Financial Management under Budgetary Stress

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Public Budgeting and Taxation Policy: Financial Management under Budgetary Stress

 

Summary of the Case Study-Financial Management under Budgetary Stress

The case study is about the severe economic recession of the early 1990s, where several states experienced difficult times because of severe ravages of the long-term slowdown in the growth of revenue with a distinct focus on the state of Indiana. During the recession, pressure mounted on the expenditure segment due to the increased demand for services from federal mandates and citizenry. As a result, multiple countries experienced an adverse impending budget shortfall that led them to determine solutions to their estimated shortfalls, and this approached varied among states. However, it generally incorporated revenue enhancements and increased cuts on spending to decrease a projected gap. Revenues severely fall short of the projections while expenditures increased unabated. Additionally, the recession led to many issues about the deficit in the federal budget and threats of conflicts in the Persian Gulf because of Iraq’s increased aggression and attacks against Kuwait.

As the focus of the study, Indiana State placed a considerable concentration on the significant revenue reduction as a critical mechanism of closing its expected gap during a 1991-1993 biennium. The vital element of Indiana’s spending reduction program was an execution of the strategy of the agency-specific financial management programs. Based on the analysis, the programs were established by a subject agency based on adequate discussion with a state budget agency. As a result, every agency was to return a significant section of the 1991-1993 biennial appropriation to the country’s overall fund. The effect was mandated by the state budget agency and Evan Bay, the governor. Based on the mandate, every agency was legalized to identify the best mechanisms to accomplish a reversion target via a continuous growth and development of its financial management programs.

In the early 1990s, Indiana’s general returns were about $ 108.8 million and 2.8% below the anticipated value for the fiscal year. Nonetheless, despite the revisions on the state revenue projection in late 1990 and 1991, there was no improvement in 1992. However, the 1991 forecast projected a 0.7% increase in the fund revenues by late 1992. Consequently, for the fiscal year 1992 and 1993, it was anticipated that more than $ 1.2 billion of general fund revenues would severely get lost to the unfortunate recession.

Based on the state expenditures, Indiana experienced increased pressure on the high demand for the spending segment of a ledger when the recession was increasingly constraining the overall growth of fund revenue. An increase in the yearly spending between the 1989-1993 fiscal years was projected in 1992 to be $ 1.2 billion, with 3.5% inflation. Key features of the increased spending involved more tuition support for all schools and colleges developing at a 5.56% compound and training annual rate. Consequently, Medicaid, high education, and corrections significantly increased at 15.4%, 4.7%, and 14.01%, respectively. Therefore, given a forecast divergence between expenditures and revenues, it was necessary to take the necessary action to close the severe estimated budget gap significantly. Despite having multiple reserve balances to assist close the budget gap, the state agency and governor Bayh were increasingly reluctant to depend on them as the primary instruments for successfully closing the budget gap.

The reserve balances were essential in covering the shortfalls between projected expenditures and revenues during the adverse 1991-1993 biennium. Nonetheless, the outcome would be the insufficient reserve balances to safeguard the nation against the current and future recession. Consequently, deteriorating and poor revenue collections could have exhausted the reserve balance. As a result, the state agency and Governor Bahy made the significant decision to decrease the increasing state expenditures. The strategy initiatives involved hiring freeze, a limit on traveling, mandatory revisions, and the moratorium on continuous pay upsurge for state works. More significant, agency-distinct financial management programs were established to help the situation. Bahy’s office encouraged every agency to determine ways of eliminating excessive spending and manage significant increases in expenditure. Consequently, the administration placed many restrictions on various operating expenses. These actions were substantial because they led to total savings of approximately $ 74.12 during the recession.

Therefore, based on the case study, states are encouraged to establish effective mechanisms and policies to encounter various disasters such as the economic recession. Consequently, the state created a financial management plan with increased financial responsibility. Moreover, the state implemented service cuts to focus on expenditure. The state board of tax commissioners (SBTC) was established to enhance reversions and overall savings during the recessions. More significant, the government established yearly balanced budgets, like the capital budgets for active economic recovery during such disasters.

Questions

Question One: What Were the Effects of the 1990s Recession on State Finances In General?

The 1990s recession was the most severe and extended economic recession after the 1980s that demonstrated a growing essence of national and international financial markets to Indiana, America, and other world economies (Deitz, Haughwout, and Steindel, 2010). In their study, Dadayan and Boyd (2017) outlined that the state’s tax general tax revenues originate from four primary sources. These include sales tax, corporate income taxes, personal income taxes, and other minor taxes. Nonetheless, during the 1990s recession, Indiana national values indicated that every source of state revenues started falling on an annual basis as bankruptcies adversely soared.

During the crisis, Indiana state’s economy experienced modest unemployment, low inflation, and robust growth. In his article, Zorn (2003) affirmed that the Indiana economy contracted with an increased rate of unemployment, rising productivity, and increasingly surging stock markets. Consequently, the state finances declined due to slow job creation and poor revenue collection. Nonetheless, despite its effects on state finance, the 1990s recession served as the best performance on every account since the 1960-1970 period. The influence and importance of the financial industry significantly grew. According to Zorn (2003), the 1990s recession resulted in the closure of production firms in Indiana; thus, a declined in productivity among workers. To respond to the crises, Indiana State established the expenditure reduction program to close the budget gap between expenditures and revenues.

