Government Finance in Perspective: A Misuse of Financial Analysis
The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.
By Thomas Snyder
November 18, 2021
Government exists to serve the people and not to be self-serving. Yet the financial analysis that is often used to evaluate programs and policies looks at what is best for the government budget and not society.
Three examples, which follow, help to make the point. The first provides some context and the latter two explicitly show instances in which financial analysis ignores the role of expenditures to benefit society.
Opportunity costs of college
To examine the concept of opportunity costs, virtually every microeconomic text looks at the cost of college. The literature from colleges and handbooks on college choice give the cost as tuition and room and board.
The micro texts point out an important additional cost: the opportunity cost of the student’s time—the foregone pay if the student had worked (and also a proxy for the student’s productivity and benefit to society) or the value of the student’s leisure if they traveled or engaged in other activities.
This analysis is from the student’s perspective. From a societal perspective, the cost of instruction is not tuition, but the cost of the teacher, the classroom and other resources used to provide the instruction. Tuition is just a method of paying for some of the costs. State aid, federal grants and endowments can also cover the costs of instruction. From a societal perspective, costs are the (opportunity) cost of the resources used to provide the service and financing is just a way to distribute costs.
The Chicago Parking Meter System
In 2009, Chicago leased its parking meter system for $1.15 billion for 75 years to a consortium of private investors. The city justified the lease based on an analysis by its financial advisor. The analysis compared the present value of the net parking revenues forgone by the city under the lease (the value of the status quo) to the upfront payment by the consortium (the value of the lease).
This approach looked solely at the net impact on the city’s budget. Under the lease the concessionaire was allowed to double parking rates in real terms which was reflected in the upfront payment. The city’s forgone revenue, however, was based on the current parking fee structure. The parking fees are pecuniary, and both sides of the payment must be considered.
If the fees were the same under both the status quo and the lease, then the analysis would measure the city’s (and thus taxpayers’) share of the benefits of any net efficiency from the lease. When a purely financial analysis with the increase in parking fees under the lease, is the only focus, however, that implies that the people paying parking fees have no standing. The city is implicitly saying benefits to the city of increased parking fees (via the lease) are relevant, but the costs to people parking their cars are irrelevant. Such logic would provide justification for any tax or user fee, even if there were no benefits.
Financing a Fire Station
The book, Capital Budgeting and Finance: A Guide for Local Governments from ICMA Press, by Justin Marlowe, William C. Rivenbark and A. John Vogt, looks at two options for a new fire station to show the proper way to evaluate a public investment. Under one option the city purchases land for the fire station. In the other alternative, the city uses land it currently owns.
The authors attribute a net savings/benefit of the price of the land to the second option since it is a “sunk cost” and not an expenditure that city needs to make from its budget. However, there is an opportunity cost for the land in the second option, just as with the student’s time in the first example. The city could sell the land or use it for another project forgoing the need for purchasing land for it. In both options there is a real resource cost for the land.
Furthermore, the authors include a benefit with both options for revenues from a new fire service fee and for the first option an additional cost for the lost tax revenues from the purchased land. Both of these are pecuniary and yield no net benefit or cost from the perspective of the citizens of the city. Financing (taxes and fees) does not change the cost of resources or benefits of the options. It just redistributes the costs from one segment of the community to another. The authors are using a financial analysis of impacts on the budget when they should be looking at impact on the citizens of the community.
Financial analysis as taught in business schools looks at benefits and costs from the perspective of an institution—a firm, a household or an individual. When used by governments, it looks at projects and policies from the perspective of an institution—government. Government, however, should use economic analysis which looks at benefits and costs to society. Government should also consider the distribution of those benefits and costs to all segments of society to assess the equity of projects and policies.
Author: Thomas Snyder, clinical professor emeritus in the Department of Public Administration and a member of the Faculty Advisory Panel for the Government Finance Research Center at the University of Illinois at Chicago
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Government Finance in Perspective: A Misuse of Financial Analysis
The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.
