training modules

BUDGET ANALYST TRAINING PROGRAM

National Association of State Budget Officers

Contents

ACKNOWLEDGMENTS ___________________________________________________________________VI

INTRODUCTION ________________________________________________________________________ 1

OVERVIEW OF STATE BUDGETING ________________________________________________________ 2 General Context _____________________________________________________________________________________ 2 The Budget Process ___________________________________________________________________________________ 2 Types of Budget and Their Applications __________________________________________________________________ 2 Revenue and Expenditure Projections ____________________________________________________________________ 3 Budgeting in Times of Fiscal Strain ______________________________________________________________________ 3 The Legislative Process________________________________________________________________________________ 3 Fiscal Note Analysis __________________________________________________________________________________ 4 Function and Role of The Executive _____________________________________________________________________ 4 Executive and Legislative Budget Staffs __________________________________________________________________ 4 Relationship with Legislative Staff, Legislators, Agencies ____________________________________________________ 5 The Players and the Role of Politics______________________________________________________________________ 5 Dealing with The Media_______________________________________________________________________________ 5 Ethics in State Budgeting ______________________________________________________________________________ 6

MODULE 1: FUNDAMENTALS OF BUDGETING _____________________________________________ 8

OVERVIEW ___________________________________________________________________________________________ 8 Budget Process ______________________________________________________________________________________ 9 Budgeting History ___________________________________________________________________________________ 11 Line-Item Budgeting _________________________________________________________________________________ 12 Program Budgeting __________________________________________________________________________________ 14 Zero-Based Budgeting ________________________________________________________________________________ 16 Performance Budgeting ______________________________________________________________________________ 18 Common Terminology _______________________________________________________________________________ 20

COMPETENCY TEST ___________________________________________________________________________________ 23

MODULE 2: OPERATING BUDGETS_______________________________________________________ 24

OVERVIEW __________________________________________________________________________________________ 24 Budget Process and Timetable _________________________________________________________________________ 25 Monitoring Financial and Economic Trends ______________________________________________________________ 26 Developing and Analyzing Spending Plans_______________________________________________________________ 27 Monitoring and Evaluating Results______________________________________________________________________ 28 Setting and Reporting on Performance Measures__________________________________________________________ 29

COMPETENCY TEST ___________________________________________________________________________________ 30

MODULE 3: FUNDING STATE SERVICES___________________________________________________ 31

OVERVIEW __________________________________________________________________________________________ 31 State Revenue Sources _______________________________________________________________________________ 32 Evolution of State Revenue Sources and Trends ___________________________________________________________ 34 Federal Funding ____________________________________________________________________________________ 35 Debt Financing _____________________________________________________________________________________ 37 Lotteries/Gaming____________________________________________________________________________________ 38

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Fees for Service ____________________________________________________________________________________ 40 State Tax Reform and Tax Policy Concerns ______________________________________________________________ 41

COMPETENCY TEST ___________________________________________________________________________________ 42

MODULE 4: ECONOMICS AND THE STATE BUDGET________________________________________ 43

OVERVIEW __________________________________________________________________________________________ 43 Economic Forecasts _________________________________________________________________________________ 44 Economic Development Strategies _____________________________________________________________________ 46 Economic Conversion ________________________________________________________________________________ 47 Economic Trends, Economic Indicators and Impacts on State Budgets _________________________________________ 48 Demographics______________________________________________________________________________________ 49 Global Competition__________________________________________________________________________________ 50 Economic Impact of Federal Tax Policy _________________________________________________________________ 51

COMPETENCY TEST ___________________________________________________________________________________ 53

MODULE 5: REVENUE AND EXPENDITURE ANALYSIS AND FORECASTING ____________________ 54

OVERVIEW __________________________________________________________________________________________ 54 What Needs to be Forecast?___________________________________________________________________________ 55 Alternative Forecasting Techniques_____________________________________________________________________ 56 Assessing Revenue/Expenditure Estimating Capacity _______________________________________________________ 58 Preparing and Updating Revenue and Expenditure Estimates ________________________________________________ 59 Political Considerations ______________________________________________________________________________ 60 Analyzing the Revenue Mix and Options ________________________________________________________________ 62 Revising Revenue Rates and Bases _____________________________________________________________________ 64 Developing Reference Documents for Revenues and Expenditures ___________________________________________ 65

COMPETENCY TEST ___________________________________________________________________________________ 66

MODULE 6: ANALYTICAL METHODS FOR BUDGET ANALYSIS _______________________________ 67

OVERVIEW __________________________________________________________________________________________ 67 Ongoing Agency Review _____________________________________________________________________________ 68 Policy Analysis: Assessing Claims About Needs and Problems_______________________________________________ 69 Assessing the Political Implications of Budget Actions______________________________________________________ 71 Analyzing Program and Service Delivery Alternatives _____________________________________________________ 72 Making Comparisons to Other States ___________________________________________________________________ 74 Analyzing Historical Spending Patterns _________________________________________________________________ 75 Examining Proposals for New Spending _________________________________________________________________ 77 Using Unit-Cost Analysis as a Tool _____________________________________________________________________ 79 Costing Out Personnel Services________________________________________________________________________ 80 Costing Out Nonpersonnel Services ____________________________________________________________________ 81 Sizing Up the Implications of Capital Proposals on Operating Budgets ________________________________________ 82 Assessing Expenditure Forecasts _______________________________________________________________________ 83 Finding Financing Alternatives ________________________________________________________________________ 84 Analyzing Costs and Benefits __________________________________________________________________________ 85 Analyzing Organization Structure and Staffing ___________________________________________________________ 86 Determining the Fiscal Impacts of Legislation ____________________________________________________________ 88

COMPETENCY TEST ___________________________________________________________________________________ 89

MODULE 7: DECISION MAKING IN THE BUDGET PROCESS__________________________________ 92

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OVERVIEW __________________________________________________________________________________________ 92 Theoretical Models of Budgeting _______________________________________________________________________ 93 Timing and the Budget Process ________________________________________________________________________ 97 Major Decision Points________________________________________________________________________________ 98 The Tradeoffs_______________________________________________________________________________________ 99 The Base Budget ___________________________________________________________________________________ 100 Revenue and Expenditure Forecasts ___________________________________________________________________ 101 Agency Budget Submissions __________________________________________________________________________ 103 Budget Strategy____________________________________________________________________________________ 105 Applicability of Strategic Decision Making in the Budget Process ___________________________________________ 107 The Change in State Budget Offices ___________________________________________________________________ 109 Establishing a Comfort Zone__________________________________________________________________________ 110 The Role of Procedures and Guidelines_________________________________________________________________ 111 The Need for Training and Networks___________________________________________________________________ 112

COMPETENCY TEST __________________________________________________________________________________ 113

MODULE 8: CAPITAL BUDGETS _________________________________________________________ 114

OVERVIEW _________________________________________________________________________________________ 114 Capital Budget Definitions ___________________________________________________________________________ 115 Assessing the Universe of Needs ______________________________________________________________________ 116 Identifying and Rating Projects _______________________________________________________________________ 117 Capital Projects and Politics__________________________________________________________________________ 118 Performing Financial Analysis of Capital Projects ________________________________________________________ 119 Identifying Funding Sources__________________________________________________________________________ 120 Analyzing Financing Options_________________________________________________________________________ 121 Scheduling, Approving, and Implementing ______________________________________________________________ 123

COMPETENCY TEST __________________________________________________________________________________ 125

MODULE 9: DEBT FINANCING__________________________________________________________ 126

OVERVIEW _________________________________________________________________________________________ 126 Policies for Managing Debt __________________________________________________________________________ 127 Debt Financing Instruments __________________________________________________________________________ 128 Indebtedness and Credit Rating Issues__________________________________________________________________ 130 Rating Agencies ___________________________________________________________________________________ 132 Understanding Bond Pricing __________________________________________________________________________ 134 Structuring Bond Issues______________________________________________________________________________ 135 Refinancing or Reorganizing Existing Debt______________________________________________________________ 136 Common Terminology ______________________________________________________________________________ 137

COMPETENCY TEST __________________________________________________________________________________ 144

MODULE 10: THE FEDERAL BUDGET ____________________________________________________ 146

OVERVIEW _________________________________________________________________________________________ 146 Basic Terms and Concepts ___________________________________________________________________________ 147 Bill Enactment Process ______________________________________________________________________________ 149 Highlights of the Federal Budget Process _______________________________________________________________ 150 Budget Timetable __________________________________________________________________________________ 154 New State Perspectives: Trends in Federalism __________________________________________________________ 156 Problems with the Current Federal System ______________________________________________________________ 157

COMPETENCY TEST __________________________________________________________________________________ 158

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MODULE 11: COMMUNICATING FISCAL ISSUES__________________________________________ 159

OVERVIEW _________________________________________________________________________________________ 159 Importance of Communication to Achieving Budget Results ________________________________________________ 160 Audience-Specific Approaches to Communication________________________________________________________ 161 Selecting the Appropriate Communication Vehicle _______________________________________________________ 162 Communicating Politically Sensitive Information_________________________________________________________ 163 Presenting Financial, Operating, and Policy Information __________________________________________________ 164 Preparing Budget Documents_________________________________________________________________________ 166 Using Graphics ____________________________________________________________________________________ 167 Editing Your Own Work _____________________________________________________________________________ 168

COMPETENCY TEST __________________________________________________________________________________ 169

MODULE 12: ETHICS AND STANDARDS OF PROFESSIONAL CONDUCT______________________ 170

OVERVIEW _________________________________________________________________________________________ 170 Ethics in State Budgeting ____________________________________________________________________________ 171 NASBO Standards of Professional Conduct______________________________________________________________ 173 Additional Insights__________________________________________________________________________________ 175

COMPETENCY TEST __________________________________________________________________________________ 176

MODULE 13: INTERPERSONAL SKILLS FOR BUDGET ANALYSTS ____________________________ 178

OVERVIEW _________________________________________________________________________________________ 178 Relationships With Other Players in the Budget Process ___________________________________________________ 179 Conducting Meetings _______________________________________________________________________________ 181 Interviewing Techniques_____________________________________________________________________________ 182 Briefing High-level Officials _________________________________________________________________________ 183 The Art of Persuasion _______________________________________________________________________________ 184 Negotiating Skills __________________________________________________________________________________ 185 Delivering Bad News _______________________________________________________________________________ 186

COMPETENCY TEST __________________________________________________________________________________ 187

APPENDIX______________________________________________________________________________ 191

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Acknowledgments

This training curriculum was authored by members of the National Asso-ciation of State Budget Officers and reflects a substantial commitment of time and effort on the part of analysts and directors in budget offices across the country. Bob Bittenbender of Pennsylvania served as Commit-tee Chair, Mary Dingrando served as the NASBO staff member for the pro-ject, and John Carvalho developed the layout.

With the concurrence of the Executive Committee, NASBO President Glo-ria Timmer of Kansas made the training initiative a priority project during her tenure in 1996-1997. NASBO would like to express appreciation to the following NASBO members and their respective budget offices who contributed to the development of the NASBO Training Curriculum:

Bob Bittenbender, Pennsylvania Peter Burns, Arizona Mike Stormes, Arkansas Stan Stancell, California George Delaney, Colorado Bob Bradley, Florida Bill Hintze, Kentucky Ray Wright, Maryland Judy Johnson, Minnesota Mark Ward, Missouri Gerry Oligmueller, Nebraska Richard Jones, New Mexico Eric Kuntz, New York Robert Powell, North Carolina Sheila Peterson, North Dakota Connie Hardin, Tennessee Lynne Koga, Utah Bob Lauterburg, Virginia Karen Washabau, Virginia

NASBO Training Curriculum vii

NASBO Training Curriculum 1

Introduction and User Guide

Budget analysis is a demanding yet rewarding endeavor. To be successful, the analyst must possess strong technical, analytical, interpersonal, and communication skills. In addition, the analyst must have a good political sense and a strong code of personal ethics. While the profession de-mands much of its practitioners, it also rewards them with significant op-portunities to shape public policy and contribute to the public good. This training curriculum was developed by members of the National Associa-tion of State Budget Officers as a legacy to those who follow in this impor-tant public pursuit.

Purpose The curriculum was designed to provide both an overview and an in-depth examination of the key concepts and processes of state budgeting in the United States today. Although it was designed with the beginning budget analyst in mind, the curriculum will also likely be useful for more experienced analysts interested in broadening their base of knowledge and skills. Parts of the curriculum can also be helpful to orient newly elected officials and appointees.

Structure of the Program

This training program consists of an overview of state budgeting and thir-teen modules on a range of topics and concepts relevant to budget ana-lysts. Each module includes an explanation of concepts, supplemental resources including publications and Internet resources, and a NASBO contact who is available to provide assistance on each topic. A compe-tency test is included at the back of each module. The answers to the tests are contained in the Appendix. This training program can also be ac-cessed via the Internet on the NASBO website at www.nasbo.org.

How to Use This Program

This training program can be used in a number of ways. First, it can be used as a self-study guide. Reading each module, going to the supple-mental resources for additional information, talking with a NASBO con-tacts, and taking the competency tests will help the analyst develop his or her budget knowledge.

Second, the program can serve as a guide for state budget agencies as they develop their own internal training programs. Each budget agency can supplement the information in the modules with information unique to its state and its working environment.

And third, the program can serve as a guide for external trainers that may be contracted by NASBO or state budget agencies to develop training programs.


Overview of State Budgeting

General Context In the United States today, government plays a major role in the economy.

Together, state and local governments spend slightly less than the $1.9 trillion that the federal government spends each year, and government is nearly always a state’s single largest employer. Because of its size, the role of government itself has become a central issue in the budget process.

