Step 6: Category 2 - Internal, Economic/Technical Causes of Financial Distress

In this category we address:

  • Management Challenges 
  • Weak Budget Development Practices 
  • Lack of Innovation and Adaptability 
  • Poor Performance
  • Ineffective Information Technology Systems 
  • Failure to Fund and Manage Retirement Benefits Prudently 
  • Deteriorating Infrastructure
  • Low Bang-for-the-Buck Development Decisions

 

Management Challenges

Management challenges can compound external difficulties or other internal challenges, or even create problems by itself.

Symptoms

  • Narrow vision. Are managers too focused on day-to-day operations and not able lead the development of a sound strategy?
  • Inadequate skills or ability. Has a manager risen through the ranks to a position that is beyond their capabilities (i.e., the Peter Principle)?
  • Displacement of activity. Is a manager focused too much on activities for which they have a natural affinity or skill at the expense of higher-priority, but less enjoyable uses of their time? 
  • Lack of diversity in viewpoints. This is often experienced as “groupthink.” Is individual creativity, uniqueness, and independent thinking are lost in the pursuit of group cohesiveness?
  • Overly bureaucratic management. Do new ideas die quickly and old work habits persist despite obsolescence? Is there institutionalized contentment with the status quo? Is there low tolerance for criticism and lack of independent thinking? 
  • No using staff for innovative ideas. Are there missed opportunities for getting input from staff?

 

Weak Budget Development Practices

Substandard budget practices contribute to financial distress. A cutback environment can severely strain traditional budgeting systems. These systems were often designed under an assumption of continued growth in revenues.

Symptoms

  • Across-the-board spending cuts. Do you use across-the-board cuts to balance the budget? This is a symptom of a budget process that does not provide a means for precisely targeted reductions.
  • Incremental budgeting. Is your budget process incremental? Under traditional “incremental” budgeting systems, last year’s budget is the starting point for the next year’s budget and adjustments are made around the margin to fit available revenue.  Incremental budget system doesn’t question the validity of the historical decisions that lead to existing programs and patterns of resource allocation.
  • Failure to incorporate reserve policies into budgeting. Are your budgets constructed in full knowledge of how the budgetary plan will impact the organization’s reserves? Continued deficit spending could be one of the tell-tale signs of this problem.
  • Lack of transparent assumptions. Budgets are developed based on certain assumptions such as the rate of inflation, new revenues that will come in, or rates of return on investments. Are these assumptions or variables made explicit and transparent? If so, the organization will more readily recognize and adapt to realities that differ from earlier budgeting assumptions. 
  • Poor debt and capital asset management. Capital maintenance often suffers during periods of fiscal distress. Similarly, a poorly managed debt program can result in downstream fiscal problems that will ultimately have a negative impact on the operating budget.
  • One-off decision making. Decisions on resource allocation should only be made with analysis of the complete comparative context of the jurisdiction’s goals and objectives and all of its responsibilities and unfunded liabilities.
  • Lack of multi-year financial planning.   If the budgeting process only considers one year resource and expenditure needs, longer term trends that affect service delivery and fiscal sustainability can be masked or overlooked. 

 

Lack of Innovation and Adaptability

Innovation and adaptability are essential for adjusting to changes in the financial environment. Lack of adaptive behavior hastens decline. Governments must be able to generate new ideas and sees them through implementation and diffusion to the entire organization. 

Symptoms

  • Dysfunctional governing board. Is there cooperation, mutual trust, and respect between board and staff? This enables government leaders to focus on achieving policy goals through consensus and makes innovations more likely to be considered.
  • Lack of team management. Does team-based management at the senior staff level build trust and openness? Such an environment lowers the perceived risk of suggesting strategies that go against the established order.
  • Leadership is not trusted. Does leadership live the values that have been proven to increase trust? Followers trust such leaders, are motivated by their innovative ideas, and are willing to share their own thoughts on what might be done differently.

 

Poor Performance

Contributed by Kristin M. Howlett and Robyn L. Raschke, PhD

Inefficiencies in operations means it takes more people or hours to do the work. Inefficiency can also sap the public’s confidence in government – if citizens get a poor value for their tax dollar, citizens will be unwilling to pay taxes. Good performance results from the right combination of skilled people, a well-designed process, and enabling technology. Hence, bad performance can result from a failure in any one of these three areas, with people being the most important.

Symptoms

  • Lack of formal process improvement initiatives. Do you have a formal and regular process improvement program to prevent processes from becoming stale? Processes can become obsolete and people can fail to work effectively within the process.
  • No formal training program. Are new employees properly acclimated to their job and existing employees helped to develop new skills?
  • Well-rounded measures of performance are not used. Do you have measures and are they focused on key indicators of process performance? What gets measured gets managed.
  • Bad examples showing up on social media. There is an increasing opportunity for the public to post pictures or videos of poor performance, e.g. workers sleeping in their trucks or spending inordinate amounts of time not performing (e.g. time spent at a donut shop).

