Budgeting and Financial Management in the Federal Government. (Off the Shelf).

Information Age Publishing Inc.

ISBN: 1-931576-12-2 (paperback); 1-931576-13-0 (hardcover).

From time to time, books are published that appear both informative and useful to members of the Department of Defense financial management community. The Armed Forces Comptroller plans regularly to print member reviews and, if feasible, will offer extracts of those books. To submit a book review, please contact Mary Barfield, 800-462-5637 ext. 228, or [e-mail].

Budgeting and Financial Management in the Federal Government is one such book. Drs. McCaffery and Jones, in this first volume of their Research in Public Management Series, give the reader an excellent picture of the history and processes used by various agencies and by the Congress in compiling, submitting, enacting, and executing the Budget of the United States.

The work is written both from analytic and from academic perspectives by authors who understand in depth the underlying details and, occasionally, the chaos and stress in this process. The book is informative and insightful in laying out contemporary challenges and potential solutions to those challenges. It is an excellent reference for students of public administration and government, as well as for anyone who works in the field of government financial management.

Constitutional Government

The United States (U.S.) Constitution gives to the Congress the right to tax and sets forth four qualifications on spending power (Article 1, Section 8):

1. No money shall be drawn from the Treasury but in consequence of appropriation.

2. A regular statement and account of all receipts and expenditures must be rendered from time to time.

3. No appropriations to support the army shall run for longer than two years.

4. All expenditures shall be made for the general welfare.

The first two points contained in Article 1, Section 8, are the cornerstones of the budget process. On the revenue side, all money bills were directed to originate in the U.S. House of Representatives because of its proportional and direct representation of the people.

The role of the U.S. Senate was debated, with the compromise that the Senate could concur with the House or propose amendments to revenue bills. Fiscal power would be developed within an environment where the Congress was expected to be a jealous guardian of its powers.

Under the impact of the American Revolution, planning had been nonexistent, management had been a legislative responsibility, and control for propriety was honored more in its absence than in its presence. The period of 1789 to 1800, however, marked the beginning of a movement toward executive management and perhaps could be called the first stage of U.S. budget reform.

The talents of Alexander Hamilton strongly influenced development in this period.

Hamilton's Rise to Prominence

Hamilton was a man of great achievement. He learned applied finance at the age of 11, while serving as a clerk in a counting-house on the island of St. Croix in the West Indies. He learned quickly and was promoted to bookkeeper and then to manager.

Before Hamilton was 21, he had impressed friends with his abilities to the extent that they sponsored him in a course of studies, first at a preparatory school and then at the predecessor to Columbia University in New York. There he quickly gained a reputation as an adroit protagonist for the cause of the American colonies.

In 1776, he won George Washington's eye with his conspicuous bravery as a provincial artillery captain at the Battle of Trenton, Washington used him as a staff officer until 1781 when Hamilton, chafing under the limitations of staff routine, seized upon a trivial quarrel to break with Washington and leave his position.

Washington seemed to have understood his impetuous subordinate well. He gave Hamilton command of a battalion that attacked a British stronghold at the siege of Yorktown in October of 1781--a siege that ultimately became the decisive battle of the Revolutionary War.

During the 1780s, Hamilton practiced law in New York City and was active in congressional politics, arguing for a strong central government. He believed that the English government, as then constituted under King George III, should be the American model. Hamilton proposed a president elected for life who would exercise an absolute veto over the legislature. The central government would appoint the state governors, who would have absolute power over state legislation. The judiciary would be composed of a supreme court whose justices would have life tenure. The legislature would consist of a senate, elected for life, and a lower house, elected for three years. In this system, the states would have virtually no power.

Hamilton's ideas seem to have had little influence upon the Constitutional Convention. However, when opponents attacked the document brought forth by the convention, Hamilton, with James Madison and John Jay, authored The Federalist Papers. These were a collection of 85 widely read essays that helped mold contemporary opinion. They became one of the classic works in American political literature.

Hamilton's Influence As Secretary of the Treasury

Washington appointed Hamilton as Secretary of the Treasury in September 1789. In that role Hamilton fused his own goals for a strong central government with the new nation's fiscal needs. His first efforts were directed toward establishing the credit of the new government. His first two reports on public credit urged funding the national debt at full value, the assumption by the federal government of all debts incurred by the states during the Revolutionary War, and a system of taxation to pay for the debts assumed.

