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Budget Tricks (Part 1)

By Scott Lazenby

lazenbyPreviously, we discussed two ways of managing public budgets. The first way, which we’ll call Theory X, is the way most governments do it. The other way, which we’ll call Theory Y, aligns the budget system with good management principles, and includes the following elements: 1) departmental revenues are allocated directly to departments; 2) general fund departments are given a fixed amount of general revenues to work with; 3) operating departments can carry forward 100% of any year-end savings; and 4) operating managers are held to the bottom line and have full authority over line items. A corollary is that any departmental revenue over the budget estimate automatically increases spending authority.

In addition to providing a better alignment between the budget system and principles of good management, a “Theory Y” budget system eliminates many of the headaches the CEO has to deal with. In this column, we’ll explore ten budget tricks that are common under traditional budget systems.

1. Magic disappearing revenue. The budget just won’t balance, but you don’t want to cut spending. Just increase the revenue estimate to make it balance and worry about it later.

Theory X response: Account for all revenues centrally, and have central finance staff perform all revenue estimates and projections.

Theory Y solution: Operating units (and internal units that bill other departments for service) are responsible, to the maximum extent possible, for estimating revenues and dealing with revenue shortfalls. There is no benefit to overestimating revenue. General revenues such as taxes will still need to be estimated centrally, but operating departments that depend on them will put pressure on the forecasters to estimate as accurately as possible.

2. The sacrificial lamb. The budget office asks for a list of programs that could be cut if spending reductions are necessary. The department head offers up the pet programs of the CEO or governing body, knowing they will be held sacred. This is the oldest trick in the book, yet people keep doing it.

Theory X response: When the tactic is too blatant, discipline the offending manager.

Theory Y solution: Governing board priorities are made clear well in advance of the budget process. Operating managers are given a total budget target to meet the board’s priorities, so there is no point in holding a particular program hostage.

3. Groundhog Day. The police chief requests an additional traffic enforcement officer, promising that additional traffic tickets will pay for the position. Over the next few years, the position is shifted and traffic enforcement drops off. The chief then requests an additional patrol officer, promising that additional traffic tickets will pay for the position.

Theory X response: Keep careful records during budget hearings in order to expose this trick and deny the request.

Theory Y solution: Not an issue in a Theory Y budget. There is no “budget request” process.

4. It’s only routine replacement. The parks department scrounges some old surplus conference chairs and a table from another department. In the next budget cycle they include a request to replace the aging office equipment.

Theory X response: Create new rules allowing for replacement costs only when equipment was originally purchased through an approved budget line item.

 Theory Y solution: Not an issue in a Theory Y budget. There is no “budget request” process.

5. Grants? What grants? The department adds a plug in the budget in case a grant is received. The grant application is unsuccessful, but the spending authority remains in the budget (and the money gets spent).

Theory X response: Centralize both revenues and expenditure budgets for grant-funded programs, to ensure that departments do not have access to the funds until the grant is secured.

Theory Y solution: All departments or programs, even those within the general fund, are self-balancing (budgeted expenditures equal estimated revenues). Bottom-line control means that total expenditures must always stay within total (actual) revenues. What this means in practice is that grant-based spending authority is created only when the grant is actually awarded.

6. Spend it or lose it. The department has a goal of spending every penny in the budget, both to avoid losing it at the end of the fiscal year, and to prove to the pesky budget analysts that they really need every cent in their budget.

Theory X response: Institute an arbitrary cutoff date for requisitions to catch departments off guard or provide extra scrutiny of requisitions near the end of the fiscal year, demanding thorough justification for each dollar spent.

Theory Y solution: The ability of departments to carry over 100% of their year-end savings ends this trick once and for all.

7. Don’t ask, it’s technical. The public works director slips in a request for a new riding lawn mower (for park maintenance), sandwiched between a twenty million dollar water plant upgrade and a ten million dollar sewer plant expansion. The city council members spend most of the budget hearing talking about their personal experience with lawn mowers, and gloss over the treatment plant budgets.

Theory X response: Allow the governing body to see only the total cost of the program; let the professionals (central staff) deal with the details since they are too sophisticated to be tricked like this.

Theory Y solution: Because there is no budget request process, games like this are pointless. Managers are paid to manage, and this includes managing their budgets.

8. The myth of the “current services” budget. The department increases next year’s budget by a combination of inflation and population growth, conveniently ignoring economies of scale, substitution of different goods and services, and the fact that not all costs follow the Consumer Price Index.

Theory X response: Entrust central department staff with the task of constructing complex forecasting models to ascertain the “true” cost increase.

Theory Y solution: The line item budgets developed by the operating departments (that add up to the total budget target) are for planning purposes only. They will be held accountable for the bottom line actual results. They may use a variety of techniques to estimate future revenues and costs (and they may be receptive to help from central financial experts in doing this). The CEO or budget director typically uses some kind of formula as a starting point to establish the departments’ spending targets and will need to use judgment in how to address inflationary pressure.

9. The moving target. Major capital improvement projects are done over several years. Few budget systems track total spending versus the original budget over multiple years, making it easy for the manager to hide the true cost of the project.

Theory X response: Establish central multi-year tracking systems for capital improvements and give project managers an annual allotment, making sure the final year guarantees the project will remain within the original budget.

Theory Y solution: The Theory Y process described here focuses on the operating, not capital budgets, and thus does not address this problem. It is simply one more weakness of the traditional annual budget (appropriations) process. Capital improvements should be budgeted on a project basis, spanning as many years as necessary to complete the project, and as with Theory Y operating budgets, control should be on the bottom line (project expenditures must be covered by revenue), not simply on the relationship between actual and estimated costs.

10. Spending the savings. New equipment is requested in the budget on the basis of future operating savings. Somehow the manager forgets to request a smaller budget in future years.

Theory X response: Keep careful notes during the budget process, and cut the department’s budget in the future when the promised savings are supposed to occur.

Theory Y solution: Managers have a built-in incentive to make investments that will reduce future costs, since they don’t need to worry that the savings will be “taken” from them and shifted to some other department. This allows them to increase or preserve service levels within the manager’s area of responsibility, and the citizen or customer benefits.

Stay tuned for next month’s column where we will explore eleven more tricks.

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