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I Trust You…Sort Of

By Scott Lazenby

In previous columns, we considered ways to adapt governmental budget systems to modern management principles of delegation, empowerment and alignment of organizational goals. Following Douglas McGregor’s work, we labeled this a “Theory Y” budget system. One critical element is a carryover savings program, where the positive (or negative) financial results of one fiscal year are automatically carried forward into the department’s budget for the next year. Managers of enterprise funds or special revenue funds have always been treated this way. This modification simply treats managers of general fund programs the same way.

lazenby 2Some early experimenters with “expenditure control budgeting” allowed operating managers to carry over some, but not all, of their budget savings (e.g., 50%). There are two reasons for this. First, there is a natural tendency for the CEO and governing board to want access to some unallocated beginning balance for equipment, capital improvements or pet projects. If the general fund’s beginning balance is scattered across a multitude of program and departmental budgets, it would not be available for large one-time projects or investments.

Second, it’s hard to argue that all of the savings are due to the hard work and excellent management of the manager and his or her staff. Surely some percentage of it is due to luck, revenue windfalls, delays in hiring caused by the HR department, good deals in materials and contracts negotiated by the purchasing department, an overly-generous target budget, etc. Why reward operating managers for something they didn’t do?

These arguments belie a Theory X philosophy (operating managers are lazy and stupid, and not to be trusted), and we’ll return to them in a moment. But aside from the issue of management philosophy, there is a strong pragmatic reason for allowing operating managers to carry forward all of their savings: anything less seriously weakens the disincentive for playing the “spend it or lose it” game. Operating managers aren’t idiots. When faced with a choice of losing half their savings or keeping as much of it as possible through a year-end spending spree, they will choose the latter. Creating a discipline of saving for the future is hard enough, since humans naturally discount the value of future spending compared to current spending. To further discount the value of future resources through an arbitrary “tax” on the savings seriously undermines this discipline.

Returning to the arguments for splitting the savings, in a Theory Y culture individuals act as good managers (and stewards of public resources) not because they are bribed or rewarded for doing so but because of the intrinsic motivation for doing good work. Allowing managers to carry over savings is not some kind of reward. It is simply a way to give them more flexibility in the use of resources to get the job done. The accounting system’s annual (or biannual) budget clock is completely arbitrary and has nothing to do with the continuing demand on resources faced by managers as they provide services to the public. We would not expect the revenues of an enterprise fund (e.g., a sewer utility or the Tennessee Valley Authority) to magically and arbitrarily disappear when the accountants’ fiscal year begins. The same should hold for programs within the general fund. Whether savings are due to management skill or dumb luck, they should be available to the manager to help him or her meet continuing service challenges and unanticipated contingencies.

lazenby 3A CEO can choose to “keep” some of the carryover savings, but in this case, the program is just a variant of the traditional Theory X budget system in which the CEO and other central staff functions are presumed to be better and smarter at allocating the organization’s resources. A rule that allows only partial carryover of savings sends a perverse mixed message: “I trust you to manage your resources…but only so far.”

For those who truly want their organization’s systems to align with a culture of trust, openness and empowerment, there is no choice but to allow managers to keep all their savings. But this still leaves the practical problem of finding resources to fund priorities of the governing board that don’t fall neatly into one of the operating programs, or exceed the resources available to any single program.

Fortunately, there are several solutions that don’t involve poisoning the health of a carryover savings program:

  • Most governments have some form of general governmental expenses that are budgeted for in one or more “non-departmental” accounts. They may include city hall utility expenses, general liability premiums, contracted legal and audit services, dues for organization-wide memberships, etc.  Good budget practice would minimize the use of these kinds of accounts since responsibility for managing expenses is diffused across multiple individuals (or entities) within the organization. But savings in this budget can be a source of the mad money that governing boards like to spend on projects.
  • The general fund, by definition, includes general tax revenue that is not legally dedicated to a specific program or service. Revenues that are generated above the estimated amount can either be allocated to departments in proportion to their budgeted allotment of general taxes or retained centrally to give the CEO and governing board some added flexibility.
  • A year-end bounty of general revenue “surplus” can be almost guaranteed if tax revenues are intentionally underestimated. However, in the spirit of openness and anti-game-playing, it is better to estimate revenues as accurately as possible and simply set aside some of it in the budget (for future allocation) before setting the departmental target budgets.
  • In many cases, the organization needs to carve out resources that will ultimately benefit (or be used by) multiple departments. Suppose a county wants to fund a major expansion of its field operations center on a pay-as-you-go basis, rather than trying to get voters to authorize bonds for it. The using departments could be charged (e.g., a premium on their normal internal “rent” payments) over time to build up a pool of cash that would then fund the improvement.
  • In some cases, departmental carryover amounts can accumulate to fairly large levels. As long as the operating manager is allowed to keep a reasonable contingency account and as long as it is done with care and good judgment, the CEO and governing body can tap into this accumulation without seriously undermining the benefits of Theory Y budgeting.
  • In a true emergency, operating managers understand that the governing board has not only a right, but a duty, to use any resources necessary (including departmental contingency accounts) to respond to the emergency. But this only applies if the emergency is generally acknowledged as such. It would not include bailing out the fire department to offset the cost of a lavish union contract.

In a healthy organization, there should be minimal need for the governing body or CEO to have a source of their “own” money. When the priorities of the governing board and the operating managers are aligned (as they should be in a well-managed organization in a representative democracy), the operating managers will act to carry out the wishes and desires of the governing board.

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