Strong opposition to these proposals arose, but Hamilton's position prevailed after he made a bargain with Thomas Jefferson, who delivered southern votes in return for Hamilton's support for locating the future nation's capital on the banks of the Potomac near Virginia.

Hamilton's third report to the Congress proposed a national bank, modeled after the Bank of England. Through this proposal, Hamilton saw a chance to knit the concerns of the wealthy and mercantilist classes to the financial dealings of the central government. Washington signed the bill establishing a national bank based, in part, on Hamilton's argument that the Constitution was a source of both enumerated and implied powers--an interpretation he used to expand the powers of the Constitution in later years.

Hamilton's fourth report to the Congress was perhaps the most philosophic and visionary. Influenced by Adam Smith's The Wealth of Nations (1776), Hamilton broke new ground by arguing that it was in the interest of the federal government to aid the growth of infant industries through various protective laws and that, to aid the general welfare, the federal government was obliged to encourage manufacturing through tax and tariff policy.

Hamilton's contemporaries seem to have rejected the latter view; the Congress, at least, would have nothing to do with it. Nonetheless, in little more than 2 years, Hamilton submitted four major reports to the Congress, gaining acceptance of three that funded the national debt at full value, established the nations credit at home and abroad by creating a banking system and a stable currency, and developed a stable tax system based on excise taxes to fund steady recovery from the debt and to provide for future appropriations.

Hamilton opposed the popular view of war with England in the mid-1790s, at a time when France and England were at war, and England was seizing American ships in the Caribbean. He believed that commerce with England and the import duties it provided were crucial. Hamilton's essays, published in New York newspapers in 1795, helped avoid war with England, thereby maintaining his revenue system.

The elements of the new nation's monetary and fiscal policy were bitterly contested issues, and groups began to coalesce around various positions, both pro and con. Hamilton became the leader of one faction, the Federalists; and because Washington supported most of Hamilton's program, in effect he became a Federalist.

The two most prominent individuals in opposition were James Madison in the House of Representatives and Thomas Jefferson in the Cabinet. Madison and Jefferson came to be considered leaders of the Republican faction.

Hamilton and Jefferson feuded constantly for several years beginning in 1791, as each tried to drive the other from the Cabinet. Finally, tired, stung by criticism of his operation of the Treasury Department, and needing to repair his personal fortunes, Hamilton announced his intentions to resign his post as Secretary of the Treasury at the end of 1794.

Hamilton did not, however, retreat to obscurity. He still held presidential ambitions that were narrowly frustrated. He was appointed to high military command and remained within the inner circle of the nation's political elite until his death in a pistol duel with Aaron Burr in 1804. Hamilton had achieved great accomplishments but had made bitter enemies.

Hamilton's role in establishing a system for debt management, securing the currency, and providing a stable revenue base make him perhaps the founding father of the American fiscal system. Without faith in a nation's currency, credit, and revenue base, it is impossible to make any budget system work.

The federal taxing power alone was a dramatic change from the system envisioned under the Articles of Confederation, which approximated a contributory position by the separate states, hectored by the central government. Only a sure and certain revenue base, providing predictable revenue collections, allows the creation and maintenance of a modern nation-state. It was Hamilton's genius to direct the United States to that pathway.

To the Congress, Hamilton represented a transitional figure. Before his appointment, the House of Representatives had a tax committee, the Committee on Ways and Means, which was established in the summer of 1789. But this committee fell into disuse when a Secretary of Treasury was appointed.

At this juncture in history, the Congress viewed the Treasury Department as a legislative agency and the Secretary of Treasury as its officer. The first appropriations bill for an operating budget came about because the House ordered the Secretary of Treasury to . . report to this House an estimate of the sums requisite to be appropriated during the present year; and for satisfying such warrants as have been drawn by the late Board of the Treasury and which may not heretofore have been paid."

When the articles of the Constitution were being debated, Hamilton wrote:

"The House of Representatives cannot only refuse, but they alone can propose, the supplies requisite for the support of the government. They, in a word, hold the purse....This power over the purse may, in fact, be regarded as the most complete and effectual weapon with which any constitution can arm the immediate representatives of the people for obtaining a redress for every grievance and for carrying into effect every just and salutary measure."

