Budgeting Bias: Designing for the Decision-Making Environment: Who People Are, Not Who They Should Be.

• Author: Gandhi, Linnea
• Position: BUDGETING BIAS

People are not rational, but we often assume they are. For example, classical economics is based on the assumption that people are rational maximizers of their self-interest. Recent Nobel Prize-winning scientific research, however, has shown that this is not true. Rather than thinking through decisions rationally and comprehensively, people use mental shortcuts to make decisions. Much of the time, this is harmless and even helpful, but sometimes our shortcuts backfire.

Behavioral scientists have cataloged a number of these shortcuts and when they can go wrong. When these shortcuts fail, they are called "cognitive biases." These biases can have a negative effect on all types of decisions, including budget decisions. But if we know these biases, we can plan mitigations.

The Anchoring Bias

An example of a common bias is called anchoring. This means that once we are presented with a number, we tend to stick close to that number for future decisions. This can be useful. For example, if you know the amount your neighbor recently got for selling their house, that information gives you a good anchor for negotiating the sale of your own home (and not selling for too little). But anchoring can backfire if your anchor isn't relevant to the decision at hand. (See Exhibit 1 for a demonstration of how this works.)

Let's think about how anchoring could apply to budget decisions. Perhaps the most obvious example is incremental budgeting, where last year's budget is the basis for next year's budget. If revenues are stable and the service demands from the community are consistent from year to year, incremental budgeting may be a workable short cut for doing budgeting faster and more easily. But if the government finds itself in a situation where revenues are not stable and/or there are new challenges that government needs to confront, then the "anchor" of what was spent before may not be so helpful. One way to help overcome this problem might be to break departmental spending down into programs, which would shift the focus from what was spent on that department last year to which programs are most important for addressing current challenges. This is known as priority-based budgeting.

Learn more about priority-based budgeting by reading GFOA's "Anatomy of a Priority-Driven Budget Process" whitepaper at gfoa.org/materials/ priority-based-budgeting.

Another example of anchoring is when benchmark statistics from comparable governments are used as a basis for...