The budget process can be viewed from a number of perspectives. Suc-cess in the budget process often has more to do with the destination than with the starting point. Governors and legislators often prefer to win than fight the good fight. The role and responsibilities of the budget office and the budget analyst in that struggle vary widely throughout the United States. But in all cases, personal integrity is a precondition to employ-ment, the roles are physically and mentally demanding, and the intrinsic rewards exceed nearly all other avenues of public service.

The Budget Process The budget process is the premier arena in which public priorities are ar-

ticulated and debated, and ultimately where important choices are made by elected officials. The budget process is also a balancing act in which the “separate but equal” branches of government struggle with one an-other based upon the checks and balances established in the United States and individual state constitutions. The budget process has devel-oped over time into a number of substantial parts: operating budgets, capital budgets, debt management practices, tax expenditure budgets, forecasting processes for both revenues and expenditures, and inflation adjustments. To the uninitiated, the budget can easily be mistaken for an expenditure plan. But as government has grown, so has the awareness that budgeting involves both expenditures and tax policies.

Types of Budgets and Their Applications Each state must budget for current operating costs and for capital expendi-

tures. In addition, the state must operate with a fiscally sound program of debt management. The operating budget for a state agency consists of current expenditures required to satisfy a particular mission and/or man-dated purpose. The capital budget is separate from the current operating budget and provides for the state’s major long-term capital investment.



Funding for capital projects may span two or more years. Managing the state’s debt is an integral part of a balanced budget. Decisions to acquire, construct, and equip facilities may increase the state’s obligation for debt service, and analysts must be aware of how bonding levels are set and how authority to issue bonds is acquired.

Revenue and Expenditure Projections Revenue projections forecast the amount of revenues that a government

will have available to support operating costs and capital expenditures over a given period of time. Expenditure projections quantify the net fi-nancial resources required to meet specific needs for a specific period. Both revenue and expenditure projections may be limited to an individual receipt, program, or department, or may project total state receipts and expenditures. Additionally, these projections can be short or long term in nature.

Budgeting in Times of Fiscal Strain If unlimited resources were available, a state’s budget could be built to

accommodate the public service needs of every resident of the state. But in reality, there will never be unlimited funds and in many budget years the resources will be much less than the perceived needs. Generally, if resources are not sufficient to address the many varied needs of the pub-lic, two simple options to cope emerge: increase resources or decrease demand. Historically, a middle course has been taken that is a combina-tion of enhancing resources and controlling demand. For the analyst dur-ing times of fiscal strain, the budget debate moves from the marginal changes against the past year’s budget to a more in-depth examination of programs within the base to determine whether continuation is still war-ranted. The key to an analyst’s contribution is the early recognition of whether the economic situation is permanent (structural) or short-term (cy-clical) because these circumstances will dictate the nature of the budget proposal.

The Legislative Process State governments follow a variety of practices in appropriating state

funds. For the great majority of states, the legal authority for formulation of the proposed budget rests with the governor. In most states, there is a special budget review agency in the legislative branch that reviews the



proposed budget and prepares the agenda for the legislature. During leg-islative hearings, the executive branch officials that were responsible for preparing the proposed budget and its document typically defend the proposals. Expenditures are authorized in the annual or biennial appro-priation act(s) that is adopted by the legislature and signed by the gover-nor.

Fiscal Note Analysis During legislative sessions, state agencies are required to prepare fiscal

notes for many bills being considered. In some states, executive and/or legislative budget staff also prepare fiscal notes for bills with financial im-plications. Fiscal notes must assess the full financial impact of proposed legislation, including probable impact on state and local revenues, ex-penditures, staffing levels, and types of service. The fiscal note analysis usually includes: the impact in dollars, the statutes affected, an estimate of the increase or decrease in revenues and/or expenditures, and any long-range fiscal or program implications.

Function and Role of the Executive Budget Office

The state’s budget is the definitive policy statement of the decision makers in government. The role and function of a budget office is to develop and define the budget process, present a financial plan which recognizes pro-gram priorities within fiscally responsible parameters, and consider and acknowledge all outside forces which may have an impact on the final product and decisions related to it. The process will clearly define the competing priorities for state resources. The budget office staff is respon-sible for assisting decision makers in ranking these priorities.

Executive and Legislative Budget Staffs The executive and legislative budget offices provide technical analysis

and assistance in the development, enactment, and implementation of the state’s budget. The executive budget office is the governor’s professional staff with respect to the budget. Typically, the legislative budget staff per-form similar services for the legislature. Whether or not the two staff agree on the political aspects of the budget, it is in the interest of both branches and their respective budget staffs to bring some order and consistency to the process. Analysts can cooperate in addressing individual agency or



program issues, within the parameters of their respective budget guide-lines or policies.

Relationship with Legislative Staff, Legislators, Agencies

The development of the budget and decision making process requires the involvement of many parties working in a cooperative way to build con-sensus, while recognizing and not compromising their respective roles. The executive budget analyst must be capable of playing different roles at different times with different groups, while maintaining integrity and credibility. The same data that convinced the executive analyst must also be provided to legislators and the legislative staff, with all the arguments and supporting information. Timely, accurate, and complete information from the agencies is critical to the success of an analyst. Knowing the people, programs, and processes as well as or better than the agency’s managers gives the analyst an edge in the process.

The Players and the Role of Politics The process of budgeting requires the collaboration and interaction of a

variety of entities and individuals. Key players in the formulation and execution of a budget include: state agencies, the governor, the executive and legislative budget offices, elected officials, special interest groups, and the media. Each of these groups has an impact on the final outcome of a state’s budget. The role of elected officials is to set the broad policies un-der which government operates. Budget analysts act as intermediaries between agencies and elected officials. Special interest groups organize based on specific areas of concern and lobby the legislature and other elected officials to secure funding for their concerns. The summaries pro-vided by the media, the self-appointed “watchdog” for the budget proc-ess, are interpretations of the process and may affect all the participants, as well as the environment in which the process takes place. The budget is the final product of the political interaction among all of these players and reflects the priorities that emerge after consideration of all the interests ex-pressed by various entities.

Dealing with the Media It is obviously in the governor’s best interest to make every effort to com-

municate the issues accurately for the news media. Cultivating a positive



municate the issues accurately for the news media. Cultivating a positive relationship with the news media is an ongoing process and a worthwhile one. The staff of the state budget office will sometimes organize press conferences and be questioned by the media. In some state offices, only the director or a designee is authorized to speak to the media, while in other cases, the analyst will be expected to deal directly with the press.

Ethics in State Budgeting In any professional environment, there are generally accepted standards

of conduct. High ethical standards are an important component in public service. Earning and maintaining the public trust is a “critical success fac-tor” in governance that is determined in large part by the performance of elected, appointed and civil service officials. Ethics or standards of con-duct are usually defined in relation to personal behavior (for example, honesty) or in relation to the conduct of one’s official duties (for example, full disclosure). Ethical dilemmas are not created equally, some are simply more important than others. In nearly all cases, there are consequences to any action that is taken. Rather than trying to avoid those consequences, experience has demonstrated that it is better to manage the consequences of an action in which you believe, than the converse. In an effort to pro-vide a starting point for considering ethics in the workplace, NASBO has developed its own “Standards of Professional Conduct” (see Module 12).


Module 1: Fundamentals of Budgeting

Overview

The budget process is the most fundamental endeavor government under-takes. Policies and priorities cannot be implemented, services cannot be provided, and programs cannot be operated without funding. Public budget documents describe what governments do by listing how govern-ments spend money. The budget process provides an arena in which public priorities on programs and spending can be articulated, debated, and ultimately decided upon by a state’s elected officials. The balancing of executive and legislative priorities makes for lively debate, victories and defeats; ultimatums and compromises; and finally, an approved budget that all parties live by. The budget process takes many twists and turns throughout the journey and even hits a few dead ends; but the process has a clearly defined beginning and ending every year. While the budget process can be both challenging and rewarding, it can be equally frustrat-ing and discouraging. The process does work and it ultimately ends with a final product.

Analysts employed by both the executive and legislative budget offices play important roles in the budget process. They are responsible for the analysis: fact finding, development of alternatives, and finally, the positive or negative recommendation. Budget analysts must understand many methods from incremental budgeting to zero-based budgeting, from line-item budgeting to program budgeting, and from performance budgeting to formula budgeting. All of these methods require different information, dif-ferent processes, and different methods of analysis on the part of the budget analysts.

BUDGET PROCESS ____________________________ 9 BUDGETING HISTORY________________________ 11 LINE-ITEM BUDGETING ______________________ 12 PROGRAM BUDGETING ______________________ 14 ZERO-BASED BUDGETING____________________ 16 PERFORMANCE BUDGETING__________________ 18 COMMON TERMINOLOGY ____________________ 20

Fundamentals of Budgeting Concepts


Budget Process In technical terms, the budget process has developed over time into a

number of substantial parts: operating budgets, capital budgets, debt management practices, tax expenditure budgets, forecasting processes for both revenues and expenditures, and inflation adjustments. To the unini-tiated, the budget can easily be mistaken for an expenditure plan. But as government influence and spending have grown, so has the awareness that the budget is both an expenditure plan and a combination of tax policies. Together they are blended in the budget process to produce a diverse range of impacts that affect both short and long-run public inter-ests and account for the redistribution of resources between geographical regions, classes of taxpayers, and generations.

Initial Stage: Guid-ance to Agencies

There are distinct stages to developing a state budget. The first stage usu-ally begins in the executive branch with gubernatorial directives or guide-lines to the cabinet and state agencies. These may include the governor’s policy priorities and growth parameters. In response, agencies analyze their own goals and objectives and budget needs in accordance with the directives. They take into account constituent requests and projections for increases in both caseloads and inflation. This stage often lasts for a num-ber of months.

Agency Budget Re-quests

The second stage of the process is consideration of agency budget re-quests. The governor’s budget office evaluates and challenges the agency requests, with these questions in mind:

• Did the agency conform with the guidelines?

• Are requests technically correct? In other words, do the numbers add up?

• Has the agency clearly demonstrated the need?

Budget Preparation The third phase is the most intensive. Two key activities occur simultane-ously: 1) the budget office begins to compile the executive budget docu-ment; and 2) the governor decides the level of funding to recommend for each agency.

During this phase, the budget office presents each agency’s request to the governor and the budget office’s recommendation for future funding ad-justments. The governor is also apprised of unusual trends that have emerged such as declining caseloads or high turnover in certain person-



nel due to low salaries. The governor is given an overview of all requests which includes percent changes proposed by each agency or department and whether or not the policy directives are being met. When final budget decisions are made, they are published in the budget document.

Release of the Budget The fourth stage is the public release of the governor’s executive budget. Its emphasis is on communicating the governor’s priorities. The objective during this stage is to ensure that the budget is understood by the media, the public and the legislature. Ideally, at this point it becomes the starting point for legislative consideration.

Final Stage: Legisl a-tive Consideration

and Negotiation

The final stage is the period of legislative consideration and negotiation. This phase is often the most public and involves the greatest number of persons and interests. During this phase, the legislature reshapes the budget to reflect legislative priorities. In most states, the governor has the authority to veto line-items in the budget act. Unless the veto is over-ridden by the legislature, the budget as amended by the governor be-comes law. The budget is now the spending plan for the state against which actual revenue collections and expenditures are measured.



Budgeting History In the early 1900s, the budget process for the federal and state govern-

ments was relatively simple and straight-forward. It was often handled by very few individuals in an informal manner. The first state executive budget act was adopted by Ohio in 1913. The federal government did not have a formal budget process until 1921 with the passage of the Fed-eral Budget and Accounting Act of 1921.

Need for Professional Budget Staff

Few states developed an annual appropriation bill which consolidated all agency requests until the 1950s. With the passage of time, tighter re-sources and increased demands for funding have contributed to the need for critical analysis of agency budget requests. Along with these demands, the complexity of government and greater public interest have created offices staffed with budget professionals who have the knowledge and analytical abilities to provide choices for decision makers. In short, the budget and its role in government have evolved, and so have the types of people and processes the budget encompasses.

Evolution of the Budget Process

Initially, budgets were documents with minimal line-items and no per-formance requirements and served primarily as annual accounting docu-ments. The budget process has evolved into a planning process where three and five-year projections are expected and where performance is measured annually. The budget document and its development process comprise a plan of action expressed in financial terms.

Changes in Budget Development

Just as the budget has evolved from an accounting document to a finan-cial plan, the processes followed during its development also have changed. States have moved from line-item budgeting to program budget-ing where functions are financed in lump sum with performance expecta-tions attached. States have also moved from a sole emphasis of keeping spending within the appropriations to asking what people and agencies actually accomplished with the funding they received. Previously, base budgets had been taken for granted and were simply increased based upon need. However, states are now engaging in zero-based and other methods of budgeting.

Budget Formats The key goals of budgets are reflected in the budget format and its relative emphasis on expenditure control, management improvement, and policy and planning. The major budget formats are the line-item budget, per-formance budget, and program budget.



Line-Item Budgeting A line-item budget is prepared along departmental or programmatic lines

and focuses on what is to be purchased with funds. A line-item budget generally provides a separate line-item appropriation for each major cate-gory of expenditure in an agency or organization. Typically, these ex-penditure categories include personnel services costs, operating costs, and in some cases, travel, capital outlay, or equipment. This approach to budgeting is used in capital budgeting where each approved project has an individual line-item appropriation. Line-item budgeting is the most widely accepted and best understood technique. Although line-item budgeting is popular, it is not always the most appropriate form for an agency. The line-item approach does not necessarily reflect programs or services nor does it reflect performance. It is a reflection of costs to oper-ate an agency and is as much an accounting document as it is a budget.

