycles, ATVs, jet skis, etc.) Some states even charge them on jewelry over a certain dollar amount, and some other states assess them on stock and bond certificates. A couple of suburbs in the Twin Cities assess these on personal watercraft and ATVs (Jesse Ventura’s main issue in his first campaign for Mayor of Brooklyn Park was the rapid increase in personal property tax on his JetSkis), but except for those few places in the Twin Cities, these are largely unheard of in this region of the country. Many, many years ago, North Dakota had a personal property tax on household items (furniture, tools, etc), but the County Tax Assessors had such a hard time figuring out how to calculate them equally that the state Legislature eventually dropped it.
Excise: These are also commonly known as “sin taxes”. They are generally charged on alcohol, tobacco, and gasoline. Both the federal and state governments charge these on gasoline. The federal government taxes some types of alcohol (particular distilled spirits), whereas the states primarily tax beer and wine. Most tobacco taxes are assessed primarily by state governments. Most of these items are not subject to sales taxes because the excise taxes are assessed instead.
Progressive and Regressive Taxation
When tax specialists, legislators, and budget calculators talk about the "fairest" way to tax people (and activities), they often end up talking about "Progressive" taxes and "Regressive" taxes.
“Progressive” taxes are those which are designed to more heavily tax a person based upon that person’s wealth. The Graduated Income Tax (where the rate of tax goes up in a system of “tax brackets”) is the only “progressive” form used in most American jurisdictions. In the discussion above on income taxes, you might remember that I talked about different rates. Let's just say, hypothetically, that there are three tax rates, 2%, 5%, and 7%. Those making the least amount of money would pay the 2%; those in the middle would pay 5%; and the wealthiest would pay 7% (again, these are just hypothetical numbers, and we're not going to talk about deductions and exemptions, which complicate the matter even further). The theory, however, should be somewhat obvious: that the wealthy are assumed to be more able to pay a higher rate than others.
“Regressive” taxes are those in which everyone pays on the same rate: the theory of those who use these terms (usually advocates for a more “progressive” system) is that if Person A makes $100,000 a year and pays $8 in excise taxes for a tank of gas, that person is less likely to be affected by the tax than Person B, who makes $30,000 a year, but still pays $8 in excise tax for the same tankful of gas. Apply the same theory to sales taxes or real property taxes. Even if my house is worth twice yours, my real property taxes will only be twice yours, even if my other income and wealth mean that I’m four or five times wealthier than you. There have been proposals for a “flat” income tax from time to time (where everyone would pay, say, 10% of their income): the proponents of progressive taxation say that this isn’t fair, since the wealthier wouldn’t be hit as hard by that 10%.
A note about "Remote Sellers"
Several of the outside readings describe some of the challenges that states have been contending with in trying to come up a way to tax what are called, in tax law, “remote sales” (i.e. sales from catalogs and Internet retailers). You'll read about the Quill v North Dakota case, from 1992, in which the Supreme Court ruled that states couldn’t tax sales unless the seller had a physical presence (or "nexus") in that state (this was actually not a new precedent; this actually stems from an earlier decision in 1967, the Bellas Hess v Illinois case). For a long time, if you bought something from a catalog, or from an Internet site, you ONLY paid sales tax if that company had a physical presence (or "nexus", to use the term from tax law) in your state.
So, for example, for those of you who live in North Dakota, you’ve longed paid sales tax on Amazon purchases, since Amazon had a major fulfillment center (i.e. warehouse) in Grand Forks. However, if you bought something online from a company that DIDN’T have a facility in North Dakota, you wouldn’t have.
However, all of that changed in 2018. That year, the Supreme Court overturned that ruling, in a case involving South Dakota and the online home décor company, Wayfair. States can now assess sales taxes on remote sales (one of the articles that I gave you lists the minimum amounts and numbers of transactions involved, for each state; you'll notice that, at least in the states that have sales taxes, almost every state is now doing so).
Let me just to give you two quick examples of why this becomes complicated. Let’s imagine you live in Frontier, ND (a very small bedroom community that’s right on the edge of the far south end of Fargo – it’s not in the city limits, but the city surrounds it on all three sides). If you live in that part of Fargo (or Frontier, or Briarwood, which is another small independent city further south), you’re postal Zip Code is 58104. Now, the City of Fargo assesses an extra 2% in sales tax (on top of the 5% state rate). Cass County assesses an additional 0.5%. So, if any of us buy something at West Acres Mall, we pay 7.5% (since West Acres is located in the City of Fargo). If I order something online (I live in the City of Fargo), I pay 7.5%. If my friends who live in Frontier order something online, they should only pay 5.5% (because they don’t live in Fargo, but they do live in Cass County). However, both my part of Fargo and the City of Frontier have the same Zip Code, so how does the remote seller figure that out? Nine-digit codes help some with that, as long as we can figure out which taxing jurisdictions are in which nine-digit zip code.
The second problem is even more complex. Every state defines which products are subject to tax, and which are exempt (or reduced), in different ways. Let me give you an example: candy. In most states, candy is defined in the tax code as something along the lines of “a mix of confections or sugars, intended to be eaten as a snack”, and almost all states apply sales tax to candy. In some states, however, any product that has at least 50% content of flour is considered a “bread product”, not “candy”, so, since bread is exempt in many states, a candy bar which is mostly flour (like the Twix bar) is exempt. In Pennsylvania (home of the Hershey company), any product containing chocolate is exempt from sales tax completely. So, imagine you’re trying to sell candy bars on the Internet (not the world’s smartest business plan, granted, but just go with it, for the purposes of a demonstration). Twix bars are taxable in some states, but not in others. Chocolate bars which aren’t at least 50% flour are taxable everywhere but Pennsylvania. Now apply that same dilemma to hundreds, if not thousands, of product definition which vary from state to state. Add onto that the special exemptions (or reductions) from the sales tax that applies to certain products (farm implement parts, for example, are subject to a reduced sales tax in many Midwestern states).
Hopefully that gives you some appreciation for the complications that this is going to cause for online retailers. One of those outside articles that I gave you is actually from an accounting firm: they make their money by calculating, on behalf of small retailers who sell a lot of stuff online, which products are subject to which state's (or local government's) tax laws.