Budgeting by priorities: Balancing stability with economic responsiveness.

Author:Jordan, Meagan M.
Position:Report
 
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ABSTRACT

This article investigates how the budget priorities of Arkansas state government departments vary with changes in economic conditions. The Arkansas Revenue Stabilization Act (ARSA) of 1945 established a formalized method of state budgeting by priorities. State funds are allocated, meaning the funds are legally made available, according to priority levels established each year by the Governor and the General Assembly. Those allocated funds are later distributed, meaning released for spending, according to priority levels as funds become available. In this study, we ask the research question: Are departmental budget priorities driven by stability or are they responsive to economic condition? Incrementalism suggests that incremental annual changes in the budget are based on the previous year's budget, they take place across-the-board, and that there lacks an in depth consideration of priorities. However, ARSA requires explicit prioritization within each department. Perceptions of economic conditions are likely to play into this prioritization. We hypothesize that the higher priority items will follow a more incremental pattern of mostly being based on the previous year's budget in favor of stability. We also hypothesize that the economy has a greater impact on the lower priority items in favor of economic responsiveness. Our findings suggest that incrementalism is a persistent influence across priority levels. However, there is rational consideration during an economic downturn that results in a decline in funding for lower priority budget items.

Keywords: incrementalism, cutback budgeting, budget process, revenue stabilization, budget priorities

  1. INTRODUCTION

    Using Arkansas' unique approach to budgeting by priorities, this study investigates how the budget priorities of state government departments vary with changes in economic conditions. The Arkansas Revenue Stabilization Act (ARSA) allocates state funds according to priority levels established each year by the Governor in the Governor's budget recommendation, with additional changes and revisions resulting from the legislative consideration process of the General Assembly. The allocated amount is the amount that is legally made available for spending. ARSA dictates the order of distribution (release for spending) of those allocated funds (Jordan, 2006).

    Although as many as six priority levels have been allocated in any given fiscal year, administrators generally view the lower priority allocations as activities and purchases that will take place only if the revenue is available. Quarterly updates of the revenue forecast are used to inform administrators of the likelihood of the distribution of funds to the lower levels. This strategy creates confidence in being able to maintain the department's capability to implement programs and services that are deemed as high priority (Jordan, 2006).

    The ARSA prioritization method of budgeting has the stated purpose of stabilizing the budget during declining economic conditions resulting in revenue shortfalls. Jordan (2006) concludes that ARSA was effective at protecting top priority budget items that made up almost 90% of the budget by essentially creating a 10% cushion, which was greater than the size of most states' rainy day funds. As a result of this process, Arkansas lawmakers did not see a need for a 'rainy day' fund also known as a stabilization fund which sets aside funds for distribution when revenue falls short of expectations.

    Arkansas administrators view the lower priority items as those activities and associated expenses that will take place only if the revenue is available. If revenue collections fall short of expectations, then the allocated items with the lower priorities are not funded. Therefore, throughout the fiscal year, administrators execute their budgets with low priority items on hold until there is a distribution of funds to pay for them. This prioritization method of allocation and distribution was created to mitigate the impact of declining economic conditions. A decline in the economy resulting in a revenue shortfall makes funding of low priority items less probable. In this study of the ARSA approach to priority budgeting, we ask the research question: Are departmental budget priorities driven by stability or are they responsive to economic condition?

    Since 1945, Arkansas' unique method of stabilization has served effectively its purpose of creating a cushion for declining economic conditions. However, in recent years the public financial environment in which ARSA operates has changed. The first change is the execution of significant funding reforms in the mid-2000s resulting from the Lake View education finance equity litigation (1). Lake View, a poor, rural school district, sued the state claiming that reliance upon local property taxes as the primary funding of education was unfair to those in districts with low property value. The Arkansas Supreme Court ruled the state's funding as unconstitutional and that the state was solely responsible for the education system. Ultimately, primary education was ruled as being a state constitutional obligation that requires "adequate" funding. The rulings required a change in budget priorities, making primary (K-12) education the "highest priority," effectively lowering the priority of other areas of the budget (Jordan, et al., 2014).