Controlled Expenditures

Unlike other forms of budgeting where objectives or performance meas-ures are critical, line-item budgeting maintains accountability by control-ling expenditures. The accountability is placed on the inputs (resources) and not on the outputs or results. Agencies typically do not have the flexibility to manage financial resources through reallocations or transfers between programs. This can work against an agency’s ability to excel in performance. Because this budgeting process is easily understood and does not require the comprehensive effort of developing goals, objectives, program descriptions, and performance measures, it is accepted by many agencies and legislative appropriation committees. The accounting and reporting systems necessary to monitor line-item budgets are not overly complex or costly, and this also leads to its general acceptability.

Incremental Budgeting

Line-item budgeting also lends itself to another budgeting style called in-cremental budgeting. Although incremental budgeting applies to all budget techniques, except for zero-based budgeting, it is most readily adaptable to line-item budgets. Incremental budgeting assumes the base budget as the starting point, and the decision-making is focused on the requested incremental increases or decreases. Line-item budgeting pro-vides the categories of expenditure to which the incremental changes can be added. Decisions to increase or decrease funding are made by simply adding to or subtracting from the existing line-items. Incremental changes can be applied to program or performance budgeting. However, in-creases in those budget styles are more often linked to program goals, ob-jectives, or performance levels, which may or may not be the case in line-item budgeting.



Outputs Not Reflected

Line-item budgeting does provide for accountability and is a user-friendly style of making appropriations. It does not, however, reflect the output of a program or service and does not demand the improvement of govern-mental services. It does not directly challenge agency management and does not encourage an agency to evolve or review where it has been and where it should go. Line-item budgeting does account for the agency’s expenditures, but a budget can be so much more than this process re-quires.



Program Budgeting Program budgeting is a process which became fashionable in the 1960s

when Robert McNamara, President Kennedy’s Secretary of Defense, brought the idea from the Ford Motor Company to the Department of De-fense. Throughout the 1960s and 1970s the program budget concept took hold in all levels of government. A program budget focuses on re-sults of discrete programs: did a program achieve the expected results?

Defining Programs and Outcomes

The concept itself is quite simple to understand. A governmental unit first defines its functions or programs. Once programs are defined, the organi-zation must apply three factors to the program: the goal, the objectives, and the strategies or performance measures to be used to determine whether the objective or goal is met. The major benefit of this process is that it forces an agency or department to focus on what it does and why, as opposed to how it does it. The emphasis is on program performance and ultimate outcomes, as opposed to inputs and processes. The process of program budgeting enables citizens served by the agency to under-stand in service and functional terms what the agency does and how its performance can be measured.

Setting Goals and Objectives

Agencies can use program budgeting to clearly articulate their current levels of performance and plan for improvement. Setting objectives en-ables agency staff to understand their role in the agency’s performance and the standards for measuring their individual performance. The task of establishing goals and objectives is not easy; management must debate the services they provide and evaluate what they do and for whom. For some agencies this is not too difficult; for others it is open to considerable interpretation. Once this task is completed, the agency must establish clear and measurable objectives by which their performance can be measured. The performance measures themselves are an outgrowth of the process of setting objectives.

Data Systems There must be assurance that data systems are in place to record and re-port information on performance measures. Establishing performance measures without having a data system available will undermine the en-tire program budget.

Flexibility in Managing Resources

Program budgeting calls for a more flexible budget appropriation. The concept of measuring performance as opposed to accounting for inputs consumed implies more flexibility in managing resources. Program budg-eting calls for “lump sum” appropriations as opposed to line-item appro-



priations. This is, in many cases, difficult for agencies when promoting program budgeting to the legislature. Legislators often worry about the lack of accountability in a “lump sum” appropriation. For example, the manager may spend more money on travel than the legislature would pre-fer. However, the agency should be held accountable for meeting its goals and objectives rather than for how the money was spent in individ-ual categories of expenditure. This is a leap of faith many legislators are not willing to take.

Outputs and Accountability

Program budgeting focuses on outputs versus inputs. Because of this fo-cus, program budgets have the most potential for allowing policy makers to review the policy implications of spending decisions. Program budget-ing requires management effort in developing programs with goals, objec-tives, and reportable performance measures. It requires accountability for services rendered and for performance which can be documented. It also clearly defines to the decision makers and the general public what an agency does, what it plans to accomplish, and ultimately, how it performs.



Zero-Based Budgeting Zero-based budgeting (ZBB) is a particular kind of program budget. It is a

process designed to analyze the very essence of an agency, program, di-vision, or department to determine its worth and value to the government and its citizens. It is a process which, in its purest form, assumes the agency and program do not exist and builds its programs, operations, and budget from zero to its optimum level. ZBB gained prominence in the late 1970s and early 1980s.

Characteristics of ZBB

The key characteristics of zero-based budgeting are:

• It begins at zero resources.

• It forces the ranking of organizational purposes and programs.

• It requires a clear focus on the priorities of and alternatives to the en-tity’s operations.

Ranking Priorities

ZBB takes many different forms in addition to the one its title implies. In some applications, a base amount (50 percent or some other amount) is established as the starting point, and agencies build their budgets from there up to 100 percent of current resources or more if allowed. ZBB may be used simply as a priority ranking process, breaking budgets down to their essential elements and forcing a prioritization of those elements by the agencies. The forms vary but the concepts of ranking and justifying are constant.

Limited Applicability

ZBB does have limited applicability. While it may be useful for analyzing priorities, in some cases it cannot be used to reach a conclusion. Doing ZBB on a Corrections system, for example, may result in a better under-standing of programs and priorities, but it will not result in closing prisons which are legal mandates. This is not the case in non-mandated govern-ment programs, however.

Prioritization Process

ZBB is a very time-consuming process for the agency and the budget ana-lyst assigned to the agency. Breaking functions down to their essential elements and then prioritizing them requires a considerable investment of time. This process must consider state statutes, federal requirements, court orders and decisions, and even constitutional references.

Ranking Programs

During the prioritization process, program managers must argue the merits of their efforts and rank them against the efforts of other programs in their departments. No program manager wants to find his or her program at the



bottom of the priority list. This process is of greatest value to the agency management and the state budget decision makers in detailing the func-tions, alternatives, and priority placed on the operation of the agency.

Technical Challenges

ZBB also presents technical challenges to the agency or governmental entity involved. There is a critical need for information systems to do the necessary research and also to record and report on decisions. An ac-counting system is essential which can record and report expenditures at the levels needed for ZBB. The process requires a major planning effort and a commitment of time and resources on the part of the agency. It places a considerable burden on management who must also continue “business as usual” while they are rethinking every program. To effec-tively use a ZBB document, the central budget office analyst must be in-volved as the agency develops its ZBB request.

Political Challenges ZBB has the potential for generating competition and conflict among and within state agencies. This is one reason for its limited use. A modified version of it, called “target budgeting” (which puts five or 10 percent of departments’ budgets at risk for reallocation) is used more frequently to-day.



Performance Budgeting A performance budget lists what each administrative unit is trying to ac-

complish, how much it is planning to do, and with what resources. It re-ports on how well it did with the resources it had last year. The perform-ance budgeting process allows for citizen input, requires planning, places resources in the priority service areas, and provides for budget account-ability on the end result of the process. All of these features make per-formance budgeting very attractive to agencies, elected officials, and the citizens being served. The popularity of this trend in budgeting has been created by such efforts as the Oregon Benchmarking program and the ef-forts underway in the State of Texas.

Emphasis on Outputs

The emphasis of performance budgeting is on getting the most service for the dollar. In this regard, it has a lot in common with program budgeting. However, the emphasis in performance budgeting is clearly on the out-puts and outcomes and not necessarily the development of mission state-ments, program descriptions, goals, and objectives that are important in program budgeting. Performance budgeting sets a budget to a desired level of service to be provided and clearly articulates how much is to be accomplished and at what cost. It is a system that establishes accountabil-ity on the part of the agency to produce and report that level of produc-tion as part of the performance budget.

Substantial Planning Effort

Performance budgeting does require a substantial planning and surveying effort to determine the performance standards for an agency and the level of service desired. Often this effort can be a statewide attempt, as was the case in Oregon, to determine what the citizens really want from their gov-ernment and how much they are willing to pay for those services. Once this effort is completed, the results can be translated into the program level. Do the citizens want to increase the standard test scores for their school children in reading and math? Are they willing to pay for it? Do the citizens want the ability to renew their driver’s license in less than thirty minutes? Are they willing to pay for that level of service? And, is the education service level more important than the driver’s license service level? These determinations can then be used by agencies in developing their service levels and in turn, the budget decision makers will consider that information in developing the budget allocations.

Discretion Performance budgeting does, however, remove some of the discretion which currently exists in the budget decision process. There is limited lati-tude to vary from the performance agreement established. For instance, if



citizens say they want quicker service in renewing their driver’s licenses and if the agreed-upon solution to providing this service requires more staff and funding, the agency is compelled to make the request and the governor and legislature are, in effect, duty-bound to approve it. Similarly, if citizens say they do not want a certain governmental service, it should be abolished. This does not mean that all the duty-bound decisions are made accordingly, but it does mean it is harder to explain why the budget decisions did not follow the “will of the people.”

Challenges The major challenges to budget offices in a performance budgeting sys-tem are: 1) determining the true measure of performance for state opera-tions, 2) establishing systems to monitor and accurately report on their per-formance, and 3) training staff and instilling the concept that they are ac-countable for their performance and that of the agency. Challenges of performance measure analysis include: 1) the difficulty in measuring the success of prevention programs, and 2) having enough historical informa-tion for long-term measures. Performance budgeting is a new way of look-ing at what government is doing and why, and how well it is doing. Some government operations can adapt quickly to such a change while others, that have not been service- or performance-oriented, may find perform-ance budgeting difficult to implement.



Common Terminology The following is a list of definitions for commonly used budget terms.

Activity An activity is a process or operation undertaken by an organization spe-cifically designed to meet a program's objective. The process or opera-tion is very clearly defined with a specified time frame and measurable outcome. Activities are used to meet objectives which are used to meet program goals.

Allotment Part of an appropriation that may be expended or encumbered during a given period.

Base The base is the component of a budget request or recommendation which reflects previous fiscal year appropriations. It may include inflation for an agency’s ongoing programs.

Budget A budget is a plan for the expenditure of funds to support an agency, pro-gram, or project.

Capital Budget The capital budget is the budget associated with acquisition or construc-tion of major capital items, including land, buildings and structures, and equipment. Funds for these projects are usually appropriated from sur-pluses, earmarked revenues, or from bond sales.

Contingency Fund A fund set apart to provide for unforeseen expenditures or for anticipated purposes of uncertain amounts.

Current Services Current services is a budget recommendation or request that encompasses the base budget plus allowances for addressing demand such as caseload growth or phased-in statutory responsibilities.

Earmarked Revenues

Earmarked revenues are the designation of certain sources of revenue for support of specific programs or agencies by statutory or constitutional provision.

Expansion/Program Change

Expansion or program change is the component of a budget request or recommendation which includes programs or purposes not previously funded by the Legislature (for example, new programs, additional posi-tions, or expansion of existing programs beyond the scope for which they were initially authorized).

FY Refers to the state fiscal year. The number following FY is the year the fis-cal year ends.



cal year ends.

General Fund General fund refers to revenues accruing to the state from taxes, fees, in-terest earnings, and other sources which can be used for the general op-eration of state government. General fund revenues are not specifically required in statute or in the constitution to support particular programs or agencies.

Incremental Budgeting

Incremental budgeting requires that only additions or deletions to current budgeted expenditures be explained and justified. Funding decisions are made on the margin, based on the justification for the increased costs of operating agencies or programs. This process can be used in conjunction with either line-item budgeting and/or program budgeting.

Input An input is the resource put into the program. Examples are dollars, number of employees, and equipment.

Item Veto Veto power that allows the governor to reject particular items in a piece of legislation such as a sentence, paragraph, or part of a sentence (syntax).

Line-item Budgeting

Line-item budgeting refers to objects or lines of expenditure (for example, personnel, supplies, contractual services, capital outlay) that are the focus of development, analysis, authorization and control of the budget.

Line Item Veto A provision that allows a governor to veto components of the legislative budget on a line-by-line basis.

Nonrecurring/One-time

Appropriation

Nonrecurring appropriation is an appropriation made for one-time items or projects. Examples include capital or major equipment purchases, special studies, and information technology upgrades.

Ongoing Appropriation

This type of appropriation is made for ongoing programs for which future appropriations will have to be made.

Operating Budget The operating budget is the budget established for operation of a state agency or program, typically based on legislative appropriation.

Outcome Measures

Outcome measures are tools or indicators to assess the actual impact of an agency’s actions. An outcome measure is a means for qualified compari-son between the actual result and the intended result. An example is re-ducing the rate of infant mortality by a certain percent.

Output An output is the good or service produced by an agency. An example is the number of personnel trained by a vocational education organization



but without qualitative or cost inferences.

Performance Budgeting

Performance budgeting is similar to program budgeting. Performance budgets are constructed by program but focus on program goals and ob-jectives; measured by short-term outputs, projected longer term outcomes, and cost/benefits analysis. Appropriations are not only linked with pro-grams, but also with expected results specified by these performance crite-ria.

Program A program is a separately identifiable and managerially discrete function within an organization designed to meet a statutory requirement or a de-fined citizen need.

Program Budgeting

Program budgeting refers to budgets that are formulated and appropria-tions that are made on the basis of expected results of services to be car-ried out by programs. The focus on outcomes is usually over multiple years.

