Local and state governments require revenue in order to facilitate their operations. Government expenditure is the monies the government requires to finance its functions while revenue is their income. Generally, government expenditure is classified into three major classes; government final consumption, government gross capital formation, and transfer payments.
Government final consumption and gross capital formation form the largest part of state and local government’s gross domestic product. Moreover, the expenditure of local and state governments is financed by government revenue.
The local government acquires revenue through taxes and non-taxes channels; non-tax revenue includes government owned corporations, fees, licenses, or sovereign wealth funds. The state government can also finance its operations with borrowed money through grants and loans.
State and local governments have to provide different goods and services to the public. These services and goods include transportation system, water and sanitation, health care and education and payment of pensions and other benefits. Generally, the above expenditures are classified in three categories, consumption, investment, and transfer payments.
Government final consumption: According to Organization for Economic cooperation (2010, p.42), “government final consumption expenditure consists of expenses incurred by the government in the production of non-market final goods and services.” Primarily, the government spending on goods and services that are used for direct benefit of its population includes defense, provision of health care, water and sanitation and education.
It is further broken down into two categories; the value of goods produced by the government itself and purchases of goods and services produced by the other market producers and supplied to the community. In addition, consumption expenditure constitutes the largest share of expenditures; they include purchases of nondurable and durable goods. Non durable goods include food and clothing while durable products include appliances and vehicles.
Government gross capital formation: Government gross capital formation is also referred to as investment expenditure and it consists of two types, expenditure on fixed investment goods and inventory investment. Fixed investment goods are goods that are used in the long term examples are factories, commercial properties, and purchase of equipment.
Part of fixed investment expenditure involves acquisition of new asset or repairs and maintenance, as well as depreciation charge of the already in use asset. Investment expenditure on institutional sector includes transport infrastructure and public buildings like school and hospitals (Organization for Economic cooperation, 2010, p.44).
On the other hand, inventory goods are goods waiting to be sold at the end of the year; they are considered as investment expenditure because they “eventually yield a flow of consumption or production services” (Organization for Economic cooperation, 2010, p.44).
Government Transfer payments: According to Baumol and Blinder (2008, p.225), “government transfer payments is the expenditure the local and state governments incur through payments that do not involve direct production of or goods or service.” Transfer payments are given to persons in order to assist them in basic living requirements; examples of transfer payments are social welfare, food stamps, and disability and retirement benefits. In addition, the need for transfer payments increases whenever there is a social or economic crisis. However, some transfer payments are temporal while others are permanent; for example, unemployment benefits are temporal while pension payment is permanent.
Local and state governments get their revenue through taxation and other non-taxation methods. However, taxation is the most reliable method of revenue collection; nevertheless, there are other sources like direct payment from federal governments, user fees, service charges, licensing, and lottery and gambling proceeds (Brunori, 2005, p.113).
Tax: Tax is a financial charge imposed on individuals or legal entities in a state. Taxation may be done directly or indirectly and the rates differ from one state to another. The governments levy different taxes on income, wealth and consumption; income tax and social security tax constitute the largest part of state government’s revenue while local governments depend on property and wealth taxes.
Taxes under consumption are sale and excise tax; sale tax is tax paid on basic goods in the market while excise tax is tax on luxury goods. Moreover, property tax is the levy imposed on homes, business premises, and land depending on their net worth at the given time of valuation.
Non-tax sources: According to Brunori (2005, p.114), “the use of non tax sources for revenue collection has developed over the past decade, it is approximated that $747 billion was collected from non tax sources in 2003.” Primarily, the local and state governments receive funds from the federals governments; however, they also obtain funds through fees like licenses, grants, unclaimed property, and loans and bonds issue. Inter governmental funds are funds collected from other regions, not in the area they are used to provide services.
Non-tax source are very important; however, they are unreliable sources of revenue. For instance, gambling and lotteries contribute a small portion to state revenue; it is approximated that New York raised $13.7 billion in 2003 from state run lotteries, about one percent of the total state economy (Brunori, 2005, p.117). Finally, the governments can obtain revenue through grants or loans from other states or organization.
In the past years, there have been some notable changes in revenue and expenditure, which have either helped or undermined the service delivery by the state and local governments. Generally, local and state governments do not control tax rates and property tax allocation (Garcea, 2008, p.13).
According to Brunori (2005, p.116), “Local and state governments cannot spend monies from the federal government as they wish hence reducing state control.” In addition, there is tight regulation on tax relief and the transfer expenditure to vet the people who claim these benefits. Moreover, issuing of grants and loans to local and state governments is regulated by higher forms of governments.
Some factors that affect the revenue and expenditure categories are; economic situation, mandate from higher levels of governments, policies and natural disasters (Honadle, Ciggler, Costa, 2004 p.5).
On the other hand, economic meltdown causes people to loss employment and business to collapse, and as a result, state and local government loss revenue from income tax, sale tax, and licensing of businesses. During an economic meltdown, the value of property goes down resulting to low revenue from property taxation, while expenditure increases due to increased number of unemployed people seeking food stamps or unemployment benefits.
Government policies and regulations on the mandate of state and local governments affect investment expenditure. In addition, regulation on transfer fund from the federal government and interstate funds can considerably lower the revenue of governments. The unpredictability of the federal funds to state and local governments affects the planning of revenue and expenditure.
Neighboring state tax policy could make business and individuals to move from one state to another. Generally, business people like areas where the environment is business friendly; thus, an influx on people in a state would result to higher revenue collection and at the same time, higher expenditure in government consumption expenditure.
Conversely, natural calamities can inflate the expenditure, leading to low revenue collection due to damage of infrastructure. In addition, an increase in life expectancy affects the transfer payments to pensioners in a state. Moreover, globalization of the market place will make administration taxes to companies difficult and more expensive.
Disruption of revenue collection and expenditure should be avoided since it could result in lack of vital goods and services. For instance, schools and health care services must not be disrupted. Besides, local and state governments are labour intensive; hence, they need funds to pay their workforce. Thus, functional sharing arrangements between local and state governments can help to reduce the impact of reduced revenue (Garcea, 2008, p.13).
From another perspective, two neighboring states can share the police force unit or any other service, and ensure that there are better policies on allocation and use of federal funds so as essential services are delivered to the public. In addition, local and state governments should develop a strong investment program, while the authority should make policies that would enable for quick recovery and avoid continued disruption.
Local and state governments collect revenue through taxation and other non taxation methods. Some taxes levied on individuals and business are property, excise, sale, and income tax while some non-taxation methods include charges, fees, licensing and transfer revenue from the federal government.
Categories of expenditure include; consumption, investment and transfer payments, with the consumption and investment expenditures taking up most of the revenue. Changes in revenue and expenditure include regulation of tax rates and allocation of revenue.
Factors that can affect expenditure and revenue categories are economic melt down, natural disasters, tax policy in the neighboring state and legislation by higher governments. To reduce the impact of revenue disruption, measures can be put in place including proper policies and functional sharing of duties between states.
Baumol, W. & Blinder, A. (2008). Macroeconomic: Principles and Policy. OH: Cengage Learning.
Brunori, D. (2005). State tax policy: a political perspective. Washington: The urban Institute publishing.
Garcea, J. (2008). Local government reform: a comparative analysis of advanced Aglo-American countries. NY: Edward Elgar publishing
Honadle, B., Cigler, B. & Costa, J. (2004). Fiscal health for local governments: an introduction to concepts, practical analysis and strategies. NY: US Academic Press
Organization for Economic Cooperation. (2010). National Accounts at a Glance 2009. NY: OECD publishing.