 

Ineffective Information Technology Systems

Limited access to timely personnel, payroll, and budget control data and reports impedes management’s ability to make sound decisions. Modern information systems can provide this information, automate control systems, and reduce time spent on routine transaction processing. 

Symptoms

  • Lack of training. Are staff trained to use the existing technology? They may not use the technology to its full potential or may develop manual work-arounds outside of the system.
  • Fragmentation. Is needed information spread across many different systems, making it difficult or impossible to aggregate data into reports?
  • Obsolete technology. Is the current system capable of easily producing desired reports, flexible chart-of-accounts administration (e.g., for cost accounting), or process automation?
  • Lack of IT governance. Are decision-rights and accountabilities for investing in technology and getting value from those investments ill-defined?
  • Over spending on technological solutions. Is the cost of a new system justified in actual cost savings and/or enhanced public service?

 

Failure to Fund and Manage Retirement Benefits Prudently

Contributed by Girard Miller 

Some retirement plans face financial stress because they promised too much; others have promised reasonable and competitive benefits, but their management was insufficient: they failed to fund the benefits properly and control abuses of their benefits.  

In the case of OPEB plans for retiree medical benefits, the vast majority of public employers nationally have relied on pay-as-you-go financing, which worked just fine in the early years when the number of beneficiaries was very small. But as Baby Boom workers near retirement, the prospects of benefits payments doubling or tripling is a clear sign that the plan is unsustainable.

Symptoms

  • Unrealistic amortization. Are the plan’s amortization practices unrealistic (e.g., 30 years), in light of much-shorter average expected remaining service lives of employees (e.g., 10-14 years)? The plan uses methods that might require higher future contributions after employees have already retired. These include deferred actuarial amortization, or smoothing periods that exceed the average expected service lives of current employees. 
  • Pay as you go OPEB. Is the OPEB plan is funded on a pay-as-you-go basis rather than an actuarial basis? This could lead projected benefits disbursements to double or triple in 10 years.
  • Optimistic investment return assumptions. Do investment return assumptions exceed the national average for plans of similar size? Do trust fund portfolios repeatedly fail to achieve assumed returns? 
  • Taking unfair advantage of pensions rules. Are there high percentages of early retirements, pension spiking, and disability retirements?

 

Deteriorating Infrastructure

Infrastructure is vital to fiscal health because it provides direct services and supports wealth creation. Deteriorating infrastructure can lead to fiscal distress as maintenance needs compound, requirements for new infrastructure mount, and existing facilities become increasingly unsafe and unsound.

Symptoms

  • Continually deferred maintenance. Is there a backlog of maintenance projects and is the condition of assets deteriorating?
  • Impacts of inadequate capital investment become apparent. Is there a loss of economic development due to poor infrastructure or a poor safety record or lawsuits?
  • Lack of timely rate adjustments.  Are rate adjustments made when warranted?  Delay often increases the amount of adjustment needed later, only making them more difficult to pass.
  • Deteriorating net financial position as reported in the CAFR.

 

Overbuilding Infrastructure

Though lack of and dilapidated infrastructure is a serious problem, local governments must also beware overbuilding infrastructure that it cannot afford to maintain. Roads are a common example. Once a road is built it is almost impossible to un-build it, no matter how sparsely used it is. Yet, the road still must be periodically maintained.

Symptoms

  • Projects not rigorously justified based on demand. Do capital project proposals include strong justification of the community’s need for the new project?
  • Over-optimistic demand projections. Are forecasts of population or other metrics of demand compared to actual results? If not, no learning from past forecasts occurs. For example, if forecasts have routinely overestimated demand then there is a good chance the local government is overbuilding.
  • Lifecycle costing not considered. The total cost to operate, maintain, and replace a capital asset is often more than the initial acquisition cost. Are total lifecycle costs, and how they will be funded, considered as part the decision to acquire and asset or not?

 

Low Bang-for-the-Buck Development Decisions

Different land uses can have dramatically different financial impacts on a local government. However, land use planning is often disconnected from financial planning.  To paraphrase Mark Twain, local governments need to use land wisely because they aren’t making any more of it. This means that in addition to how any given development proposal pencils out, local governments must consider the “opportunity costs”. By approving a development what future opportunities will be foregone?

Urban form can also affect the costs of servicing development. For example, “leap-frog” development on the urban boundary where a new development is not contiguous with the rest of the built-up area can cause added costs for servicing, e.g. sewer lines must be extended further than necessary and garbage trucks have to travel further to serve the remote development.

Symptoms

  • Lack of analytical capacity. Does your local government have the capability to conduct fiscal impact analysis? Or do you rely on developer estimates of the costs and revenues local government will experience from new development?
  • Ignoring tax productivity of land use. Is the fiscal impact per acre of development considered? A per acre perspective is the land use equivalent to bang-for-buck.
  • Not understanding minimum development need to cover service costs. Any given land parcel has a minimum amount of taxes it must produce to cover the cost of the services it consumes (including upkeep of infrastructure). Does your government know what that amount is and is it considered when approving development proposals?