Structural Deficit Structural deficits occur when growth in spending needed to maintain current services and growth in revenues from current taxes and other revenue sources are inconsistent.

Supplemental Appropriation

Supplemental appropriation is an appropriation made to an agency or program during the current operating fiscal year to cover unforeseen events, projected over expenditures, or to replace revenue shortfalls.

Zero-Based Budgeting

Zero based budgeting subjects all programs, activities and expenditures to justification (in contrast to incremental budgeting). Funding requests, rec-ommendations and allocations for existing and new programs are usually ranked in priority order on the basis of alternative service levels, which are lower, equal to and higher than current levels. This process can be used in conjunction with either line-item budgeting and/or program budgeting.


Fundamentals of Budgeting Competency Test

Competency Test

Q1: When did the federal government first adopt a formal budget proc-ess?

Q2: Describe the evolution of the budget process from its beginning as an accounting document to today’s techniques.

Q3: What limits agency creativity in solving problems or service delivery issues in a line-item budgeting process?

Q4: Why is line-item budgeting so prevalent throughout state govern-ments' appropriations processes?

Q5: Name the three primary factors an agency’s program budget presen-tation must include.

Q6: What constitutes the primary resistance to program budgeting by leg-islative appropriating committees?

Q7: What is the primary purpose of developing a zero-based budget for any department, division, or agency?

Q8: Describe the challenges zero-based budgeting presents to agency managers.

Q9: Explain the role statewide and/or departmental planning plays in the development of a performance budgeting system.

Q10: What are the key advantages to a department in using a perform-ance budgeting process to obtain annual appropriations?


Module 2: Operating Budgets

Overview The operating budget is that portion of the budget which addresses pro-gram activities and services authorized by the state’s legislature and gov-ernor. The construction and renovation of buildings and the purchase of major equipment is not included in the operating budget, but is instead addressed in the capital budget.

Operating budget items typically include personnel services (salaries, wages, and fringe benefits), contracted services, rent, travel, utilities, equipment, supplies, and other operating expenses. The number of full-time positions associated with the operating budget may also be included as a standard component of agency operating budgets. Funding for oper-ating budgets is usually from annual or biennial legislative appropriation. Actual expenditures are reported in the state’s annual financial statements.

Monitoring the results of programs in the operating budget, as well as fi-nancial and economic trends, is essential for making appropriate deci-sions regarding programs in the operating budget. This information can also be used to determine if there is a need for implementing certain ex-penditure controls to keep the budget in balance.

BUDGET PROCESS AND TIMETABLE __________ 25 MONITORING FINANCIAL AND

ECONOMIC TRENDS ______________________ 26 DEVELOPING AND ANALYZING

SPENDING PLANS ______________________ 27 MONITORING AND EVALUATING RESULTS____ 28 SETTING AND REPORTING ON

PERFORMANCE MEASURES ______________ 29

Operating Budgets Concepts


Budget Process and Timetable

The development of state budgets usually involves numerous participants and various procedures. To ensure efficiency in the budget process, budgeting is usually conducted on a cycle. Although different states may label the phases of the cycle differently, typical phases of this cycle in-clude preparation and submission, approval, execution, and audit or evaluation.

Budget preparation actually begins with the planning process. During planning, program goals and strategies are developed to accomplish the directives of the state legislature and the governor. Through integration of planning and budgeting, the cost of activities and programs is established and funded within the amounts determined to be available through reve-nue forecasting.

Financial Plan The operating budget represents the financial plan for that part of the budget which supports program activities and services. It is developed during budget preparation, reviewed by the executive and legislative branches, and finally approved and put into place with legislative action and the governor’s signature. Budget certification (the conversion of legis-lative action to a beginning base budget) begins the phase of the budget cycle identified as budget execution. It is during this phase that the oper-ating budget undergoes a series of revisions to accommodate changing needs and conditions.



Monitoring Financial and Economic Trends

Planning, budget preparation and budget execution all involve monitor-ing financial and economic trends. Budget preparation relies on forecast-ing to determine revenue availability for supporting continuation (or base budget) as well as expansion budget needs. Since forecasting may be done far in advance of the actual review and implementation of a budget, revision during the legislative review process should be expected. Further monitoring and adjustment of the budget will be necessary after the budget has been approved and put into place.

Monitoring and Adjustments

Analysts will use information on financial and economic trends to make informed recommendations on requests for budget revisions. Shortfalls in revenue collection may impact how the budget is administered. Policy makers and budget officials, responsible for ensuring a balanced budget, will use this information to set into motion cost-controlling measures. These measures may include adjusting the flow or distribution of funds approved by the legislature for a given program or implementing position freezes or controls on other areas of spending such as equipment or travel.



Developing and Analyzing Spending Plans

Spending plans are the result of integrating the planning process with budget preparation. Program planning sets out the needs of a program and describes the activities that will meet that need. Budget requirements for those activities are then determined and incorporated into the con-tinuation (or base budget) or expansion budget preparation process as appropriate. Spending plans must be adaptable to changing economic and political environments, and therefore, must be continuously moni-tored and analyzed for revision.

Balanced Budget Requirements

Forty-three states require their governor to submit a balanced budget. The legislature must pass a balanced budget in all but eleven states and the governor must sign a balanced budget in thirty-one states.

Spending Limits Many states either by constitution or statute have limits on the amount of expenditures that can be made and/or the revenues which can be col-lected. Before the operating budget is developed, the spending cap must be calculated.

One-Time vs. Ongo-ing Expenditures

As the budget is developed, it is important to calculate how much of the revenue estimate is attributable to continuing or ongoing sources and how much is attributable to one-time sources. One-time monies should not be budgeted for ongoing expenditures. Otherwise, in the next budget cycle, ongoing programs may have to be cut or revenue may have to be di-verted from other sources.



Monitoring and Evaluating Results

Monitoring and evaluation separate the “bean counters” from the budget analysts. Analysts draw from program data, expenditure reports, and per-sonal analysis to form conclusions about the relative effectiveness of pro-gram activities and strategies in accomplishing program goals and objec-tives. Through monitoring and evaluation, analysts can provide feedback to decision makers on the success or failure of the spending plan. Future funding decisions are often made on the basis of this feedback.

Monitoring and Evaluation

Monitoring is the ongoing collection and examination of program and expenditure data to determine if activities and strategies are being carried out in accordance with plans. Evaluation utilizes data from the monitor-ing effort, coupled with more rigorous quantitative and qualitative meth-odologies such as surveys, client interviews, statistical analyses and use of control groups, to determine whether program strategies and activities re-sulted in the desired effect. Monitoring and evaluation are the best ways of determining whether program activities and strategies are successful and are responsible for producing desired outcomes.

Periodic Monitoring

Once it is passed by the legislature, the budget becomes the standard by which revenues and expenditures are measured. Processes for comparing actual revenues and expenditures to the budget vary across the states. Accounting reports are usually produced monthly to show the compari-son. Agency budget and/or accounting personnel and program managers are responsible for monitoring the spending and the patterns that develop. Projections for the remainder of the fiscal year are taken into account as well. Changes to the budget, such as an increase in federal funds, may be allowed if the budget office concurs. Most states increase the level of monitoring as the fiscal year end approaches so as not to overspend budgeted amounts.

Rainy Day Funds Despite a state’s highly technical and sophisticated revenue forecasting methods, it is difficult to predict exactly what the economy will do and what taxpayer behavior will be. To allow for a cushion, some states ap-propriate less than 100 percent of the revenues estimated. Many states maintain a rainy day fund or budget stabilization fund for unforeseen cir-cumstances.



Setting and Reporting on Performance Measures

Formulating good performance measures can help establish a sound basis for monitoring and evaluation. Performance measures can also help de-cision makers see what the funds expended by an agency or program have actually accomplished and how much progress has been made to-ward specific performance objectives that have been articulated.

States are moving away from measures that focus on inputs or simple out-puts, and are focusing more and more on outcome measures. For exam-ple, input measures for a job training program might measure number of dollars appropriated or number of instructors hired. Output measures would record the number of classes held or number of students who have graduated. Outcome measures, which really start to reveal if the program is successful, might address the number of students finding employment after training or employer ratings of satisfaction with the quality of program graduates that have been hired.

When a performance measurement system is initiated, the first round of measures developed may need to be refined with experience. This flexi-bility should be available. Reporting on performance measures will likely be a learning process for the reporter as well as the audience for the re-port. Feedback from report users should play back into refinement of the measures. Hence, setting (or refining) performance measures serves as both the beginning and ending of the planning/budget cycle.


Operating Budgets Competency Test

Competency Test

Q1: The operating budget represents the financial plan for what part of the state budget?

Q2: List the types of items you would expect to see in a typical operating budget.

Q3: In how many states is the governor required to sign a balanced budget?

Q4: Funding supporting operating budgets usually comes from what source?

Q5: Why should one-time revenue sources not be budgeted for on-going expenditures?

Q6: Why is it important for a budget analyst to be aware of financial and economic trends?

Q7: Why do some states have rainy day funds?

Q8: Explain the differences between input, output, and outcome per-formance measures. Which type of measure generally yields the most meaningful information?


Module 3: Funding State Services

Overview Public budgets link decisions about how much, and for what, govern-ments spend available resources. Most state governments in the United States are required to maintain, or at least propose, a budget that balances spending and resources for a fiscal period. Some states allow external borrowing to achieve budgetary balance, although it is typically permitted only for capital budgets. A revenue estimate for an operating budget es-tablishes a significant constraint on the development of that budget. Lim-ited by estimated available revenues, the dynamics of establishing budg-etary balance may involve making decisions on proposing increases or decreases in revenues, whether through taxes, fees or borrowing. The choices made in those decisions usually have consequences well beyond the budget year for governments and their citizens. While these conse-quences may not always be fully understood, they should be analyzed as a part of the decision-making process.

STATE REVENUE SOURCES ___________________ 32 EVOLUTION OF STATE REVENUE SOURCES

AND TRENDS ____________________________ 34 FEDERAL FUNDING __________________________ 35 DEBT FINANCING ___________________________ 37 LOTTERIES/GAMING _________________________ 38 FEES FOR SERVICE __________________________ 40 STATE TAX REFORM AND TAX POLICY

CONCERNS ______________________________ 41

Funding State Services Concepts


State Revenue Sources Budgets are more than a compilation of planned levels of expenditures.

The sources and amounts of resources estimated to be available during the budget period are a vital component of a budget. A requirement in most states for a balanced budget makes revenue estimates a primary de-terminant for the size of a budget. Consequently, a capability to estimate revenues available for expenditure is critical to good budget develop-ment.

Estimating Revenue

Revenue estimation depends on the character of revenue sources and the ease of their estimation. Revenue sources such as personal income and general sales taxes are heavily influenced by current and projected eco-nomic conditions. Other revenue sources such as license fees, tobacco taxes, and alcoholic beverage taxes have more stable short-term bases but are subject to long-term changes. Other elements that must be considered in the development of revenue estimates include tax payment mecha-nisms and timing of collections. Any given tax payment may represent a tax liability from several different time periods and may also be net of credits and debits (for example, refunds). Corporate income tax pay-ments, in particular, often exhibit these kinds of characteristics.

Tax Sources A general separation of revenue sources and taxing authority has evolved among the different levels of government - federal, state, and local. A separation of tax sources is beneficial in that it helps avoid taxation con-flicts and offers administrative convenience. The separation of revenue sources has not occurred by design, although the kinds of taxes state gov-ernments can levy are constrained by the Constitution of the United States. States are prohibited by the U.S. Constitution from levying duties on imports or exports, from setting tax policy that discriminates against non-residents, and from impeding interstate commerce with onerous tax structures.

Revenues and Levels of

Government

The federal government relies primarily on individual and corporate in-come taxes. Local governments rely heavily on real and personal prop-erty taxes. State tax revenues can be placed into six categories in general order of their importance: 1) general sales, 2) selective sales [excise, gross receipts, motor fuels, utility, tobacco, insurance, alcohol, pari-mutuel, amusement, etc.], 3) individual income, 4) corporate income, 5) licenses, and 6) miscellaneous [severance, property, death and gift, documentary and stock transfer, etc.]. Non-tax revenues include: 1) interest, 2) fines and penalties, 3) fees, 4) charges for service [tuition, hospital copayments, etc.],



5) enterprise profits, and 6) intergovernmental transfers and grants. This latter category is important in that the separation of revenue sources be-tween the levels of government is moderated by the amount of intergov-ernmental grants provided to subordinate levels of government.



Evolution of State Revenue Sources and Trends

Revenue Diversification

States, in the early years, relied upon the general property tax as their ma-jor revenue source. Gradually, states diversified their revenue sources be-yond the property tax. Early in the twentieth century states accelerated the diversification of revenue sources by raising the importance of general sales taxes and motor fuels taxes. More recently, that diversification has led state governments into taxation of income. In 1995, almost 50 per-cent of total state tax revenues were provided by sales and gross receipts taxes, 31 percent came from individual income taxes, and 7.3 percent from corporate net income taxes. Property taxes contributed only 2.4 percent of state tax revenue.

Earmarked Taxes In today’s general climate of a reluctance to increase general tax levies, there is an inclination to establish some link, real or imaginary, between a revenue source and a disbursement. Linking a revenue source to a service or program is known as “earmarking.” The most common forms of tax earmarking may be the funding of highway costs from motor fuels taxes and the funding of unemployment compensation payments from em-ployer and employee payroll taxes. Many budget professionals are criti-cal of revenue earmarking – it removes resources from the review and pol-icy direction of the budget process, including legislative oversight; it may reduce accountability for effective use of public resources; and it can re-quire more complex administration than general revenues. The linking of a revenue source to a specific purpose may be done without any connec-tion between the amount of revenues produced and the amount needed for the program. There may not even be a programmatic connection be-tween the source and the use. Despite these shortcomings, there can be an effective rationale to earmarking revenues, especially when a strong link can be made between the benefits received by programs funded by taxes or charges levied on the recipients. In fact, many states consider motor fuel taxes to be user fees.



