What's wrong with budgeting? A framework for evaluating and fixing public sector financial planning processes.

• Author: Christensen, Peter

Rather than abandoning budgeting altogether or living with its defects, governments are using the National Advisory Council on State and Local Budgeting's recommended practices as an organizing framework to enhance the credibility and vitality of the budgeting function.

Budgeting is under attack. Critics contend that budgeting is incremental, consumes many months and thousands of hours of staff time, is dollar-centric and ignores performance, and leads employees to focus on the wrong targets at the expense of customer service and overall corporate goals. And the criticism does not stop here. Budgeting is argued to be autocratic because central oversight agencies are domineering and restrict the managerial flexibility of line departments and bureaus, limiting their capacity to innovate. The competition for resources forces bureaucrats toward the single-minded pursuit of budget maximization. (1) Budgeting is also seen as a regime that regenerates itself, as being cumbersome, and as one of the few administrative functions that technology hasn't done much to improve. Even corporate debacles such as Enron and WorldCom are being blamed in part on budgetary incentives that promote a "gaming" and a "massaging" of the numbers. Has budgeting simply outlived its usefulness?

BEYOND BUDGETING

Criticisms of budgeting have achieved prominence in a recent book by Jeremy Hope and Robin Fraser about budgeting in the private sector, Beyond Budgeting: How Managers Can Break Free From the Annual Performance Trap (2003). The authors define budgeting broadly as the entire "performance management process" and take the extreme position of urging companies to abandon budgeting altogether in favor of a more flexible model by which "front line managers are able to regulate their own performance," and financial planning processes and individual behavior are therefore better aligned with corporate strategy. (2)

According to Hope and Fraser, "abandoning the annual budgeting process opens up two opportunities. One is to enable a more adaptive state of management processes, and the other is to enable a radically decentralized organization." (3) The authors present case studies of companies based in Denmark, France, and Sweden that have jettisoned budgeting in favor of new processes. All of this brings us to the question: So what is the traditional budgeting function to be replaced with?

The beyond budgeting model focuses on six principles (Exhibit 1) that link the often disparate decision streams of strategic planning, budgeting, and performance management. It is hard to argue with the notion that resource allocation on the whole will be more effective when these areas are coordinated. The ideas in Beyond Budgeting are getting some play, as many companies are seriously considering scrapping budgeting. More than 60 are supporting the research of Hope and Fraser by funding a consortium known as the Beyond Budgeting Round Table. Should governments jump on the bandwagon?

Exhibit 1: The Six Adaptive Process Principles of Beyond Budgeting 1. Set stretch goals aimed at relative improvement 2. Base evaluation and rewards on relative improvement contracts with hindsight 3. Make action planning a continuous and inclusive process 4. Make resources available as required 5. Coordinate cross-company actions according to prevailing customer demand 6. Base controls on effective governance and on a range of relative performance indicators Source: Beyond Budgeting, pp. 69-89. Beyond Budgeting is a provocative book that does a respectable job of describing some of the frustrations people experience with budgeting. In fact, much of what is presented in the private sector case studies has relevance to government. The attempt to build a coherent resource allocation framework that is tied to the performance management process is also laudable. However, the authors do not make a strong enough case that many of the problems they cite cannot be addressed within the modern budgeting framework.

The new "adaptive process" model is at best a loose set of propositions that aren't on the whole very convincing. The case studies do not provide rigorous empirical support that demonstrates a statistically controlled relationship between budgeting methods and organizational performance. Some of the major challenges in organization theory, such as how principals (shareholders) keep agents (managers) from shirking from corporate objectives, are simply assumed away by phrases such as "setting people free" from "stifling bureaucracies." (4) In short, we are not convinced that budget reform in the public sector should rely on Beyond Budgeting as a change platform (although, in fairness, this was not an objective of Hope and Fraser, who focused on private sector companies). Interestingly--and somewhat against the trend Hope and Fraser would probably like to see--some companies with decentralized global operations are now examining more rather than less stringent financial control mechanisms, even using government tools such as encumbrance accounting.

PUBLIC SECTOR BUDGET REFORM

Talk of reforming the budget function began almost from the very moment budgeting was introduced in local governments in the early 1900s. Aaron Wildavsky summarized what people find wrong about budgeting and examined why budgeting persists:

Over the last century, the traditional budget has been condemned as mindless, because its line-items do not match programs; irrational, because they deal with inputs instead of outputs; shortsighted, because they cover one year instead of many; fragmented, because as a rule only changes are reviewed; conservative, because these changes tend to be small and ineffective. Yet despite these faults the traditional budget reigns supreme virtually everywhere, in practice if not in theory. Why? (5) "Traditional budgeting" is the result of a long process of experimentation that has settled on a number of traditions:

* Annularity--that uncertainty makes it realistic to plan only one year at a time

* Citizen participation--that citizens should influence priority setting

* Intergenerational equity--exemplified by the separation of current expenditures from long-term capital programs

* Executive-driven processes--pinpointing accountability for administration

* Input and control focus--controlling what public money is spent on and mitigating the risk of over-spending

* Incrementalism--where the previous year's appropriation is the starting point for budget formulation, with negotiations focused on increments or decrements (6)

* Balanced budget requirements--found in most state statutes and local ordinances.

A number of these traditions are being challenged, but most of remain intact. So in some ways the recent attack on budgeting is yesterday's news to public managers who have lived through repeated waves of reform such as program, performance, and zero-based budgeting, as well as the more recent reengineering and reinventing government efforts, only to fall back on traditional budgeting. (7)

The GFOA Research and Consulting Center receives numerous inquiries from finance officers, public managers, elected officials, and citizens about how to improve budgeting. Judging from the questions, there are a half-dozen or so areas that people cite as being most in need of improvement. Some of the most frequent questions include the following: Can we budget longer than one year at a time? Is it possible to build a credible five-year financial plan amid economic and political uncertainty? Is there a process for tying operating and capital budgets more closely to the strategic plan? Since our council/governing board cannot agree on what's important, is there a formal priority-setting process that we can consider? What elements should be considered in a comprehensive financial policy so that we can avoid the fiscal instability caused by piecemeal decision making? How can we tie agency performance to the resource allocation process?

This article presents a general approach used by the authors to help governments with an operational review of the budget process. We will not be providing a new model of budgeting; instead, we present an evaluative framework that permits the identification, diagnosis, and correction of problem areas.

To get ahead of the story, the good news is that not all governments are passively living with the defects of traditional budgeting practices. Many are adopting new practices in specific financial planning areas (e.g., long-term plans, strategic plans, priority setting) and are thereby providing models to other governments. Many are using the recommended practices established by the National Advisory Council on...