FINANCIAL FOUNDATIONS FOR BUDGETING

A related collective action problem is when stakeholders try to use public resources without contributing to the upkeep/renewal of the resource. Another challenge is deciding how to use public resources given differing preferences of stakeholders. Finally, an important challenge is coordinating the efforts of several organizations to bring their shared, but limited, resources to bear on shared problems that don’t fall neatly into the responsibility or ability to solve of one jurisdiction.

Fortunately, there is a Nobel Prize-winning body of research that has found best practices to solve collective action problems. GFOA, National Civic League, and researchers at the University of Southern California and the University of San Francisco translated this 40 years of research to local government. The result was GFOA’s Financial Foundations for Thriving Communities.

Financial Foundations for Thriving Communities was used as the basis for this document. Financial Foundations provides a mental model for what it takes for local governments to make wise financial decisions that are sustainable. Below are summaries of the eight practices of Financial Foundations for Budgeting.  Note that it is not necessary that a local government implement all Eight Practices of Financial Foundations to get better budgeting. Using just a few can make a big difference. Throughout our discussion of the Practices, we will show how governments have benefited from focusing on particular practices.   

You can click the links for more details on each.

This document provides examples of how local governments have used these practices. We encourage the reader to think about ways in which they might use these practices, beyond the illustrations we have provided. These practices are not meant to be a step-by-step budget process; they are the latticework on which to hang the steps and the actions that make up a budget process. The Rethinking the Budget Process section of this site uses these eight practices to present a budget process. You can see a summary of the eight practices above and their implications for budgeting here. Read on to gain a deeper understanding.

A common threat or challenge can bring people together by promoting collective action, shared identity, and increased cooperation. The budget might be able to use this by being clear about long- and short-term risks that the budget needs to address. For example, threats like public health problems or inadequate infrastructure could compel people to take collective action. Finally, even simple actions can impact the extent to which participants in the budget process identify with the local government versus its subunits. Here are three examples: 

• If members of departments show up to budget meetings wearing department uniforms or other markers of departmental affiliation, then that sets them apart from other participants and activates their identity as a department member. Encourage attire that does not reinforce competition between participants. To illustrate, imagine a meeting where everyone wears a polo shirt featuring their department name and logo. Now imagine a meeting where everyone wears a polo shirt with just the local government’s name and logo. How might the dynamic in the room be different? 
• The room setup for a meeting might activate department identities. For instance, if members of each department all sit together and tables are arranged in a way that suggests opposition between the participants, that could reinforce us-versus-them dynamics. An example would be if parties are seated as if sitting across a negotiations table. Instead, use room arrangements that promote a collaborative approach. 
• Encourage positive social interactions between participants outside of budget discussions. Despite the budget office’s best efforts, there is an element of competition involved in budgeting. It is not possible for everyone to get everything they want. If budget discussions are one of few, or the only times participants interact, it will be difficult for them to look past the competitive elements and toward a greater good. However, if participants have a successful history of working together on other tasks, it will be easier to work through the competitive elements. 

That said, it is not necessary or desirable for participants to leave all allegiances with their subunit out of budget discussions. In fact, too much pressure to put aside subunit allegiances could backfire, causing people to emphasize those connections more.

Fairness is essential to sustainable decisions. If people feel unfairly treated, not only will they be less likely to accept decisions that go against their interests, but they may also try to undermine those decisions. Fairness helps maintain people’s commitment when there are limited resources and not everyone can have what they want. 

Further, fair and inclusive decision-making helps organizations perform at their best. Fairness and inclusiveness are two elements of trust. Organizations with high trust outperform those without it. For example, people are willing to share their best thinking and efforts in a high-trust environment. You can think of trust as the oil that lubricates the machinery of government: Everything runs smoother with it and will grind without it. GFOA's "What's Fair?" Series describes the different forms of fairness and how they can be practiced in public finance. According to former GFOA president, Timothy Riordan, “every public servant should read these.”

If fairness is an essential element of trust, how do we increase people’s perceptions of fairness? We can start by recognizing three forms of fairness that finance officers need to be mindful of:

• Procedural justice refers to fair processes. This could refer to the negotiation between people inside government that happens as part of budgeting or how the public engages with the budgeting process. 
• Interactional justice is about how people interact. It concerns whether people are treated with respect and empathy. 
• Distributive justice refers to the fair distribution of resources.