Question Two: How Reliable Are Revenue And Expenditure Forecasts In General?

Organizations use three forms of forecasting. These include the time series analysis and projection, causal models, and qualitative techniques. Forecasts on revenues and expenditures are considered significant and increasingly reliable since they determine the post-economic performance, marketing efforts, new global situations, rate of inflations, and seasonal demands. Based on the case study, forecasting on expenditures and revenues enabled Indiana State to make correct decisions to counter the budget deficits and increased inflation (Zorn, 2003). State legislators and governors are required to pay increased attention to the forecasted gaps between expenditure and revenues.

In his study, Zorn (2003), for instance, outlined that state agency and governor Bahy decided to decrease spending after the forecasted gaps in 1992 annual spending and fund revenue growth. The decision occurred after paying increased attention to the impacts associated with the predicted gaps. To guarantee fiscal responsibility in place of forecasts, governments rely on budgetary responsibility principles, which involves maintaining sustainable public finances. Subsequently, the states adopt the financial responsibility regulations to enhance the current estimates for expenditures and revenues.

 

Questions Three: What Options Are Available To States When They Face a Budget Deficit but Are Required To Balance the Budget?

The budget deficit implies increased government expenditure and lower taxes. In the case study, the budget deficit during the 1990s economic recession occurred as the yearly shortfall between Indiana government tax revenues and spending. In their article, Savage (2019); Amadeo (2020) outlined that budget deficit causes an upsurge in the national debt, upsurge in the aggregate demand, and investment in the public sector. Consequently, governments experience severe inflation during crises. Nonetheless, the impacts of the budget deficit rely on the current condition of the economy among nations. Subsequently, Rivlin and Sawhill (2004) asserted in their study that budget deficit relies on reasons why the administration borrow and the influence of economic growth on the forthcoming tax revenues. Therefore, there are two main options available for states when they experience a budget deficit. These are increasing revenue and decreasing spending as outlined below

Increasing revenue

The concept of revenue entails three essential terms; Average, marginal, and total revenues that are essential in supporting the growth and development of the economy. States can only increase revenues by increasing the economic growth or raising taxes on services and products provided by every sector of the economy (Amadeo, 2020). Increasing revenue during budget deficit enhances the profitability of enterprises and organizations since significant revenue growth serves as the engine for effective investment, production, and acquiring of resources.

The research by Kaufman (2010) determined that substantial revenue growth, distinctly growth rates are essential features in developing the evaluation mechanism for organizations and enterprises. More significant, revenue growth enhances productivity among consumers and workers to achieve their financial objectives (Smith, 2019). In the case study, the Indiana government increased revenues to counter the negative impacts of the budget deficit. The government increased revenue through increasing costs of services and goods, growing the number of consumers for every service, and enhancing the frequency for all transactions per consumer.

Countries use different revenue models to increase revenue collection. These include ad-supported where the business content or product is free to consumers. The subscription model that primarily works for products, materials, and services for an organization (Smith, 2019).The freemium model is being applied to digital and physical products to create a captive audience. Consequently, organizations and businesses use the affiliate marketing model that increases revenue for digital and physical products.

Decreasing expenditure

Government expenditures are categorized into current spending, transfer payments, and capital expenditures that are considered essential during a budget deficit. Amadeo (2020) affirmed that decreasing spending is considered a vital factor during a budget deficit. Economists recommend cutting the non-essentials services that impact economic growth during crises. In her article, Smith (2019) outlined that increased expenditure leads to growth in aggregate demand. Subsequently, it affects the supply chain system of the economy. Decreasing spending slows demand flows among citizens. In the case study, state agency and governor Bahy decided to decrease the increasing state expenditures by hiring free and imposing limits on travel (Zorn, 2003). Consequently, the Government Established Mandatory Revisions on the Fiscal Budgets.

Question Four: What Are The Advantages Of Centralized Financial Management Versus Decentralized Financial Management?

Advantages

Centralized organizations and systems are considered extremely useful regarding enterprise and financial decisions. Through centralized economic control, organizations and nations develop mission, set objectives, and vision that helps achieve strategic commercial activities. Success relies on the ability of a company to or country to secure, develop, and retain the highly motivated workforce, to enhance production through centralized financial control. In their study, Xian-feng and Center (2017) identified that there is the application of better middle and lower management of funds to accomplish effective financial control during crises.

Centralized financial management is characterized by clarity in effective decision-making and increased response times. Moreover, there is a streamlined implementation of initiatives and strategies and effective control over all strategic direction regarding funds. In his article, Zorn (2003) outlined that centralized financial control enhances links between responsibility and compensation during crises. Subsequently, centralized management does not require organizations and nations to incur extra prices to recruit specialists, provide more services, and collect revenues.

Disadvantages

Unlike decentralized financial control, the central financial system is characterized by severely limited opportunities for workers to provide economic feedbacks. Additionally, there are higher threats of inflexibility. In their study, Olliphant et al. (2017) outlined that there are coordination challenges since decision –making is primarily delegated in the decentralized system. The effect is because it is challenging to guarantee that every segment of the organization is performing consistently to accomplish the strategic financial objectives of an organization. Decentralized financial control is characterized by increased administrative prices due to significant duplication of the efforts (Zorn, 2003). Therefore, the state is required to have effective mechanisms to counter the impacts of disasters like economic recessions to avoid a budget deficit, increased inflation, and severe decline in economic growth.

 

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