Institutional design principles for sustainable communities.

• Author: Kavanagh, Shayne
• Position: THE NEW FINANCIAL SUSTAINABILITY FRAMEWORK: PART 2

This article, the second in a series, was adapted from a GFOA white paper, "The New Financial Sustainability Framework: A How-To Guide for Changing Governance to Sustain Your Community Without Breaking Your Piggy Bank." For more information, see the paper at gfoa.org/financial-sustainabilityresourcecenter.

The first installment in this series--leadership strategies--was published in the June 2017 issue of Government Finance Review.

To be financially sustainable, a local government needs leadership that can inspire people to look beyond narrow self-interest and participate in decisions that advance the interests of the entire community. The institution of local government must be designed to consistently produce financially sustainable decisions. This article will explore the principles for designing such an institution.

Eight institutional design principles dictate the shape of how local government and related organizations work together to achieve a sustainable financial future. These are:

* Well-defined guidelines.

* Proportional equivalence between benefits and costs.

* Collective choice arrangements.

* Monitoring.

* Graduated sanctions and credible rewards.

* Conflict-resolution mechanisms.

* Minimal recognition of rights.

* Networked enterprises.

WELL-DEFINED GUIDELINES

In a local government, it is important to establish parameters that dictate how financial resources will be used and to explain why those parameters are important. For example, financial policies might define the amount of financial reserves that will be kept on hand, why that amount is needed, and the purposes for which reserves can be used. These and other policies define good financial management.

Temporal boundaries must also be recognized. Because local governments legally appropriate and authorize spending annually, the default timeframe of any given decision is often conceptualized as a single year. However, many decisions have unambiguous and significant financial impacts on future generations of local leaders and citizens. For example, if the elected body of a jurisdiction approves new debt and pension obligations as part of its annual budget, the impact of these decisions may be relatively minor in the current year, but the effects could be much larger in years to come. Hence, institutional design must encourage participants to look beyond a single year.

PROPORTIONAL EQUIVALANCE BETWEEN BENEFITS AND COSTS

When benefits from the resource system are proportional to the distribution of costs, users are more likely to contribute to the system's sustainability. Put another way, if taxpayers don't feel that they are getting good value from their contribution to the common pool of financial resources, they will want to reduce their contributions. To establish proportional equivalence between benefits and costs for different groups of stakeholders, local governments are faced with multiple, and potentially competing, responsibilities, including:

* Civic Responsibility. Jurisdictions must provide basic services for maintaining the health, safety, and welfare of the community, regardless of an individual resident's ability to pay.

* Corporate Responsibility. Jurisdictions must ensure that basic services are provided at prices that are fair to current and future residents.

* Fiduciary Duty. Jurisdictions must ensure that current and future expenditures are justified by benefit-cost calculations and supported by reliable revenue streams. Hence, local governments must think carefully about ways to clarify the relationship between the benefits received by stakeholders and the contributions they make to sustaining local government.

One way to create proportional equivalence between benefits and costs is to link the source of revenues more explicitly to what they pay for. Local governments have historically funded most services through general tax dollars generated from across the community. In an environment of increasing resource scarcity, however, citizens...