Procedural justice is important because people are more willing to accept outcomes that go against their wishes if they think the decision-making process has been fair. Since it is impossible to give everybody everything they want as part of a budget, procedural justice increases the chances that people remain committed to the local government even when decisions don’t go their way. When considering if procedural justice is present, ask: Do people have the chance for input? Is the information used to make decisions seen as accurate? Are clear decision-making criteria applied equally to everyone? If the processes produce a bad decision, is there a way to recognize and correct the decision?

Interactional justice is important because every time the budget officer interacts with someone, that person’s trust in the budget officer and, by extension, the budget process can be affected.  

Distributive justice is important because how resources are distributed is what the budget is about, which includes “equity.” Equity means treating people differently to compensate for their circumstances and/or the need for help from government to alleviate disadvantages they are faced with. Based on the experiences of 11 cities, GFOA's Budgeting for Equity: Tensions, Lessons, and Steps for Success describes the nuances and tensions involved in putting an equity lens on budgeting.

Distributive justice also includes “proportionality.” This means people should feel that the benefits they receive from the budget are fair compared to the contribution they are making to the local government. Proportionality is discussed further under “Practice 6: Benefits Proportional to Cost.”

When it comes to using a scarce, shared resource (like a local government budget), there will be temptation among participants to gain an advantage for themselves by doing things like overspending a budget or using rainy-day funds when the sun is out. Research suggests that people are more prone to self-interested behavior when they feel they cannot be seen and their reputations are not on the line. For example, experiments have evaluated whether the conditions in a room cause people to cheat on a test. The results suggested that people cheated more when the lights were dimmed (the subjects felt less visible), and they cheated less when there was a cartoon image of an eye nearby (the subjects felt watched).

Governments need to create conditions where the participants in decision-making feel their actions will be transparent to others so that they will be less tempted to break the rules or go back on commitments. Unfortunately, just buying stronger light bulbs or redecorating offices with eye-themed art will not be enough to create feelings of transparency in local government finance. Hence, local governments need to create systems of internal monitoring that make credible information available on how financial decisions are made and the outcome of those decisions. Mechanisms that provide transparency of decisions and impact encourage participants in financial decision-making to work within agreed-upon boundaries, and it gives them confidence that others are staying within the boundaries too.  

A key monitoring system for budgeting is forecasting. Forecasts provide boundaries by showing the future effects of decisions made today. If today’s forecast shows a future imbalance, then it suggests the need to take corrective action. Long-term forecasts can be useful to highlight trends that are not obvious in the near term. This allows for early and timely adjustments that are consistent with a learning culture.

Financial policies are a powerful way to create boundaries on acceptable actions. Behaviors can then be monitored against those boundaries. For example, a rainy-day fund or reserve policy should establish a floor and a ceiling of acceptable reserve amounts. Then it is possible to monitor whether reserves are staying within those boundaries. If reserves are outside the boundaries (too high or too low), then that suggests a course of action. There are other policies that can provide boundaries for budgeting including one-time revenue policies, user fee policies, and structurally balanced budget policies. The way in which budget decisions are made contributes to transparency on what others are doing so that members of the group know what is happening.

Once the budget has been developed, a system to monitor compliance with agreed-upon spending levels is needed. The City of Tempe, Arizona, has color-coded budget variance reports, which are used to classify the current performance of major revenues and department expenditures against their historical performance on a quarterly basis. “Positive” (green) means there is overperformance of any kind or underperformance of less than 2%. “Watch” (yellow) is underperformance of 2% to 5%. “Negative” (red) is underperformance of greater than 5%. Finance staff members produce a summary like the one shown here. A half-page, detailed analysis is provided for each revenue and department that shows the numbers behind the summary rating and gives a short explanation of the situation. This visual approach creates a common and easily understood standard for evaluating how the city is doing to stay within its budgeted boundaries during the year.

