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Capital Budgeting: What Is It And How Is It Used By State Governments?

Capital budgeting is an important budgetary tool utilized by states as they plan for acquisition of capital assets.

A capital budget is a plan for acquisition of capital assets, which are resources that have an expected lifetime that extends beyond the acquisition year. A capital budget reflects the value of time and usually has distinctive funding sources, such as bonds. These funding sources are necessary for long-term projects, like roads, bridges, and infrastructure. A capital budget has several key characteristics:

  1. It mainly exists at the state and local level. The United States Congress does not utilize capital budgeting, but instead employs a form of operating budgeting, which is a plan for revenues and expenses for a single, current or next, fiscal year.
  2. Purchased capital assets are meant to provide services for a long period of time.
  3. Capital assets, represented in a capital budget, are typically financed through borrowing.
  4. It requires a separate planning and budgeting process.

Why Do States Utilize A Separate Capital Budget?

Capital budgets are important in state budgets because projects are often big, expensive, and permanent. Due to the permanence of capital and project size, a special review of projects is necessary. Capital budgets allow for analysis of long-term benefits and costs. Financing capital projects through borrowing promotes efficiency and equity over time. Capital budgets can also stabilize tax rates because expenses are paid overtime and immediate/drastic tax increases are not needed. They lock in completion of projects, assuring that full cost is considered and available for project, i.e. funding the whole thing, but spending money overtime. Most states have a Capital Improvement Plan (CIP), which lists projects, generally 5 to 7 years, in priority order. The first year’s projects become the capital budget for the current fiscal year. There are some problems associated with capital budgeting, such as inappropriate borrowing to put off costs, disagreements about the classification of capital, and failure to adequately account for all costs.

Is Capital Budgeting Used at the Federal Level?

There is no federal capital budget, but there is still a need to create and analyze capital projects. There is a wide variation in use of capital by agency, which makes it difficult to establish a singular capital budget utilize by all agencies. In 1967, the Commission on Budget Concepts for the Federal Government “strongly recommended against a capital budget, which would provide separate financing of capital or investment expenditures on the one hand and current or operating expenditures on the other, because it would seriously distort the budget as a decision-making tool.” However, they did acknowledge the merits in the publican and improvement of useful calculations of capital items as a secondary budgeting tool.

What Do You Think?

Would the U.S. federal government benefit from implementing a capital budget that encompasses all agencies?

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2 Comments

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Profile Photo Kim Truong

Thanks for introducing capital budgeting – didn’t learn about this through my studies! Diggin’ the Euros in the pic too. I would be interested in reading about case studies of success and challenge.

Michael

Capital budgeting works well for local governments where budgets have to be balanced every year. At the federal level it could be used to distinguish between investment and simple unfunded expenditures.