Federal Funding

Federal funds represent an important revenue source for states and sup-port a wide range of programs ranging from social services to transporta-tion projects. Federal assistance is provided to state governments in the form of grants, entitlements, administration funds, and tax expenditures.

Types of Grants Grants are a lump sum federal “payment” for a specified purpose. Grants are usually appropriated yearly by Congress and have authorizing legisla-tion describing a program distribution formula, program goals, and pro-gram requirements. Generally, the amount of funds appropriated by Congress provides a cap on the amount of federal funding available for each grant program. For states there are usually three types of grants:

1. A categorical grant that can be used only for a specific program as specified in the authorizing federal legislation.

2. A block grant that can be used for a variety of activities within a broad functional area.

3. A specific project grant that is allocated to a state, usually through a special earmarking in an appropriation bill by a member of Congress or through a direct contract with a federal agency.

Entitlements Entitlements are federal assistance to states included in the provisions of the law authorizing the program. The level of federal funding available is determined by the number of clients or other entities that meet the eligibil-ity criteria for the program. Generally, the state is committed to providing services for those who are eligible as defined by both the federal govern-ment and the state. The state will be reimbursed by the federal govern-ment at a particular match rate for all who are eligible. Federal funds for entitlements are not capped by federal appropriation amounts.

Administration Administration funds are derived from the authorizing legislation and al-low the state to spend up to a certain percentage or specified amount of the program’s funding for administering a program.

Tax Expenditures Tax expenditures are indirect assistance provided through tax laws. The ability for states and municipalities to issue federally tax exempt bonds is an example. The tax exemptions provided for investors allow bonds to be sold at a lower interest rate thus reducing financing costs for state govern-ments.

Requirements and Federal requirements and conditions accompany virtually all federal funds. Generally, categorical grant programs are among the most restric-



Conditions funds. Generally, categorical grant programs are among the most restric-tive while block grants are intended to allow states flexibility to determine specific program criteria. Under the 1996 Personal Responsibility and Work Opportunity Reconciliation Act (federal welfare reform bill), gover-nors were generally supportive of the effort to make the program a block grant. Even though this could eventually lead to less federal funding in future years compared to when the program was an entitlement, the trade-off was a fixed amount of funding for several years in exchange for in-creased programmatic flexibility. Some types of federal funding require states to be directly responsible to the federal government for the imple-mentation of Congressional policy decisions. This can take the form of participating in a federal program and following program guidelines such as submitting program plans and follow-up audits under the Single Audit Act. In some cases, federal requirements generate costs at the state level as a result of mandates that Congress has enacted without providing fund-ing. The Americans with Disabilities Act (ADA) is an example of a federal mandate without funding.

Fiscal Years Vary Preparing budgets for states is complicated by the federal fiscal year. The federal government operates on a fiscal year from October 1st to Septem-ber 30th. Many states have a different fiscal year, often July 1 to June 30. This timing requires states to anticipate federal funding levels far in ad-vance of the actual availability of federal funds. To address this concern, some federal programs, including most programs in the Departments of Education and Labor, are forward-funded. That is, funds appropriated on October 1 will be available the following July 1, allowing states to know the level of federal support when the state budget is prepared.



Debt Financing

Governmental spending includes resources directly or indirectly con-sumed over a short period of time, such as for salaries and commodities, and resources that will be consumed over an extended period of time, such as for the construction of a school building or a museum. Purchase of these long-lived assets represents an investment of public funds that should provide utility long beyond the period in which the funds were expended. A policy of paying for expenditure items completely from cur-rent resources is called a “pay-as-you-go” policy.

An alternative to pay-as-you-go financing is one where ordinary expenses are paid from current revenues while capital expenses, which provide benefits over a multi-year term, are financed with debt and paid for over a period longer than their construction or acquisition. Such an alternative can be described as a “pay-as-you-use” policy. Debt financing, although more expensive, is often justified because the acquired capital asset will benefit the government and/or its citizens immediately. Borrowing to spread the cost of capital investment over its useful life also can provide for a more equitable allocation of costs to the citizens receiving the benefit over the extended period of time.

Debt Policies Pledging future resources to bondholders places the government at greater financial risk than it would be otherwise. A commitment to pay bondholders their principal and interest when due represents competition for budget resources. A decision to borrow funds long-term carries con-sequences that should be fully recognized and analyzed for affordability and risks over the term of the debt. Such an analysis must also address the purposes for which borrowing is undertaken.

Relying on debt financing for operating expenditures, such as education and training, is an invitation for trouble. This practice can lead to over-borrowing and destabilization of fiscal conditions as the costs of carrying the debt and repaying the amount borrowed rise in each fiscal year. Care must be exercised in making decisions to borrow. Establishing and fol-lowing reasonable debt policies may prevent borrowing that could lead to an out-of-control budget. A comprehensive discussion of debt policies and practices is found in Module 9.



Lotteries/Gaming

During the past generation there has been a dramatic expansion of legal-ized gaming as a means to supplement state revenues. Gaming that bene-fits states takes many forms: lotteries, horse and dog racing, casinos – on land and water, and jai alai. Beginning with New Hampshire in 1964, 37 states and the District of Columbia have instituted lotteries. As recently as 1988, only two states allowed casino gambling. Today, 23 states and a number of Native American reservations allow casino gambling.

Legalized gambling has become very big business. Total wagers reached nearly half a trillion dollars in 1994. This significant revenue source is used extensively by state governments to support public programs. Re-cent estimates are that state governments take about one-third of the amount wagered to finance public sector activities.

Unique Characteris-tics

What distinguishes lotteries and gambling from other state tax revenue sources is that taxes are imposed, while participation in gaming is purely voluntary. The voluntary nature of gaming makes it a revenue source that is easy to rationalize in an anti-government and anti-tax environment. Lot-teries and gaming are further distinguished from other types of state reve-nues such as fees in that there is no connection between the source of the gaming proceeds and the disbursement. Lotteries are used to support education, senior citizen programs, parks, and a wide variety of other ac-tivities.

Marketing Strategies

The nature of gaming is entirely different from that of other more tradi-tional tax sources. Gaming must be run as a business in order to sustain and increase gaming revenues. Extensive marketing efforts must be main-tained to attract and retain player participation. Products or games must be changed periodically so play does not decline as states’ gaming ven-ues mature. Variety and game enhancements are essential to maintain revenue generating potential. States continue to investigate and imple-ment new gaming strategies such as video lotteries, keno machines, and riverboat gambling. Concerns about criminal influence, compulsive gam-bling, and age limitations must be addressed before alternative gaming strategies can be undertaken by a state.

Volatile Revenue Source

Reliance on gaming revenues to support public programs can be risky if safeguards are not imposed. Gaming revenue must be considered a vola-tile revenue source that can be influenced not only by economic condi-tions but also by consumer choice. Declining participation due to the



maturation of gaming venues, competition from other legal or illegal gam-ing opportunities, poor game design, or an unsuccessful marketing cam-paign can lead to sharp unanticipated revenue declines. Reliance on gaming revenues will continue to grow as an alternative to traditional tax sources. Costs of public services supported by gaming revenues must be carefully balanced against the ability of a state or locality to maintain or increase gaming receipts.



Fees for Service

States charge various fees to offset the costs associated with certain activi-ties and services of state government. Fees are defined as monetary charges that are made for licenses, permits, certifications, privileges, goods, or services. Privileges include the granting of access to or use of state facilities, or enforcing actions or behaviors that are otherwise re-stricted by law or regulation. Services include a wide range of benefits such as advisory services to local governments, social services to indi-viduals, medical treatment, and institutionalization.

User Fees User fees have the advantage of allowing those who pay to select only the services they want. No one has to pay if they do not want the service or believe the cost is too high. Many groups support user fees because they seem to be fair and voluntary. If someone does not want a service, they do not have to pay for it, and if they use less, they pay less. One of the disadvantages is that fees often have little to do with ability to pay.

Fee Level and Cost of Activity

Fee levels should be set at rates that reflect the governmental cost of fee-related activities and lead users to bear the cost of services provided. How much of the cost should be borne by users depends on who benefits from the service provided. In cases where fees benefit a specific group of individuals or business enterprises, the state should recoup the cost of conducting fee-related activities from that group. Such costs should not be borne by the general taxpayer. In other cases, where fees support regulatory activities which generally benefit all citizens, most or all of the fee-related costs should be supported by the taxpayer. Sometimes fees serve as an economic rationing mechanism or serve to minimize capri-cious use. With certain fees, revenue generated may be more than the cost of conducting the fee-related activities. Examples are fees received in exchange for licenses, permits, certifications, privileges, goods, or services in competition with private enterprise or to the economic benefit of pri-vate enterprise.



State Tax Reform and Tax Policy Concerns

The primary function of taxes, fees, and other charges is to produce reve-nues for governments. However, fiscal actions are not economically neu-tral. Due to their capacity to alter economic behavior of individuals and businesses, taxes have considerable effects beyond their revenue raising purposes. Therefore, taxation can be employed as a major instrument of social and economic policy.

Principles of Taxation

An area of great debate in public finance is the discussion of what princi-ples of “justice” should be employed in taxation decisions. Classical eco-nomics provides three principles of taxation: 1) equity - that taxpayers in similar situations should be treated similarly, 2) ability-to-pay - that wealthy taxpayers should pay proportionately more than the poor, and 3) benefit – that taxpayers pay amounts in relation to the benefits received.

Modern Doctrines

In addition to these principles from classical economics, there are modern doctrines that influence tax policy decisions. Among these doctrines are: 1) social equalization - to achieve a redistribution of income and wealth from the rich to the poor, 2) group discrimination - the favoring of one group against another, such as farmers, oil well owners or homeowners, 3) regulation – controlling consumption or distribution of products deemed undesirable or harmful, and 4) promotion of economic growth - stimulat-ing investment or the exploitation of natural economic advantages.

Tax Alternatives Adhering to any of these principles or doctrines will produce conflicts with the others. Whenever reform to an existing tax system is imple-mented or a new tax levied, there will be gainers and losers in either an absolute or relative sense. Consequently, when public officials need to raise taxes they confront a myriad of conflicting interests. The usual po-litical objective is to structure tax changes to minimize opposition and maximize support. Achieving this objective requires an analysis of the options from both an economic and a political perspective. Tax alterna-tives should also be evaluated for ease and cost of collection, certainty, simplicity, convenience, stability, responsiveness, cost of administration, and ease of estimation.


Funding State Services Competency Test

Competency Test

Q1: How does your state’s reliance on various forms of taxes differ from the national average? Can you think of the reasons why they are similar or significantly different?

Q2: Examine your state’s major earmarked revenues and evaluate why or why not their earmarking is an effective budgeting tool.

Q3: Are total appropriation amounts for federal entitlement programs capped in authorizing legislation?

Q4: What are the advantages and disadvantages of using revenue de-rived from gaming to support public sector programs?

Q5: Name some of the factors that distinguish gaming from other more traditional types of revenue sources, such as taxes and user fees.

Q6: What can be the consequences of not having a debt financing policy or having one that is imprecise in its definition of capital and operat-ing expenses and the use of debt financing for each?

Q7: What should be the guiding policy for establishing or revising fees for services?


Module 4: Economics and the State Budget

Overview A state’s public revenues and expenditures are tied inextricably to private economic activity. Budgets can be affected by declining economies ei-ther through decreases in revenues or increases in program expenditures triggered by increased unemployment and poverty. State budget analysts need exposure to the principles of economic analysis in order to evaluate policy proposals and to estimate future revenues, program caseloads, and other budget variables based on economic conditions.

ECONOMIC FORECASTS______________________ 44 ECONOMIC DEVELOPMENT STRATEGIES______46 ECONOMIC CONVERSION __________________47 ECONOMIC TRENDS, ECONOMIC INDICATORS,

AND IMPACTS ON STATE BUDGETS_______48 DEMOGRAPHICS __________________________49 GLOBAL COMPETITION ____________________56 ECONOMIC IMPACT OF FEDERAL TAX POLICY 51

Economics and the State Budget Concepts


Economic Forecasts Revenue and

Caseload Estimates State budget offices rely on economic forecasts for two main purposes: 1) to guide the preparation of state revenue estimates, and 2) to estimate caseloads for health, welfare, employment, and corrections departments. Ideally, a single economic research function is the sole source of eco-nomic forecasts, trends, indicators, and impacts on state budgets for all government departments, the governor, and the legislature. Frequently, however, there are duplicate functions and economic data in a variety of locations, leading sometimes to conflicting and competitive estimation and economic tracking results. Some states have instituted a formal commission or committee to pass final judgment or reach consensus on the economic forecast. Other states informally seek advice and approval of independent business and academic economists. In any case, it is de-sirable to remove the economic forecast from political influence if at all possible. Commissions, committees, and outside advisors can de-politicize the economic forecast while at the same time improving the ac-curacy of the forecast.

Key Economic Variables

State level economic data are generally derived from national data. The key economic variables that drive revenue forecasts are nonfarm payroll employment and personal income. These are based in large measure on a quarterly payroll tax report known as the ES-202, prepared by state em-ployment agencies in each of the fifty states. Access to this report is essen-tial to have any chance of an accurate forecast.