Whatever the flaws of the Act creating the Department of the Treasury, it seems clear that its intent was to make the Congress alone responsible for the budget process. That there was little room for executive leadership is demonstrated in the fact that the Act mentions the President only in connection with appointment and removal of officers.

Furthermore, while the Act was being debated, opinion was divided over the wording of the duties of the Secretary of the Treasury with respect to whether he was to digest and report revenue and spending plans or whether he was to digest and prepare plans.

Those Congressmen hostile to strong executive power believed that giving the Secretary the power to digest and report plans would rake the fiscal policy initiative away from the House. If the Secretary only reported what he had already done, it would deprive the House of its ability to exercise a prior restraint on the actions of the Secretary. Consequently, the word report was deleted from the legislation and prepare was inserted and carried by the majority.

Some observers have mistaken Hamilton's approach to appropriation as having established an executive budget system. The traditional model of an executive budget system would encompass a presidential review of departmental documents, revision of estimates, and a unified submission by the President or his agent of those estimates to the Congress for its approval.

As Secretary of the Treasury, Hamilton did not wish the system to function in this manner and, personally, he acted as an agent of Congress. The development of an executive budget system occurred in a more gradual process, with a steady line of evolution leading to the authorization of a formal presidential budget--but not until 1921.

The first appropriation act of the Congress was brief and general:

"That there be appropriated for the service of the present year, to be paid out of the monies which arise, either from the requisitions heretofore made upon the several states, or from the duties on impost and tonnage, the following sums. Viz. A sum not exceeding two hundred and sixteen thousand dollars for defraying the expenses of the civil list, under the late and present government: a sum not exceeding one hundred and thirty-seven thousand dollars for defraying the expenses of the department of war; a sum not exceeding one hundred and ninety-six thousand dollars for discharging the warrants issued by the late board of Treasury and remaining unsatisfied; and a sum not exceeding ninety-six thousand dollars for paying pensions to invalids."

Although salaries are the largest single item in this list (civil list), mandated expenditures (that is, bills and pensions) composed 45 percent of the budget; defense, 21 percent; and entitlements, nearly 15 percent. De facto uncontrollability was high.

True to modern practice, this appropriation bill was not the only money bill passed by the Congress. Between the summer of 1789 and May of 1792, numerous bills were passed to provide for a variety of expenses, including defense, Indian treaties, debt reduction, and establishment of the federal mint.

The first three bills were written as lump-sum general appropriations, for the civil list, the Department of War, invalid pensions, the expenses of the Congress, and contingent charges upon government. Appropriating by lump sum caused resentment among some Congressmen. One wrote of the appropriations bill of 1790 in his diary:

"The appropriations were all in gross, and to the amount upward of half a million. I could not get a copy of it. I wished to have seen the particulars specified, but such a hurry I never saw before....Here is a general appropriation of above half a million dollars--the particulars not mentioned--the estimates on which it is founded may be mislaid or changed; in fact it is giving the Secretary the money for him to account for as he pleases."

Notwithstanding their general nature, appropriation bills were linked to estimates of expense as specified in other bills. Expenditures for salaries were generally governed by laws enumerating the salary and number of the officers stipulated--for example, five associate supreme court justices at a salary no more than $3,500 per year. Estimates for the military were assumed to control the appropriations voted for the military.

Therefore, even though the appropriations were voted in gross, the calculations adding up to the total were assumed to control the total. By 1792, the Congress was appropriating money in gross but stipulating what the money was to be used for, using "that is to say" clauses followed by specific sums attached to an enumeration of the corresponding general items.

Thus, the Congress was now planning in detail and the executive branch accepted that detail, although knowing full well that the dictates of administering might make it imperative to depart from the detailed plans expressed in the appropriation acts. Budgeting by lump sum was not a characteristic of the routine of American government except in case of emergency appropriations. The Congress increasingly specified the itemization of appropriation bills, in part as a strategy to control Secretary of the Treasury Hamilton, who was viewed by some as a member of the executive branch.

In 1790, the House had 65 members, and most of its business could be carried out as a committee of the whole. But by 1795 it was clear that the Treasury Department could not serve the needs of the Congress as well as it could serve the needs of the executive. Therefore, Congress reinstituted the Committee on Ways and Means, initially as a select or special committee and, by 1802, as a standing committee.

