Question

Government activities may be less “profitable” than they appear.

A city prepares its budget in a traditional format, classifying expenditures by fund and object. In 2010, amid considerable controversy, the city authorized the sale of $20 million in bonds to finance construction of a new sports and special events arena. Critics charged that, contrary to the predictions of arena proponents, the arena could not be fiscally self-sustaining. Five years later, the arena was completed and began to be used. After its first year of operations, its general managers submitted the following condensed statement of revenues and expenses (in millions):

Revenues from ticket sales                                 5.7

Revenues from concessions                               2.4

8.1

Operating expenses                                           6.6

Interest on debt                                                  1.2

7.8

Excess of revenues over expenses                     0.3

3

At the city council meeting, when the report was submitted, the council member who had championed the center glowingly boasted that his prophecy was proving correct; the arena was “profitable.” Assume that the following information came to your attention:

• The arena is accounted for in a separate enterprise fund.
• The arena increased the number of overnight visitors to the city. City administrators and economists calculated that the additional visitors generated approximately $0.1 million in hotel occupancy tax revenues. These taxes are dedicated to promoting tourism in the city. In addition, they estimated that the ticket and concession sales, plus the economic activity generated by the arena, increased general sales tax revenues by $0.4 million.
• The city had to improve roads, highways, and utilities in the area surrounding the arena. These improvements, which cost $6 million, were financed with general obligation debt (not reported in the enterprise fund). Principal and interest on the debt, paid out of general funds, were $0.5 million. The cost of maintaining the facilities was approximately $0.1 million.
• On evenings when events were held in the arena, the city had to increase police protection in the arena’s neighborhood. Whereas the arena compensated the police department for police officers who served within the arena itself, those who patrolled outside were paid out of police department funds. The police department estimated its additional costs at $0.1 million.
• The city provided various administrative services (including legal, accounting, and personnel) to the arena at no charge at an estimated cost of $0.1 million.
• The city estimates the cost of additional sanitation, fire, and medical services due to events at the center to be approximately $0.2 million.

1. Would you agree with the council member that the arena was fiscally self‐sustaining?
2. In which funds would the additional revenues and expenditures be budgeted and accounted for?
3. Comment on the limitations of both the traditional object classification budget and fund accounting system in assessing the economic costs and benefits of a project—such as the sports and special events arena.
4. What changes in the city’s budgeting and accounting structure would overcome these limitations? What additional problems might these changes cause?

Answer 1

The term financially self-sustaining means “management and operating expenditures equal to or less than proceeds derived from fees and other receipts for resource use and development and interest on invested funds. Management and operating expenditures shall include Trustee expenses, salaries and benefits of staff, administrative and operating expenses, improvements to and maintenance of lands and facilities of the Preserve, and other similar expenses. Funds appropriated to the Trust by Congress, either directly or through the Secretary, for the purposes of this title [16 USCS § 698v et seq.] shall not be considered.

A condensed income statement is simply an income statement with many of the usual line items condensed down into a few lines. Typically, this means that all revenue line items are aggregated into a single line item, while the cost of goods sold appears as one line item, and all operating expenses appear in another line item

“The progress of the enormous debts which at present oppress, and will in the longrun probably ruin, all the great nations of Europe has been pretty uniform. Nations, like private men, have generally begun to borrow upon what may be called personal credit, without assigning or mortgaging any particular fund for the payment of the debt; and when this resource has failed them, they have gone on to borrow upon assignments or mortgages of particular funds.”.

Unsustainable debt paths may eventually lead to sharp adjustments if not to crises—i.e., to generalised failure of economic agents to meet their obligations. Hence, sustainability is a most desirable quality. The emphasis of this merely expository note shall be on the ex-post algebra of sustainability. While the ex-post algebra of sustainability is rather straightforward, ex-ante analysis is not: the key variables involved are either endogenous, uncertain, or both; expectations playing a prominent role driving equilibria and, therefore, driving expectations themselves. Nonetheless, the simple ex-post algebra of sustainability provides a useful framework to identify vulnerabilities and risks—after all, a most fertile source for insight in hindsight.

1. Simple Algebra of Fiscal Sustainability Indicators of fiscal sustainability are constructed to shed light on the following equation.

  “Can the current course of fiscal policy be sustained, without exploding debt? Orwill the government have to sharply increase taxes, decrease spending, have recourseto monetisation, or even repudation?”

Let Dt denote the stock of government debt at the end of year t, let it be the (average) nominal interest rate, Bt the primary (i.e., non-interest) government balance (Bt > 0 means that the government runs a surplus), and let Mt denote the end-of-period stock of high-powered money. The government budget constraint implies that: Dt = (1 + it)Dt−1 − Bt − ∆Mt (1) = Dt−1 − (Bt − itDt−1) | {z } Overall Balance − ∆Mt | {z } Seignorage (2) Equation (1) always holds ex-post. It simply states that the government meets its debt obligations, and that any gap, Bt < 0, must either be financed by new debt, or monetised, or a mix of the two. In contrast, a surplus, Bt > 0, can be used to reduce the stock of existing debt or the stock of money—e.g., see the flow of funds displayed in Table 1. Note that any gross amortization due during t will require a rollover unless a government surplus—i.e., (B + ∆M) > 0—allows for a net amortization effectively reducing the debt stock. For example, assume that a portion α of D−1 comes due and that (B + ∆M) = 0, then we’d have D = [1 + αi + (1 − α)i−1]D−1, which simplifies to D = (1 + i)D−1 when i = i−1. 2 It is useful to normalise the quantities in equation (1) by some measure of the government’s ability to service and repay its debt—e.g., government revenues, GDP, exports in the case of external debt, etc. The most common choice used for normalising government debt is GDP. Dividing equation (1) by nominal GDP, PtYt, results in: Dt PtYt = (1 + it)Dt−1 PtYt − Bt PtYt − ∆Mt PtYt (3) = (1 + it) (1 + gt)(1 + πt) Dt−1 Pt−1Yt−1 − Bt PtYt − ∆Mt PtYt (4) where gt is the real growth rate and πt is the inflation rate (measured as the rate of change of the GDP deflator, P).

By applying the above,I agree with the council member that the arena was fiscally self‐sustaining.