Cost Behavior in Local Governments from the Theory of Public Finance Perspective.
| Autor | Fabre, Valkyrie Vieira |
1 Introduction
Since the mid-18th century, public finance has been an important subject of study (Musgrave & Peacock, 1958), for which the balanced budget is consolidated in the literature and practice of several countries (Edgeworth, 1897). However, the research focus has been on revenues, and the understanding of costs remains partially unclear (Bracci et al., 2015; Santos, 2008; Santos et al., 2017).
Musgrave's (1959) Theory of Public Finance (TFP), one of the most important theories focused on government management, has its origins in economics and focuses on management efficiency. In its approach to government functions, which establishes the purpose of the governments actions for using resources, it characterizes public costs as allocative, distributive, or stabilizing (Santos et al., 2017).
The TFP directs a large amount of government accounting standards in several countries and has been consolidated worldwide. In Brazil, for example, public accounting regulations follow the TFP's precepts and establish mandatory budget plans and their execution balance, including penalties for non-compliance. Among the public accounts associated with the TFP, those with a functional classification best represent the purpose of costs according to the governments areas of action. This research follows the international literature by using the term "public costs" as a synonym for executed budgetary expenditure.
In recent years, governments have deliberately increased costs in the public sector (Bracci et al., 2015; Mou et al., 2018). However, political and economic reforms aim to restructure public accounts, and some governments search for ways to reduce costs without even understanding their actual behavior (Kulmala et al., 2016). While in the public sector the budget result is measured in the period and balance is expected (total revenue = total cost), in the cost behavior theme, which comes from the private sector, the behavior is measured by the variation between periods (variation of costs in comparison with variation in revenue), in which the result can be symmetric or asymmetric. Thus, government cost behavior represents one of the main research gaps in the last two decades (van Helden & Uddin, 2016).
The cost behavior theme evolved from the traditional accounting approach (more focused on symmetric behavior) to the contemporary one (more focused on asymmetric behavior). In fact, some research (Cohen et al., 2017; Hosomi & Nagasawa, 2018a, 2018b; Nagasawa & Nagasawa, 2021) states that the contemporary approach may not apply to the pure public sector (where resources are purely public, balanced budgeting and nonprofit activities prevail). This understanding is mainly due to the fact that successive balanced budgets make asymmetric behavior unfeasible.
The possibility of asymmetric cost behavior is already consolidated in the private sector literature (Banker et al., 2018; Banker & Byzalov, 2014; Richartz & Borgert, 2014), but the discussion is incipient in the public sector. However, recent research (Joyce & Pattison, 2010; Kulmala et al., 2016; Mou et al., 2018) indicates that governments are not always able to maintain budget balance in times of crisis, which may show a behavior that is different from expected (which would be symmetric).
In the private sector, the cost stickiness phenomenon has been highlighted through research that has identified several determinants and is currently focused on explaining its consequences (Malik, 2012). Meanwhile, in the public sector, cost behavior still needs evidence, as the existing results are not conclusive or are not in accordance with the contemporary accounting approach (Campagnoni et al., 2021). Therefore, this research, whose purpose is to analyze in an unprecedented way the cost behavior in local governments from the Theory of Public Finance perspective, presents theoretical and empirical contributions so that the theme can be expanded, to also cover the public sector, without disregarding its peculiarities.
The public cost behavior theme is scarce and requires a different overview (Cohen et al., 2017). The use of tools and innovations from private management accounting can potentially be explored in public sector research (Lapsley & Wright, 2004), especially to understand how costs behave (Bracci et al., 2015; Kulmala et al., 2016; Lapsley & Weight, 2004; Santos, 2008; Santos et al., 2017), since specificities of the public sector, such as multiple activities, non-profit purposes, and independent records of revenues and costs, need to be observed in a particular way.