Forecasting Models

The most widespread method of estimating key variables of a state’s economy is to begin with a forecast of the nation’s economy and then to scale this to the state. Few states maintain their own national forecast models. Most either simulate one of the several commercial models or simply accept the “most likely” forecast from one of these firms. Others use a consensus forecast such as Eggert’s Blue Chip Survey.

Econometrics Once a national forecast is accepted, the scaling to the state begins by re-fining known linkages between national economic activity and that of the state. Generally, these relationships are tested through econometric analysis. For example, a state may have a significant industrial sector pro-ducing lumber for the construction industry. An equation estimating this state’s employment in lumber production would have a variety of ex-planatory variables, such as national construction activity, tax rates, inter-est rates, or other similar values. Each major industry’s employment would be estimated in similar ways, using national and state economic



variables to explain employment. Employment estimates and other na-tional variables would become explanatory variables for equations that estimate profits, personal income, unemployment, and other variables. Local inflation forecasts are similarly derived from the national inflation forecast.

Forecasting and Policy Decisions

Once the estimates of state economic variables are completed and agreed to by participating economists, they are made available to revenue, health, welfare, employment, and other departments to use as a basis for their revenue forecasting and budget planning activities. Economic fore-casts generally become the driving force behind many of the major policy decisions of the governor’s administration and the legislature.



Economic Development Strategies

State budget officers are often required to analyze economic development options that call for the government to interact with the private sector to increase the amount of economic activity. The most common policy op-tions are tax reduction and expenditure increase.

Tax Reduction Tax reduction proposals aim to reduce the burden of taxes for selected groups of businesses or households as an inducement to locate or in-crease capacity in a state. These proposals are usually supported by ar-guments that tax reduction will allow the state to compete with surround-ing states or foreign countries. The economic argument is straightforward: when the cost of doing business falls in a state, more business is con-ducted there -- all other things being equal.

Expenditure Increase

On the expenditure side, the principle options are: 1) to spend tax dollars on goods or services needed by the target industry, thereby reducing the industry’s cost-of-doing-business in the state (sometimes called subsidies, and 2) to provide a credit against taxes owed by the industry. In a bal-anced budget environment, expenditures by state governments on goods and services are viewed by most economists as being an inefficient eco-nomic strategy for economic development. The argument is that taxes need to be raised by amounts sufficient to fund expenditures. This would have the effect of reducing the expansive effects of government demand. The exception to this may be found when providing funding for infrastruc-ture (roads, schools, ports, etc.). If financing infrastructure increases the profitability of doing business in a state and/or decreases the costs of living in a state, the losses from taxes for infrastructure financing are offset. Tax expenditure has much the same economic effect as tax reduction, except additional administrative costs are incurred by private firms, households, and tax processing operations in state government.

Incentives The breadth of tax reduction or expenditure (who or what the policy ap-plies to) may be as important as its dollar magnitude. When governments reduce taxes for selected industries, the incentive is for profit-maximizing firms and investors to shift resources from other industries, regions, or countries. An economic development strategy that provides special tax treatment for a certain industry may create the impression of expanding the industry while in reality, the resources are simply shifting from other industries in the state.



Economic Conversion The term “economic conversion” can be applied to any structural change to

a state’s economy; for example, a conversion from a heavy manufacturing to a service economy. Recently the term has been applied almost exclu-sively to the transformation of closed military facilities to private economic activity. Since the late 1980s, many military bases have been closed and many more are scheduled to close. The idea of conversion activity as a substitute for economic activity that would otherwise have occurred exposes conversion proposals to the same standards of cost-benefit analysis as other economic development strategies.

Primary Effects The impact of the sudden reduction of federal spending in a region has two primary effects: 1) loss of consumer spending, and 2) increased demands upon social welfare programs. The loss of spending comes from laid-off military base employees, both uniformed and civilian. Local merchants ex-perience losses of sales, and state and local governments’ tax receipts are reduced (particularly property tax losses due to declining real estate prices). The increased demand for social welfare benefits may have a great impact on areas that have bases with large civilian staffs. The staff, who tend to be well-paid in relation to other workers in the local marketplace, may possess skills in low demand locally after the base closes.

Implicit Subsidy The premise of economic conversion is to exploit the physical plant left be-hind by the base closure and the skills of the laid-off staff to encourage the growth of new businesses. By offering land or buildings at less-than-market cost, an implicit subsidy is created to encourage new business activity. Some states also may subsidize labor by means of direct subsidies including job retraining programs or tax expenditures.

Opportunity Cost While there are claims of successful economic conversion, each must be considered in terms of two factors: opportunity cost and substitution of con-version-type activity for activity that otherwise would have happened. All tax expenditure programs cost money that could have been used for other programs or could have been returned to tax payers. The economic con-cept of opportunity cost calls for an evaluation of the value of the resources applied to their next best use. The opportunity cost of lost revenues from providing base facilities at less-than-market rental rates, tax expenditures from explicit or implicit subsidies of labor, as well as the expected reduction in social welfare costs, should be considered in a cost-benefit analysis of conversion programs.



Economic Trends, Economic Indicators, and Impacts on State Budgets

Economic Conditions

Once forecasts are accepted and a budget is adopted, it is essential to track both the economic variables and revenues against actual results. The task of tracking economic statistics is complicated at the state level by revisions, which can be large and can even involve a change of direction (reported increases can suddenly be revised to become decreases). In addition, revenue forecasting and analysis staff need to be kept abreast of changing economic conditions at the national, state, and local levels to ensure that they can prepare realistic estimates of future revenue and to understand economic reasons for differences between revenue forecasts and actual revenue collections. Health and welfare departments need the same information for analysis of caseload fluctuations. They also need cost-of-living indices for legislated adjustments to monthly welfare sti-pends.

Economic Variables

Typical economic indicators tracked by analysts include national, state, and local data. National data include the levels and rates of change for gross domestic product, employment, unemployment, income, inflation, consumer price indices, construction, exports, imports, deficits, interest rates, and investment. State data include the levels and rates of change of employment, inflation, consumer price indices (where available), building permits, retail sales (where available), and a variety of state-specific meas-ures of industry employment. Industry output is not measured frequently on the state level. Rather, employment and personal income are key in-dicators of economic activity in specific industries because these are available on a monthly or quarterly basis. (As noted previously, the qual-ity of the employment and income data can be substantially improved by timely use of the ES-202 reports.)



Demographics Demographic analysis is an important factor in budget preparation.

Demographics is the study of the level, composition, and changes to measures of population. State demographic research can be centralized in one department or distributed across departments. Some states prepare their own population estimates, but most accept those made by the fed-eral Bureau of the Census.

Population and Funding Formulas

Population estimates are the basis for the amount of certain federal funds transferred to states for support of various programs. These estimates are also used for the subsequent re-distribution of funds (federal and state) to local governments, primarily for highways, health and welfare expendi-tures, and education.

Other Estimates Beyond overall state population estimates, demographic research can in-clude estimates of city and county populations, average daily attendance in public schools, inter-regional and international migration, and other components of population levels and change. While some of these esti-mates are provided as a service to academic and industry researchers, most of the sub-state estimates are driven by tax redistribution programs.



Global Competition States compete not only with each other but with other countries for new

economic activity. For some states today, international trade is at least as important to the gross state product as interstate trade. It is important to note that trade data are among the weakest economic data commonly used.

Export Data International exports are measured in two ways: by port activity and by point of manufacture. Port activity data measure the dollar volume of ex-ports (and imports) that flow through a port. Point of manufacture data attempt to connect exports from any port with the state where it was manufactured. A simple example of the difference is that port activity data from North Dakota to Canada show large numbers of avocados being ex-ported. Barring greenhouses in North Dakota, these avocados were grown in California. The point of manufacture export data show the state of origin more clearly. Note that services exports (including computer software development, consulting, etc.) are not tracked at all on a state basis.

Policy Decisions Global competition can affect a state’s economy and policy decisions in a variety of ways. Plant location arguments for economic development policies may be based as frequently upon global as interstate compari-sons. Policy questions may be raised concerning the efficacy of opening export-facilitation offices in foreign countries. These offices made state administrators responsible for budgets for expenditures made in foreign currencies and subject to foreign inflation rates -- a complex environment for those unfamiliar with it.



Economic Impact of Federal Tax Policy States can be affected by changes in federal tax law in three primary ways:

marginal tax rate changes, administrative rules changes, and tax expendi-ture changes. In each case, federal changes can be considered preemp-tive in the sense that federal tax policies, rules, and programs seldom take into account the impact on state policies, rules, and programs.

Marginal Rates, Administrative

Conformity, and Tax Expenditure Rules

When federal marginal rates change, state tax revenues will be driven up or down by economic activity encouraged or discouraged by changing tax rates -- if the state makes no corresponding adjustment to its rates. When federal tax administrative rules (like record keeping, reporting, or timing) change, significant pressure will be put on states to conform their rules to federal rules to hold down administrative costs for individuals and companies. For federal tax expenditure rules, the issue of conformity is most pressing. If the state and federal governments have different tax cred-its or subsidy arrangements (different in terms of structure, not percentages or levels), states will usually find that companies will conform to federal law and frustrate attempts by states to conduct entirely independent incen-tive programs.

Corporate Profits Tax

The major federal tax on businesses is the corporate profits tax. Overall, the federal government marginal profits tax rate is 35 percent for large corporations, while for states, marginal rates are between zero and less than 10 percent. Clearly, changes in federal business profits taxes will be much more important to business decision makers than proportionate changes to state taxes.

Personal Income Tax

Federal marginal personal income tax rates peak at 39.6 percent, while states range between zero and less than 10 percent. The extent that state personal income taxes are deducted from household incomes subject to federal tax further reduces the ability of state tax policy to affect household behavior. Thus, if tax policy affects economic behavior, it is federal tax policy for households or businesses. If sufficiently large, differences be-tween state tax rates could affect the location of economic activity.

Capital Gains Tax

Another issue of major significance is the capital gains tax. Over the last twenty years, the rate at which capital gains have been exposed to taxes has been the most volatile federal tax rule. In the early 1980s, the rate was halved and a substantial amount of previously-accumulated capital gains was exposed to taxation. This rush was later accelerated in the 1980s as discussions progressed toward increasing the exposure rate of



capital gains to taxes and ended with implementation of the higher expo-sure rate. State governments that did not conform their exposure rates for capital gains to federal rates experienced significant growth in state per-sonal income tax revenues when federal tax rates fell. This revenue growth for states accelerated towards the end of the “window of opportu-nity” for households. In the largest states, this “revenue windfall” ap-proached $1 billion per year. As the window closed, these states experi-enced revenue shortfalls of similar magnitude. This episode of capital gains taxation is one of the clearest examples of the impact of federal tax law on individual and corporate behavior. The 1997 federal balanced budget agreement calls for a further reduction in the tax on capital gains -- an action that will be felt in state coffers around the country.


Economics and the State Budget Competency Test

Competency Test Q1: Why are economic forecasts made for a state?

Q2: What is the general method of approach to developing economic forecasts?

Q3: Why are economic trends and indicators maintained for a state?

Q4: What economic variables are generally tracked?

Q5: What is demographics?

Q6: How do demographics affect a state’s budget?

Q7: Does the private sector react more to federal or state tax policies? Why?

Q8: What can be expected if states do not change their policies when federal rates change?

Q9: What are the major types and purposes of economic development policies?

Q10: What is meant by the breadth of a policy proposal? How can this affect the efficacy of a proposal?

Q11: How does global competition affect a state’s economy and budget?

Q12: What problems exist for analyzing global competition proposals?

Q13: What does economic conversion mean?

Q14: What does opportunity cost mean? How does this enter into the analysis of an economic conversion proposal?


Module 5: Revenue and Expenditure Analysis and Forecasting

Overview Revenue and expenditure forecasts are integral components of a state’s fiscal planning process. There are numerous methods of generating fore-casts, and these vary in conceptual sophistication and resource require-ments. There are also different times and reasons to do forecasts, such as during budget development periods or as adjustments to unexpected events. Because they are fundamental building blocks of the budget, revenue and expenditure forecasts are often highly political. Their impor-tance in politically-charged decisions heightens the need for clear com-munication on how the forecasts are generated, why errors occur, how forecasts are to be interpreted, and potential risks to current projections. Not all revenues or expenditures need to be forecast. Forecasting efforts should be focused on large, discretionary areas of the budget or activities that have multi-year planning horizons.

WHAT NEEDS TO BE FORECAST? ______________________ 55 ALTERNATIVE FORECASTING TECHNIQUES ___________ 56 ASSESSING REVENUE/EXPENDITURE

ESTIMATING CAPACITY ___________________________ 58 PREPARING AND UPDATING REVENUE AND

EXPENDITURE ESTIMATES _________________________ 59 POLITICAL CONSIDERATIONS _________________________ 60 ANALYZING THE REVENUE MIX AND OPTIONS ________ 62 REVISING REVENUE RATES AND BASES________________ 64 DEVELOPING REFERENCE DOCUMENTS FOR

REVENUES AND EXPENDITURES___________________ 65

Revenue and Expenditure Analysis and Forecasting Concepts


What Needs to be Forecast? When formulating a budget, making an educated guess about future eco-

nomic conditions is certainly desirable. However, knowing future condi-tions is not equally important for all state revenues and expenditures. For example, self-regulating or self-funding areas of the budget will generally have a lesser need for forecasting. Such activities are funded by user fees, are self-supporting, and require less discretion in the budgetary process with regard to allocation of funds.