For a monitoring system to be effective, the information must be accessible to nonexperts. Sharing the information with public officials is a necessary but insufficient condition for access. Accessibility requires establishing a baseline of financial fluency among public officials and community members through shared, mutually understandable terminology and presentation techniques. Greater fiscal fluency can lead to higher quality conversations with the public and elected officials during budget deliberations. A good starting point is for finance officers to provide their audiences with better “mental models.” A mental model is a way in which we view the world. They guide how we make decisions. If public finance officers can give decision-makers a better mental model, better decisions can result.

Graphics can also be of great help. For example, a graphic can illustrate actual performance against a threshold for desired performance. Following is an illustration of monitoring reserves against agreed-upon boundaries from Tempe which was used by City staff to help the City Council better understand and monitor fund balance. If the green line stays within the golden area, then Tempe is in good shape. Note that this graphic represented a change in the mental model for reserves. Tempe used to have a single point goal of their reserves (25% of revenues). Changing it to a range gave City Council a new mental model. The new model positioned reserves as a boundary that they needed to stay within, including a floor and a ceiling. The old model was a single point that did not provide clear guidance on the range of good and bad outcomes.

Finance officers can also translate numbers to a scale that speaks to people’s everyday experience and frame of reference. Numbers in public finance are often measured in millions (or more). Most people have no experience dealing with millions of dollars in their personal lives, so they do not have a feel for the size of these numbers. There are techniques available for transforming numbers into a human scale. To take one example, rounding numbers to a smaller number of digits (e.g., going from $3,410,539 to $3.4 million) makes it easier for the audience to get their minds around the numbers. These techniques make the budget more transparent and monitoring systems more understandable.

A good next step is to consider the level of control in the budget. What are the boundaries that departments have discretion to spend within? Can they freely transfer funds between line items? Local governments can develop systems that put the onus on participants in budgeting to manage their budgets well but also give them the autonomy to use available resources to meet their goals. Generally, there are two broad principles for assigning autonomy and responsibility:

1. It is wise to differentiate authority for personnel spending from other spending. Once a new position is established, it becomes a semi-permanent cost. For example, a department may have the autonomy to move funds between the contracts and commodities budgets but not from commodities to personnel. A central budget office provides valuable organization-wide perspective on total employee headcount and the continued affordability of the local government’s labor force.
2. Autonomy does not need to be one-size-fits-all. Those who live up to their commitments can enjoy greater autonomy. Later in the section on “Graduated Sanctions and Rewards,” we will show how Minneapolis created such a system.

Finally, we should emphasize that the principle of subsidiarity does not require that all decisions be pushed to the lowest level possible. There may be situations where the best decision-maker is a central authority. Employee costs (salaries, benefits) are costs that are understood and obvious. There are nonobvious examples, too. Commercial insurance is usually purchased by the central risk manager, not by each individual department. However, in many governments, each department builds “budget insurance” into their budgets by padding their budgets to provide cushion against unplanned, unavoidable expenditures. Across all departments, this padding can add up. Local governments have realized millions of dollars in budget savings by providing a centralized budget contingency pool that departments can access in case of unplanned, unavoidable expenditures. In exchange, departments give up their padding.

Incentives and sanctions matter. Each can be subtle, hard to design and administer, and their effects difficult to predict. Therefore, incentives and sanctions are often not given the attention they deserve. In the budget process, incentives can encourage participants to make financially sustainable choices that benefit as many people as possible, or disincentives can discourage short-term thinking that benefits narrow constituencies.

Incentives in the budget process come from the power of the purse strings. Using this incentive starts with making clear: A) who holds the purse strings; and B) that the holder of the purse strings is willing and able to use that power to reinforce constructive behavior. Before going further with our discussion of incentives, we should consider expectations. For sanctions and rewards to work, people must know what they are expected to do to avoid sanctions and obtain rewards.

As consumers of private goods, we expect to get what we pay for. This attitude carries over to our lives as participants in a commonly owned resource, like a local government budget. People expect to derive a reasonable return from their contribution to the system of local government. A person’s sense that their contribution to the commonly owned resource system is “worth it” is essential to the sustainability of the system.