This research follows the proposal of Anderson et al. (2003) of calculating cost behavior using robust panel data regression statistics to analyze accounting data from 295 local governments in Brazil over a 16-year period (2005-2020), totaling 141,600 observations. All 32 models analyzed showed asymmetric behavior of public costs, with 75% being characterized as cost stickiness (47% sticky and 28% anti-sticky) and 25% as reverse cost (a new phenomenon identified, typical of the public sector, but which can also occur in the private sector).
The contributions are relevant, as the research proves that the contemporary accounting approach (cost stickiness) can be applied to the pure public sector, it reveals the weakness of the fundamental precept of the TFP (budget balance), and it identifies a new phenomenon called reverse cost, which applies to both symmetric and asymmetric cost behavior, changing the consolidated accounting classification in the current literature.
2 Literature review
The theoretical basis of this research is supported by the combination of two distinct themes. The first deals with Musgrave's (1959) Theory of Public Finance and the second deals with Cost Behavior, in the contemporary approach of Anderson et al. (2003). The theoretical intersection point and focus of this research is government cost behavior, whose literature is incipient in both themes.
2.1 theory of public finance
By creating the TFP, whose focus is on government management efficiency, Musgrave (1959) reinforced an already consolidated practice in governments, which was the assumption of a balanced budget. Based on this understanding, the cost behavior in the public sector is expected to be symmetric. However, recent research has raised suspicions of an imbalance, as Joyce and Pattison (2010) point out that governments are not always able to maintain budget balance in times of crisis and Kulmala et al. (2016), indicate that excessive outsourcing leads to an imbalance. Furthermore, Mou et al. (2018) state that, in times of economic crisis, an imbalance occurs in specific accounts, generating deficits that are subsequently offset by surpluses, rebalancing the public accounts. Such suspicions have not yet been confirmed, but they point to the possibility of asymmetric cost behavior in the public sector.
The TFP can be summed up in three approaches, also known as Musgrave's trilogy: government functions, public goods, and equity. At many points the approaches merge, as the assumptions of budget balance, the State's action in market failures, and fair taxation permeate them. But, in general, the government functions approach represents the purpose of public costs, the public goods approach involves stimulating the supply of goods and services (not necessarily those of the State), and the equity approach focuses on fair taxation for the taxpayer in order to bear government costs. However, this research uses the government functions approach, which considers that all costs are generated to fulfill a purpose, that is, an allocative, distributive, or stabilizing function (Musgrave, 1959; 2008).
In the case of the allocative function, it is believed that private initiative does not always meet all of society's needs. There are goods and services that it does not offer or that are provided and/or performed in quantities below those demanded. According to Musgrave (1959; 1997; 2008), the State, through the allocative function, aims to overcome this deficiency in the market by complementing what is already offered or providing society with what is not provided by the market. The allocative function encompasses most public costs (Musgrave, 2008), but when the private sector is consolidated, the government may stop providing services, so the private sector takes control of them (Musgrave, 1973). Some authors mention security (Jordaan, 2013; Maciel, 2013), justice, inspection, executive sovereignty (administration), the legislative branch, infrastructure works, culture and history (Jordaan, 2013), social development (Fourie, 2009), education and health (Costa & Gartner, 2017; Fourie, 2009; Maciel, 2013; Sabina, 2011), welfare and work (Maciel, 2013), national defense and public order (Sabina, 2011) as allocative costs.
The State's distributive function is manifested by withdrawing part of the income or assets from several people or through the legal forms in which they organize themselves, in order to redistribute those incomes according to equity and social justice criteria (Sabina, 2011). These are policies aimed at distributing income, goods, or tax incentives (tax exemptions) to individuals or legal entities that for some reason are unable to compete in the market because of their vulnerable situation. Public welfare (Musgrave, 2008), social assistance (Costa & Gartner, 2017), and social security services (Musgrave, 1973) are mentioned as typical public services of the distributive function. A global example of a distributive function, which increased costs during a period of crisis, is the government assistance to individuals and companies that had their income reduced due to the COVID-19 pandemic.
The stabilizing function deals with the government's role in maintaining the economic balance of a nation or region. For this reason, the State acts to control supply and demand, seeking to reduce the negative effects...
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