Budget and Revenue Structures

Most state budgets and state revenue structures have literally hundreds of small items that make a forecast by a central group impractical. Instead, forecasts for these items have to be done by agency personnel for execu-tive or legislative budget staff. On the other hand, large components of state budget and revenue structures, such as general fund revenues and expenditures, represent large pools of revenues and spending. Distribu-tion of these funds requires discrete decisions by the governor and legisla-ture. An estimate of revenues available and/or expenditure demands is essential before funding decisions are made. These large discretionary areas are the most important to forecast. For the general fund, revenues and primary expenditure drivers should be projected. In addition to large, discretionary components of the budget, programs that require multi-year planning beyond the budget horizon should be forecast. For example, capital outlay programs, such as transportation or public education, often require a long-term perspective to aid decision making in the short-term.



Alternative Forecasting Techniques Several types of forecasting techniques are commonly used, including

econometric analysis, time series analysis, and mathematical and ad hoc methods. The technique used depends on data availability and/or the stability of the basic structural relationships underlying the variable to be forecast.

Econometric Analysis

Econometric analysis uses statistical methods to estimate the relationship between the predicted variable and known explanatory variables. If fore-casts of the explanatory variables are available or can be generated, then the primary variable of concern can be forecast. Econometric analysis offers the greatest possibility for explaining a forecast using clear linkages to intuitively appealing basic driving variables. However, proper applica-tion of econometric analysis requires more sophisticated training and data. Current mainframe and PC-based software packages make econo-metric analysis relatively easy to execute.

Time Series Analysis

Time series analysis also uses statistical techniques, but makes projections based on historical patterns in the variable being forecast, without much reference to fundamental driving variables. Compared to econometric analysis, time series methods need less data, usually only one data series (for example, the one you want to predict), and are theoretically simpler. Explanations of a forecast will boil down to extensions of past trends, with no clear linkages to basic driving variables. There are a number of easy-to-use mainframe and PC-based software packages for time series analysis.

Mathematical Methods

Mathematical methods do not use statistical theory or techniques, but use relatively simple mathematical calculations, such as moving averages, to discern trends and patterns for predictive purposes. These methods re-quire relatively little data, no training in statistics, and fairly basic mathe-matical skills. Any spreadsheet software can be used to develop a fore-cast.

Ad Hoc Methods Ad hoc methods refer to any approaches other than the above. Ad hoc methods are usually required when there are not enough data or historical stability for more sophisticated techniques. If the fundamental economic, social, and institutional relationships underlying or driving a particular variable are shifting, more sophisticated techniques often prove inade-quate.

Choosing the Technique

Variables with long histories and stable relationships with respect to eco-nomic, demographic, or policy drivers are very conducive to economet-



Technique ric, time series, and mathematical techniques. Tax and non-tax (for ex-ample, fees) revenue sources often, but not always, fit in this category. As a variable’s history (and data availability) shortens or as basic structural relationships become less stable, econometric and time series analyses become less useful compared to mathematical and ad hoc techniques. Intergovernmental revenues, personal service and entitlement expendi-tures, and debt service expenditures/revenues tend to fall into this cate-gory, though not always. These variables typically are subject to signifi-cant administrative or program changes in response to politically driven shifts in spending priorities, by either the state or federal governments.

General Considerations

The following are a few general considerations about forecasting:

• A variety of forecasting methods are available to the budget analyst. These techniques can usually be used to predict both revenues and expenditures.

• Always remember that forecasts are only educated guesses that carry with them varying degrees of uncertainty. The imprecision of the es-timates should always be communicated to decision makers.

• Even with the most sophisticated methods, subjective judgements on the part of the analyst are usually necessary in developing a projec-tion. Forecasting is as much an art as it is a science.



Assessing Revenue/Expenditure Estimating Capacity

Not surprisingly, forecasting capacity depends on the human and techno-logical resources available, either directly or indirectly. In terms of human resources, good general analytical skills are a minimum requirement. Forecasters should be adept at developing, understanding, and commu-nicating abstract concepts; have good basic math skills; and have enough creativity and flexibility to apply lessons from experience and formal train-ing. An understanding of economic theory and the application of econometric and time series statistical methods are powerful tools and can be learned through formal training. However, some of the most important aspects of forecasting, the subjective elements, can only be learned with experience.

Computer Resources

A forecasting effort can be based in a personal computer environment, a mainframe computer, or some combination of the two. Generally, more skilled forecasters can utilize a wider range of software packages and may need more powerful hardware on which to operate.

In-House vs. Third Party Forecasting

The ability to acquire and maintain relevant data is a second crucial physical resource determining forecasting capacity. Funds should be available on a recurring basis for purchasing needed economic and demographic data. There also needs to be a commitment from state agencies to consistently collect and maintain important data series (for ex-ample, tax receipts information). While the assumption is that reve-nue/expenditure forecasting will be done “in-house” by employees of the state, it may be appropriate in some cases to purchase forecasting services from third parties. For example, many states purchase projections of the U.S. economy from research companies that specialize in such activities.



Preparing and Updating Revenue and Expenditure Estimates

The essential purpose of revenue and expenditure forecasts is to facilitate planning. Consequently, one obvious time to prepare or update a fore-cast is when preparing a budget. Even if previous forecasts are on target at the time, it is often worthwhile to reexamine the outlook. This may entail estimating revenues and/or expenditures under current law assumptions, then doing separate forecasts related to any proposed law changes ac-companying the budget.

Monitoring for Accu-racy

Budget development is the primary reason for updating a forecast, and the primary determinant of the timing of forecast revisions. However, once a forecast has been developed, it is very important to monitor it monthly for accuracy. If actual experience begins to deviate substantially from projec-tions, then it may be prudent to revise the estimates and possibly adjust the budget or other plans accordingly.



Political Considerations Revenue and expenditure forecasts that are used for budget development

and other planning purposes are politically sensitive. At stake are gov-ernmental spending decisions that will affect the interests of a broad array of constituencies.

Errors in Estimates Forecasts are never one hundred percent accurate, so the forecaster must be able to explain to decision makers any errors in the estimates. If deci-sions based on erroneous forecasts must be changed, the reasons for do-ing so must be clear.

Forecasting Current Se rvices Levels

Forecasting several years of expenditures at current service levels can be useful even though current service levels will probably be changed in each budget cycle. Such a forecast provides a good reference point for present budget decisions. However, if such a forecast is done, great care must be taken to ensure that the estimates are not misinterpreted as rec-ommendations that current spending be continued at certain levels.

Interpreting a Fore-cast

Interpretation problems can arise when current services expenditure fore-casts are combined with current law revenue projections. While such outlooks can be useful as a point of reference for predicting possible struc-tural imbalances in a budget, predicted structural surpluses or deficits can be easily interpreted as a prediction of what will actually happen. Misin-terpretations such as this can happen if decision makers lose sight of the fact that annual budgets do not operate on “automatic pilot” and are usu-ally forced into balance.

Dynamic Modeling With respect to estimates of the impacts of law changes, it is not uncom-mon for policy makers to have preconceptions about how the numbers should look. It is also not uncommon for the estimates to be different from those preconceptions once a careful, objective analysis is done. This situation has given rise in recent years to the use of “dynamic modeling,” which attempts to more fully account for economic and other feedback arising from specific policy changes. In doing so, the ultimate impacts of a policy change are less extreme than might otherwise be estimated. In theory, dynamic modeling is a more complete approach to forecasting. In practice, it is far more complex and expensive to do and often does not drastically change the ultimate outcome of the estimate. These considera-tions make it very important to explicitly state the estimate assumptions and methods.



Long Term Trends and Potential Cycles

Real world trends often change and take off in undesirable directions. Most notably, national and state economies experience business cycles that are potentially very disruptive to state revenue and spending flows. Sight of this fact is often lost in the immediacy of political decision making. For this reason it is useful to produce forecasts that show both the long-term trend and the potential cycles of revenues and expenditures. A cycle forecast, communication of forecast risks, and continual monitoring of current revenue and expenditure patterns are crucial to alerting decision makers that an economic turning point is near and that preparations should be made for adjusting spending or revenue policy.



Analyzing the Revenue Mix and Options Revenue decisions include: 1) technical estimates of how much income

will be available in a future period, and 2) policy decisions about the level and type of taxation. Political concerns are always an important element in determining the shape of a state’s revenue structure. However, there are also non-political aspects of taxes and fees that are often important to decision makers. The following criteria should be part of considerations pertaining to revenue structures and tax policy.

Tax Incidence First, tax incidence refers to who ultimately bears the burden of a particu-lar tax. Many times the party that bears the burden is not the party that remits the revenues to the state. For example, taxes that are paid by busi-nesses are passed on to either the consumer or the stockholder/owner, so the incidence of some business taxes may not be entirely on businesses. Common tax incidence concerns are whether or not a tax falls dispropor-tionately on a particular income group or whether a tax is born by resi-dents or non-residents of a state.

Equity A second tax policy criterion is equity. Are taxpayers with similar eco-nomic circumstances treated equally by the tax laws? Will tax breaks be granted, and if so, to whom, and for what purpose? Equity considerations may relate to interstate or intrastate economic competitive positions.

Stability Stability of the revenue source is a third criterion. A stable revenue source is easier to forecast and facilitates planning of governmental operations. Stable sources include individual income and general sales taxes. Less stable are corporate taxes which are subject to wide fluctuations.

Revenue Yield Fourth, revenue yield is almost always significant. Does a revenue source or structure yield a large amount of revenue at a low rate of assessment? Another way of saying this is, does the revenue source have a broad base? If so, it may be a good major component of a state’s revenue structure.

Sufficiency Fifth, the sufficiency of a revenue source or structure refers to the ability to keep pace with changing expenditure demands for either the overall budget or particular program areas. This can be especially important in rapidly growing states. If a state’s revenue structure is insufficient to meet critical expenditure demands, there is constant pressure to change the tax structure.

Simplicity Finally, but not least, is simplicity. A simple, uncomplicated tax is easy for taxpayers to understand and comply with and for the government to ad-minister. Simplicity also lowers the private and public sector costs of hav-



ing a tax “on the books.”

Comparisons Across States

Analyzing a state’s revenue mix and options can be aided by assessing what is “normal” or average among other states. Such comparisons can be made in terms of tax rates for specific taxes. Additionally, revenues per capita or per $1000 of income for specific sources or for all revenues combined can be compared. These kinds of comparisons, for example, can give some idea as to a state’s relative economic competitive position, but only to the extent that taxes are important to the location of economic activity.



Revising Revenue Rates and Bases There is sometimes a desire to revise revenue bases and rates. This may

be in response to political considerations, to improve the revenue struc-ture in terms of the policy criteria discussed above, or a combination of the two. A worthwhile exercise is to periodically evaluate whether or not current taxes and fees are meeting certain policy criteria. If not, changes can be proposed.

Estimating Problems

When revising revenue rates and bases, special estimating problems can arise. In particular, useful data are often sparse or non-existent. This is especially true in the case of tax base changes. Scarcity of data in turn requires simplistic, assumption-laden (i.e., subjective) estimation tech-niques. Consequently, the revenue estimates can be very unreliable. Fur-ther, these issues can be very sensitive politically, increasing the impor-tance of a clear statement of assumptions and methods.

Criteria for an Opti-mal Revenue Fore-casting Process

The National Association of State Budget Officers (NASBO), in conjunc-tion with the Federation of Tax Administrators, has identified the following criteria for a good revenue forecasting process: 1) governors should un-derstand and participate directly in forecast development, 2) the forecast-ing process should utilize the expertise of academic and business econo-mists in developing the state forecast, 3) governors should produce a monthly report on revenue collections and an annual report on the vari-ance between estimates and collections, 4) experts should maintain flexi-bility to respond to economic changes by revising the revenue estimates, and 5) governors should share revenue-related information with the pub-lic throughout the fiscal year.



Developing Reference Documents for Revenues and Expenditures

Reference documents relating to the revenue structure and expenditure patterns can be very useful to analysts and decision makers for under-standing the current situation and considering possible changes. There are several ideal elements of such documents.

Elements of Refe r-ence Documents

First, a descriptive and quantitative historical perspective should be in-cluded. For major revenue sources or for major expenditure catego-ries/programs, this means several years of actual collections/expenditures compared with forecasts and a description of significant changes in tax rate/base or program structure. Second, a thorough description of the cur-rent base and rate of major revenue sources and the current elements of major spending programs is needed. Third, a forward-looking perspective will augment the history. Forecasts of the major revenue sources and ex-penditure categories should be provided. Fourth, a “menu” of estimates of the impact of potential structural changes rounds out the list of ideal elements. A set of manuals or reports to complement the above would contain history and forecasts of the main social, economic, and demo-graphic variables that drive revenues and expenditures.


Revenue and Expenditure Analysis and Forecasting Competency Test

Competency Test

Q1: Why is it important for a budget analyst to monitor forecasts of gen-eral fund revenues?

Q2: Which budget expenditures should be forecast, and why?

Q3: What are the primary forecasting techniques and when should each be used?

Q4: What are some important analytical skills necessary to do revenue or expenditure estimating?

Q5: What physical resources are required to do revenue or expenditure estimating?

Q6: When should revenue and expenditure estimates be updated?

Q7: How can the analyst prepare decision makers for unexpected devia-tions from forecasts?

Q8: Why is it important to be able to clearly explain the assumptions or origins of estimates of the impacts of law changes?

Q9: What are the primary criteria for judging a state’s revenue mix and options?

Q10: What are some ideal elements of reference documents relating to a state’s revenue and expenditure patterns?

Q11: What are the nationally-recognized criteria of a good revenue fore-casting process?


Module 6: Analytical Methods for Budget Analysis

Overview Budget analysts must be prepared to assess a range of issues using a vari-ety of methods. Although there is no standard bag of tricks that promises to address every analytical challenge faced by the analyst, experience over the years and across the states points to some approaches and meth-ods that have repeatedly proven useful. This module presents sixteen analytic approaches used by budget analysts in a typical state budget of-fice.