Let’s start with the most obvious application of this practice: the financial contributions taxpayers make. The “reasonable return” for a taxpayer does not necessarily refer to an economic return. The return could be psychological, such as a deepened emotional connection to one’s place of residence. Or perhaps a taxpayer gets a psychological return from contributing to a greater public good and a thriving community for everyone. Further, the return does not have to be one-for-one, where someone who contributes twice the taxes as someone else must experience twice the return; rather, the taxpayer must only feel that their contributions are worth it on some level.

Rather than the budget being a matter of precedent, the ideal budget is driven by “reciprocity.” Reciprocity is when one person or group exchanges something with another for mutual benefit. Reciprocity advances large-scale cooperation in a complex system, like an organization. The budget is often not reciprocal. Rather, resources are allocated by the elected decision-makers to departments based mainly on historical precedent. Thus, resource distribution becomes customary and less connected to a mutually beneficial exchange between public servants and the public.

It would be difficult for a local government budget to become completely reciprocal. That might involve re-justifying spending each year. Even so, there are opportunities to move the budget closer toward reciprocity and away from custom.

First, when asking internal stakeholders to “give up” part of their budget for some greater good, highlight the benefit the department will realize from that greater good. The budget “given up” becomes a mutually beneficial exchange.

Second, reduce the relation between managers’ prestige and the size of their budgets. Often, the larger the budget a manager controls and/or the greater number of direct reports they have, the greater prestige the manager enjoys. One practical effect of this is that compensation systems often base, at least partially, a manager’s compensation on the number of direct reports and resources under their responsibility. Such a system incentivizes managers to maximize the resources under their control. Though the compensation system is usually outside of the purview of the budget staff, the impact of the compensation system incentives on budgeting invites consideration. For example, can prestige and compensation be linked with the results one achieves (especially when achieved with fewer resources)? This leads us to our next opportunity…

The budget is often designed to avoid conflict by relying on historical precedent. However, conflict is often needed for progress to happen—new ideas need to be discussed, issues debated, and resources need to be reallocated.

The allocation of public resources can become a high-stakes affair. Not everyone will be satisfied, thus the potential for conflict is high. Conflict can be constructive if it forces people with different viewpoints to share their positions and find common interests so they can move forward together. However, conflict can also be destructive. When tempers flare, people’s willingness to work together suffers, undermining trust in the financial decision-making system.

The budget officer’s job is to set up the discussions needed to make progress and facilitate fast and fair conflict resolution.

Let’s begin with “preventative strategies” for destructive conflict.

First, recall our earlier section on “Fair and Inclusive Decision-Making.” If people feel fairly treated, they are less likely to enter into destructive conflict, even when budget decisions don’t go their way. Conflict is likely when resources need to be reallocated. If the budget process is perceived as fair, then people are more likely to accept decisions that result in resources being allocated away from their preferred choice.

Second, define the scope for potential conflict. This can take many forms.

Most fundamentally, consider what portion of the budget will receive the most scrutiny. An incremental budget avoids conflict by shielding large portions of the budget from scrutiny. If the money was budgeted last year, it will be budgeted again the next year without many questions asked. Rethinking Budgeting does not mean going to the other extreme of questioning everything. Instead, think about what part of the budget could benefit from increased scrutiny. Read more about this in the Rethinking Budgeting process section.

To conclude the topic of fast and fair conflict resolution, we will address the potential for the budget process to better reveal the preferences of the participants. Conflict can fester when people are not aware of available consensus positions. Public budgeting often does not provide a way for people to reveal their full range of preferences, making it difficult to identify areas of consensus. For example, someone may put forward a single budget proposal when there are probably other spending proposals they would be satisfied with. Let’s illustrate with the Metropolitan Government of Nashville and Davidson County (“Nashville”). The finance committee of Nashville’s Metropolitan Council had to recommend to the mayor a set of spending priorities. The Council, however, was having a hard time finding a consensus because there was not enough time in public meetings for everyone to share their views on the spending proposals under consideration. The Council decided to try a voting method called “quadratic voting,” designed to reveal clear preferences among the participants. You can read about Nashville’s full experience and results in GFOA’s case study of Nashville. In short, quadratic voting gives participants the chance to vote on a full slate of budget options, but the voting is structured in a way that participants reveal their preferences more fully than conventional (yes/no) voting methods. This allowed the chair of the Finance Committee to put a recommendation forward to the mayor that most participants felt good about. The chair of the Finance Committee hopes to repeat the process, and the Nashville Health Department soon after used quadratic voting to help with their internal department budget deliberations.