By Thomas Snyder
November 18, 2021
Government exists to serve the people and not to be self-serving. Yet the financial analysis that is often used to evaluate programs and policies looks at what is best for the government budget and not society.
Three examples, which follow, help to make the point. The first provides some context and the latter two explicitly show instances in which financial analysis ignores the role of expenditures to benefit society.
Opportunity costs of college
To examine the concept of opportunity costs, virtually every microeconomic text looks at the cost of college. The literature from colleges and handbooks on college choice give the cost as tuition and room and board.
The micro texts point out an important additional cost: the opportunity cost of the student’s time—the foregone pay if the student had worked (and also a proxy for the student’s productivity and benefit to society) or the value of the student’s leisure if they traveled or engaged in other activities.
This analysis is from the student’s perspective. From a societal perspective, the cost of instruction is not tuition, but the cost of the teacher, the classroom and other resources used to provide the instruction. Tuition is just a method of paying for some of the costs. State aid, federal grants and endowments can also cover the costs of instruction. From a societal perspective, costs are the (opportunity) cost of the resources used to provide the service and financing is just a way to distribute costs.
The Chicago Parking Meter System
In 2009, Chicago leased its parking meter system for $1.15 billion for 75 years to a consortium of private investors. The city justified the lease based on an analysis by its financial advisor. The analysis compared the present value of the net parking revenues forgone by the city under the lease (the value of the status quo) to the upfront payment by the consortium (the value of the lease).
This approach looked solely at the net impact on the city’s budget. Under the lease the concessionaire was allowed to double parking rates in real terms which was reflected in the upfront payment. The city’s forgone revenue, however, was based on the current parking fee structure. The parking fees are pecuniary, and both sides of the payment must be considered.
If the fees were the same under both the status quo and the lease, then the analysis would measure the city’s (and thus taxpayers’) share of the benefits of any net efficiency from the lease. When a purely financial analysis with the increase in parking fees under the lease, is the only focus, however, that implies that the people paying parking fees have no standing. The city is implicitly saying benefits to the city of increased parking fees (via the lease) are relevant, but the costs to people parking their cars are irrelevant. Such logic would provide justification for any tax or user fee, even if there were no benefits.
Financing a Fire Station
The book, Capital Budgeting and Finance: A Guide for Local Governments from ICMA Press, by Justin Marlowe, William C. Rivenbark and A. John Vogt, looks at two options for a new fire station to show the proper way to evaluate a public investment. Under one option the city purchases land for the fire station. In the other alternative, the city uses land it currently owns.
The authors attribute a net savings/benefit of the price of the land to the second option since it is a “sunk cost” and not an expenditure that city needs to make from its budget. However, there is an opportunity cost for the land in the second option, just as with the student’s time in the first example. The city could sell the land or use it for another project forgoing the need for purchasing land for it. In both options there is a real resource cost for the land.
Furthermore, the authors include a benefit with both options for revenues from a new fire service fee and for the first option an additional cost for the lost tax revenues from the purchased land. Both of these are pecuniary and yield no net benefit or cost from the perspective of the citizens of the city. Financing (taxes and fees) does not change the cost of resources or benefits of the options. It just redistributes the costs from one segment of the community to another. The authors are using a financial analysis of impacts on the budget when they should be looking at impact on the citizens of the community.
Financial analysis as taught in business schools looks at benefits and costs from the perspective of an institution—a firm, a household or an individual. When used by governments, it looks at projects and policies from the perspective of an institution—government. Government, however, should use economic analysis which looks at benefits and costs to society. Government should also consider the distribution of those benefits and costs to all segments of society to assess the equity of projects and policies.
Author: Thomas Snyder, clinical professor emeritus in the Department of Public Administration and a member of the Faculty Advisory Panel for the Government Finance Research Center at the University of Illinois at Chicago
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