Hammering Out Fiscal Policy

During that period, Secretary Oliver Wolcott, Jr., Hamilton's successor at Treasury, was embroiled in an increasingly bitter argument with the Congress over the transfer of appropriations. Although the Congress could appropriate in very specific terms, it could not stop the administration from transferring from one account to another when the situation seemed to warrant such transfers. The War and Navy departments seemed particularly able to transfer funds, thereby dissolving the discipline of detailed itemization.

In 1801, when the Federalists were defeated and the Republicans took office, Thomas Jefferson spoke to the need for increased itemization of expenditure in appropriations. Nonetheless, the transfer of appropriations was an accepted practice in the administration, albeit an illegal one. Jefferson himself made the Louisiana Purchase after a liberal interpretation of executive authority to issue stock when government revenues were

Insufficient to cover necessary expenditures. Congressional insistence on itemization led to deficiencies in accounts. Later, budget practices also became part of developing party policies.

The Federalist Party believed in a strong executive and, consequently, preferred lump -sum appropriations for activities that would give administrators as much flexibility as possible in managing programs. Meanwhile, the Republican Party favored specific line-item appropriations that limited department heads to doing specifically what the Congress intended.

However, the Congress found out it could not control everything and, beginning with appropriations for the Army and the Navy, it relaxed line-item controls and chose not to invoke other controls.

The tension between delegating power to the executive and retaining appropriate congressional control over the "power of the purse" has remained an issue to current times. Generally, when relationships between the executive and legislative branches deteriorate because of divided party control or because an executive agency becomes either too aggressive in its budget practices or not aggressive enough, the Congress imposes controls. These include limiting reprogramming within appropriation thresholds (ceilings), requiring advance notification (to the Congress) for reprogramming changes from one category within an appropriation account to another, or attaching a legislative interest note to an item to ensure that money is spent in a special way or that a program is executed within the fiscal year.

By 1800, the initial pattern had been set. The Congress passed appropriation bills linked to specific estimates for specific purposes, allowing some flexibility between military and civil expenditures and recognizing that transfers of funds between categories were technically illegal but necessary to meet contingencies unforeseen at the time of appropriations. The House held major control of the purse.

By 1802, it had developed a standing committee to deal with revenues and appropriations while, on the executive side, the Secretary of Treasury more clearly became the President's agent in shaping appropriations bills, collecting revenues, and debt management. Both the legislature and the executive were elected by and responsible to the people.

Rudimentary and disconnected as it seems from modern perspectives, no other country had achieved such a budget system.

Making the System Work: 1800-1921

The transfer of power to Thomas Jefferson and the Republicans marked the end of the period of creation of the Republic, the end of the process of separating from England and the setting up of a new government. Much remained to be done, but many of the basic mechanisms of governance and of monetary and fiscal policy were not in place.

In fiscal affairs, the federal government had established its powers to tax and to budget, as well as to issue notes of credit when revenues did not match expenditures. Budgeting was, in the main, a legislative power. The Department of the Treasury was originally conceived as Congress's assistant.

Budgeting power in the Congress was held in the House, which was small enough so that it could operate as a committee of the whole. As the Treasury increasingly served the President, Treasury's role declined as an agent of the Congress, and the Congress formed its own internal review and enactment body, the Committee on Ways and Means, which would gain great power.

During the course of the nineteenth century, appropriation bills would be sent to other committees as the Ways and Means Committee workload became heavier or as political factors dictated. After the Civil War, the House created a Committee on Appropriations.

However, when that committee used retrenchment powers to reach into substantive legislation under the jurisdiction of other committees, the Congress reacted against this expansion of Appropriations Committee power. It seems that whenever a committee role became too important, the Congress changed its procedures to redistribute power. Thus, while legislative procedures changed, budgeting maintained eminence as a vital legislative process.

In Brief

Jerry L. McCaffery is Professor of Financial Management and Budgeting, Department of Administrative Sciences, the Nova! Postgraduate School at Monterey, California. In addition to numerous articles and books on government budgeting, he has published a book on another passion--lighthouses--titled The Point Pinos Lighthouse.

L.R. Jones is Professor of Financial Management and Budgeting, Department of Administrative Sciences, the Naval Postgraduate School at Monterey, California, and President of Management and Policy Associates, lnc., a research and management consulting firm.