Quadratic voting is not the only way to reveal preferences. Many techniques thought of as “public engagement” could be used just as well with staff and elected officials as with the public. Quadratic voting falls into this category, as do other techniques.

Just as no person is an island, neither is any local government (at least metaphorically). The overarching theme is that if a budget stakeholder believes that another stakeholder is likely to work cooperatively with them for the betterment of the local government, then widescale cooperation is likely to happen.

However, the local government budget is often inward looking and may miss opportunities to work effectively with others. Most immediately, this means departments working well with each other. This extends to relationships with outside groups, including other governments, the private sector, nonprofits, and the public.

Let’s move on to working with outside groups, like other governments, the private sector, and nonprofits. Here are three different ways local governments could create productive relationships with other groups, supported by research from our “Local Government Fragmentation Series.”

Networks. A network connects separate actors in the pursuit of a shared vision and objectives and then multiplies their collective power to achieve that objective by tying them together in a system of mutual accountability. Local governments can rely on networked forms of organization to solve community problems, without growing public budgets. There are financial limits to what local governments can do within their own authority and resources. Further, problems of great concern to the public require the efforts of multiple sectors. They may not fall squarely within the responsibility of one local government jurisdiction. A local government planning and budgeting process can contribute to the formation of a network by clarifying the goal of the network. For example, a planning process might identify impediments to a thriving community (e.g., health, safety, etc.), including measurements of the nature and scale of the problem. This information can be used to convene a network of public, private, and nonprofit organizations that have a stake in the issue.  

Government as a platform. In a traditional government, the departments of the government are the service provider. Government as a platform is about working with the community to determine the service objectives of government and then “plugging in” the most effective service provider, regardless of whether it is the local government itself, a private, nonprofit, or another public organization—or if it is an activity performed directly by the citizens. This model is like the ubiquitous smartphone. A company like Google or Apple provides the platform, and the best apps can be plugged in to accomplish the objectives of the end user. Similarly, local government provides the authority to provide public services, and the best providers can do the hands-on work of delivering that service.

The planning and budgeting process can contribute to local government becoming a platform by developing a program inventory. A program is a distinct service offered by the government, like police patrol or tree services. This compares with the traditional approach of organizing by departments, like police and public works. Programs are directly relevant to how people experience public services. Therefore, they are more useful in a discussion about how to provide services compared to departments and line items. The program inventory can be used to compare services with nearby organizations and see where there might be opportunities. Or the program inventory might make the government aware of programs that self-evidently have potential to share. For example, they may become aware of maintenance services or other services that have potential to be provided by the private sector.

Addressing fiscal disparities. One of the downsides of the principle of subsidiarity (see our section on Local Autonomy) is that in a federal system of government, “fiscal disparities” can arise between local governments. A well-known example of fiscal disparities is the disparity between school districts. This happens when schools are funded mainly by local property taxes, and when some districts have a higher value of taxable property in their boundaries than others. This will result in some children getting a worse education based on where they live. There are ways to partially address fiscal disparities, including revenue/tax base sharing and regionalization of services.  

Finally, let’s address relations with the public. It may be important to engage with the public on budget issues in a variety of circumstances. This could range from keeping the public informed of decisions local officials have made to asking the public to decide how public resources should be used. Further, appropriate relations with the public may require local government to shift the question being asked in the budget process from “What do you want?” to “What would you do?” and, ultimately, “What should we do?” (the government and public together). This takes the citizen out of the role of an individualistic consumer of public services to being part of a team effort to address community problems. The best way to bring this perspective into public engagement in planning and budgeting is to require participants to work through making trade-offs. So rather than asking for more, they must decide what they are willing to give up to get it. Ideally, this would include conversations with fellow citizens and negotiating preferences in a group setting. GFOA’s Rethinking Public Engagement goes deeper into methods of this kind of public engagement, particularly “deliberative democracy” methods.