    Second, despite the effectiveness of ARSA, lawmakers established a rainy day fund in fiscal year 2007 as a political signal that the state was fiscally responsible. A rainy day fund essentially creates a second opportunity for an item to be funded even if revenue falls short. The Arkansas Rainy Day Fund was created during a time of surplus but due to the subsequent recession did not receive allocation for several budget cycles. In fiscal year 2012, the rainy day fund received allocation for the first time of only $10 Million out of a budget that is over $4 Billion. This amount is far less than the rule of thumb of 5%, which has often been found to be inadequate for state budget stabilization (Joyce, 2001; Hou, 2004).

    Finally, Arkansas was one of a few of states with a biennial legislature which met every other year, in odd-number years. In 2008, there was a ballot initiative to change budgeting to an annual process in order to make revenue forecasting easier and more accurate. Voters unexpectedly approved the constitutional amendment to have legislators meet for a budget session in even-numbered years. This modification made the state one of the first to make the switch in the budget process from biennial to annual within the last two decades (Snell, 2011).

    Combined, these changes suggest a need to reexamine ARSA to determine whether they have impacted departmental resource allocation decisions. Therefore, we seek to determine if ARSA is still used to respond to economic conditions. Our study spans the period 1992 through 2014, which encompasses these environmental changes surrounding ARSA.

  2. ARSA ALLOCATION AND DISTRIBUTION

    Table 1 shows the budget allocations and distributions under ARSA for 1992 through 2014. Across the years, the number of priority levels receiving distributed funds fluctuated from four levels in the mid-1990s to only a portion of the first level in 2010. However, for most years, only the first two budget levels are distributed. The consistent distribution of funds to the first priority level is evidence of the efficacy of the process at protecting the top priority budget items.

  3. INCREMENTAL VS. RATIONAL APPROACHES TO BUDGETING

    Wildavsky's (1964) introduction of the incrementalism theory of budgeting has held a firm and prominent place in public administration. It theorizes that the stickiness or stability of the status quo and limited comprehensive consideration create across-the-board budget adjustments in small increments from the base or previous budgeted amount. In theory, this decidedly non-rational approach is employed to mitigate conflict and the costs of negotiation and, therefore, avoids strategic review and deliberation of the entire budget (Schick, 1983). Robinson, et al. (2007) and Ryu, et al. (2008) conclude that spending patterns can be largely explained by incrementalism. However, there have been challenges to the exclusive focus on incrementalism that suggest that there are more rational approaches to budgeting used in practice. In fact, Reddick (2003) tests the use of incrementalism, the garbage can theory, and rational approaches such as biennial budgeting, and he concludes that there is not a singular "catch all" theoretical explanation of state budgeting (p. 337). He finds a dominant presence of incrementalism in combination with rational methods. This challenges the focus on incrementalism theory and suggests that the budget in practice is more rational under certain conditions. We argue that responding to strong economic downturns and allocating resources within specific budgeting frameworks require explicit and rational consideration of priorities used in cutback budgeting and various budget processes.

  4. CUTBACK BUDGETING

    Incrementalism as a budget theory was born during a time of resource increase. As a flip side to incrementalism, decrementalism avoids in-depth programmatic reviews and makes across-the-board small reductions. Decisions are made on the margins, leaving most of the budget unexamined (Schick, 1983). Levine (1978) argues that in the face of "zero growth and absolute decline", there is a need to re-examine the expansionist view of budgeting (p. 317). During strong economic downturns, states are faced with a balanced-budget requirement which brings about greater reductions via cutback budgeting instead of decrementalism. At a time of deep budget declines or cutbacks, tough choices are not mitigated. The idea of a department receiving its fair share of the budget adjustment cannot persist during cutback budgeting. As the size of the cuts...

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