ONGOING AGENCY REVIEW____________________________ 68 POLICY ANALYSIS: ASSESSING CLAIMS ABOUT

NEEDS AND PROBLEMS ____________________________ 69 ASSESSING THE POLITICAL IMPLICATIONS OF

BUDGET ACTIONS _________________________________ 71 ANALYZING PROGRAM AND SERVICE DELIVERY

ALTERNATIVES ____________________________________ 72 MAKING COMPARISONS TO OTHER STATES _________ 74 ANALYZING HISTORICAL SPENDING PATTERNS ______ 75 EXAMINING PROPOSALS FOR NEW SPENDING_________ 77 USING UNIT-COST ANALYSIS AS A TOOL _____________ 79 COSTING OUT PERSONNEL SERVICES _________________ 80 COSTING OUT NONPERSONNEL SERVICES ____________ 81 SIZING UP THE IMPLICATIONS OF CAPITAL

PROPOSALS ON OPERATING BUDGETS ____________ 82 ASSESSING EXPENDITURE FORECASTS ________________ 83 FINDING FINANCING ALTERNATIVES _________________ 84 ANALYZING COSTS AND BENEFITS____________________ 85 ANALYZING ORGANIZATION STRUCTURE

AND STAFFING ____________________________________ 86 DETERMINING THE FISCAL IMPACTS

OF LEGISLATION __________________________________ 88

Analytical Methods for Budget Analysis Concepts


Ongoing Agency Review One of the budget analyst’s most valuable resources is basic knowledge

about assigned agencies, the programs they administer, and the services they provide. In addition to being useful for budget analysis, this knowl-edge is also important for 1) responding to questions from the governor’s office, other state agencies, legislators, and the public, 2) assisting and educating key executive branch actors during the transition from one gu-bernatorial administration to the next, and 3) providing relevant informa-tion when government reorganization and restructuring issues arise. Ana-lysts should therefore monitor their agencies on a regular basis.

Institutional Knowledge

A budget analyst who prepares or reviews budget proposals and legisla-tion needs substantial knowledge of the agency’s history, mission, opera-tion, and statutory responsibilities. Knowledge of agency history is com-monly gained through review of available documents, such as audit re-ports, program evaluation studies, and newspapers and interviews with knowledgeable individuals. These individuals may work for the agency or be external to the agency, such as legislative budget analysts or exter-nal auditors. The statutory responsibilities of an agency are ascertained through review and analysis of the state constitution, the state code of laws, acts of the state legislature, review of court decisions, and review of state attorney general opinions.

Agency Mandates

Periodic assessment of agency mandates is a basic and ongoing responsi-bility of a good budget analyst. The assessment would involve critically examining the implications of state and federal court decisions, laws, rul-ings, and regulations. This analysis is very important during development of the governor’s budget. In analyzing mandates, analysts need to ques-tion whether agencies are interpreting mandates correctly; if alternate in-terpretations are allowable and desirable; if mandates are in conflict with current state policies; the extent of the conflict (policy and fiscal); changes needed to comply; and the implications of not following the mandate.

Information Sources

Important sources of information on federal government policies and mandates and on court decisions include national associations such as the National Center for State Courts, National Governors’ Association, Na-tional Association of State Budget Officers, Council of State Governments, National Conference of State Legislatures, as well as publications such as Governors’ Bulletin, State Budget and Tax News, and State Policy Re-ports.



Policy Analysis: Assessing Claims About Needs and Problems

Budget analysts often need the results of a policy analysis for decision making during the budget process. Policy analysis can be viewed as a process of systematically questioning what the government should do, if anything, in response to a specific issue, need, or problem.

Policy Analysis Steps Policy analysis usually requires information collected through interviews, surveys, review of records, and other research methods. After data is gathered, quantitative and qualitative analysis is conducted and results are presented to decision makers. Good policy analysis usually consists of the following steps:

1. Define the problem. What is the issue? Why is it a problem? Who is affected? How are they affected? To what extent is it a problem? Needs should be examined in terms of whether they are supported by normative, comparative data, or whether they are simply expressed needs.

2. Determine the current policy. What are the statutory requirements, constitutional provisions, regulations, executive orders, court orders, federal mandates, policies, procedures, and other requirements related to the problem? What is currently being done? What resources are al-located? What are the results of programs and services that address the problem?

3. Research the issue. What do the people affected by the problem want? What is the current thinking of experts, based on normative or comparative data? To what extent are other states, public and private entities, and nonprofit organizations successfully dealing with the problem.

4. Develop alternatives or options. The range of alternatives usually in-cludes maintaining the status quo and letting the private sector resolve the problem.

5. Assess each alternative. What are the advantages and disadvantages? What are the costs and benefits to both the public and private sectors? Who supports and who opposes each alternative? How high a priority is this for the governor, legislators, and taxpayers? How would it be implemented? What resources are needed to implement each alterna-tive?



Alternatives for Consideration

This analytic approach is appropriate for analyzing controversial issues and initiatives because it provides information important to decision mak-ers about an array of alternatives for consideration. Because it requires considerable time and resources, budget analysts do not often conduct full-scale policy analysis. More often, they summarize an analysis pre-pared by an outside source, and provide an outline of the findings and conclusions for decision makers.



Assessing the Political Implications of Budget Actions

Maintaining attention to political implications of budget and legislation proposals is an on-going responsibility of the budget analyst. When deci-sion makers act on a recommendation, they also want to know the range of responses that can be expected as a result of their action.

To accurately assess the political implications of budget actions, budget proposals must be carefully studied to determine if the action is related to an existing political issue or situation and what the direct or indirect effects might be. These effects could include partisan conflict, legisla-ture/administration conflict, intergovernmental conflict, and personality issues.

Political Environment

Maintaining awareness of political issues and personalities and being sen-sitive to what effect the agency proposal or other issue being analyzed will have on the political environment is critical. Toward this end, analysts must stay well informed about the political environment surrounding their areas of responsibility. This involves analyst attention to legislative action and comments, reading extensively (for example, newspapers, related trade publications, and local government and interest group newsletters) and talking regularly with agency and legislative staff about programs and issues. Line agency staff usually have the most direct knowledge of the political background and implications of budgetary and legislation pro-posals.

Keeping Information in Perspective

Understanding political implications is important, but an analyst should not let the political environment affect the conclusion of the analysis. While it is appropriate to mention in the analysis that a preferred policy will negatively impact, for example, the district of the Speaker of the House, it is not appropriate for this fact to dictate the outcome of the analysis.



Analyzing Program and Service Delivery Alternatives

Analyzing program and service delivery alternatives involves actively in-vestigating and evaluating options for providing and financing public goods and services. This analysis provides policy and decision makers with data needed to determine if more effective or efficient means can be employed to provide services to customers, assuming that program goals and objectives are not in dispute.

Assessing the Alternatives

This type of analysis is similar to policy analysis in that alternatives are identified and the pros, cons, and other related considerations for each alternative are assessed. An assessment of alternatives should address the following questions:

• Is this activity in accord with the mission of this agency?

• Is this a mandated program?

• Is this the appropriate agency to engage in this activity?

• Is this function available from other governmental or nongovernmental entities?

• Are there policies established by law, regulation, or the constitution which govern how this program or service is to be delivered?

• What resources are required (staff, equipment, regional offices, auto-mated systems, etc.) and do they already exist in the agency?

• Do other entities carry out similar functions and already have the re-quired resources in place?

• Who are the customers?

• Could automation be introduced to improve efficiency or effective-ness?

• How do other states address the need for this service?

Understanding the Programs

This approach can be used when analyzing current or proposed operat-ing or capital programs, especially when program expansion, privatiza-tion, elimination, or transfer of a program to another entity is being con-sidered. Analyzing program and service delivery alternatives is particu-larly necessary when initiatives are advanced which would change the nature, scope, cost, or customer base of the program. For a budget ana-



lyst to be successful in program analysis, a comprehensive understanding of how programs and services work is crucial. Toward this end, a budget analyst should devote a significant amount of time to ongoing agency re-view -- visiting programs and talking to clients and program directors.



Making Comparisons to Other States

This type of analysis can answer questions about a state’s policies, pro-grams, organization, and financing in relation to national norms or to other states and groups of states.

Basic Principles Making comparisons with other states is a relatively easy process. The fol-lowing are some basic principles to follow:

1. Know the resources available (as well as the reliability of the data) in the areas of population, economics, government finance, natural re-sources, education, health, public safety, transportation, and social ser-vices. Keep in mind that unique state mandates, organizational structures and staffing levels, state/local assignment of responsibility, extent of priva-tization, and other factors can significantly affect the data you collect and its relevance to your analysis.

2. Determine the parameters or the basis for selecting other states or groups of states for making the comparison.

3. Make valid conclusions about the significance of time series and com-parative data considering any anomalies or data reporting issues which could affect the comparison.

Information Sources

Principal sources of comparative information include:

• US Bureau of the Census’ Census of Governments, Government Fi-nance Series

• State Policy Reports and State Budget and Finance

• State Fact Finder (State Policy Research Inc.)

• Council of State Governments

• National Association of State Budget Officers

• Direct requests to other states for comparative information.

Gaining Perspective

Comparative analysis is a technique that is appropriate for confirming as-sertions that a policy issue is substantial or that the state overfunds or un-derfunds a particular area. It can quickly and economically bring an issue into perspective in the absence of more in-depth policy, program, or fi-nancial analysis. Important executive and legislative decisions are often made based on this type of analysis.



Analyzing Historical Spending Patterns

Understanding and analyzing historical spending patterns of state agen-cies and programs is one of the basic functions performed by budget ana-lysts. Knowledge about the agency’s spending patterns will help an ana-lyst assess whether programs are being operated efficiently and effectively and also strengthen an analyst’s understanding of the entities or clients receiving funds or services from the agency.

Relating Funds and Services

The analysis of historical spending patterns focuses on the relationship between expenditures and the agency’s mission, services, and customers. These relationships are identified through supporting documentation and narrative that describe how programs are operated and services are deliv-ered. Such information should clearly identify the customer base and the expected outcomes or results of the services. The information should connect the relationship between the funds spent and the services pro-vided. The basic question is: what does it take in the way of funds and personnel to ensure an agency meets the needs of its customers?

Questions to Consider

In reviewing historical spending patterns, a series of questions should be routinely considered. This approach is appropriate for any analysis that involves the allocation of funds for a specific program or service. Portions of this type of analysis may also be applied to the review of new programs.

• Is spending in line with the amounts budgeted for a particular activity or function?

• Are there discrepancies that recur from one year to the next?

• How has spending changed over time? Are these changes attributable to known events?

• Do the activities represented in the expenditures fit within the mission of the agency?

• Are activities represented that were never authorized?

• Is an activity staff intensive? Do the expenditures match the staffing levels that exist?

• Are the position allocations consistent with the activities of the agency and are they funded at the proper amounts and from the proper fund sources?

• Are positions fully funded or do they reflect adjustments for turnover and vacancies?



• Are nongeneral fund appropriations consistent with revenue forecasts?

• Are the revenue forecasts consistent with historical patterns?

• Are the expenditure details appropriate for the activity or program?

• Has the agency experienced funding shortfalls in any areas?

• What statutory or regulatory changes have occurred and how will they affect the agency’s mission, activities, and spending patterns?

• How many customers are being served and will this number change?

• Is a more effective and efficient approach to delivering services avail-able?

• Has the customer base changed?

• Have the services to this customer base changed? Should they?

• Are the assumptions used to create past funding levels still valid?

• Are mandated services, activities, or programs appropriately funded?

• Do past expenditures reflect any major one-time items?

• Have efficiency measures, such as the consolidation of offices, privati-zation, or the introduction of automation, had the desired/promised impact on program expenditures?



Examining Proposals for New Spending

This approach is similar to the analysis of historical spending patterns, but there is an important difference -- historical data is not available. This ap-proach involves critically examining requests from agencies for new fund-ing. The agencies make such requests based on a desire to implement new initiatives or the need to supplement existing operations. Critical ex-amination involves assessing whether such proposals are necessary to conform with the law, to serve the public, and to address effective and ef-ficient program operations.

Criteria to Consider In analyzing new spending proposals, analysts should determine whether the proposal:

• Provides a valuable service to the public,

• Is critical to the operation of state government,

• Addresses important legal issues (for example, state or federal man-dates) for which the state must make provisions, or

• Is one of the governor’s policy priorities.

If the proposal meets any of the criteria listed above, then new spending may be warranted.

Types of Justification

Analysts should be proactive in requesting justification from the agency and should request the following types of justification:

• Workload measures (for example, number of restaurants to be in-spected by one health/safety inspector per year) to justify staff addi-tions,

• Performance measurement data (for example, number of students re-ceiving computer training) to assess outputs,

• An explanation of the methodology used to calculate the new spend-ing needs,

• An explanation of why the agency cannot absorb the cost within exist-ing resources,

• A projection of the rate of growth in the future costs.

Assessing and Verifying Information

The analyst also should question how other states may structure similar program operations and if non-state revenues (for example, federal dollars) might be available to leverage state funds. The analyst should recalculate all cost figures submitted by an agency and verify agency figures with out-



side experts, if necessary. If, after receiving agency information and per-forming independent research the analyst is unable to write his/her own justification for new spending, then most likely, the proposal cannot be justified.

Times When Useful During development of the governor’s budget, this approach should be used to evaluate the merits of agency proposals for new spending. This approach would also be used at any time during the year when a request for emergency spending is received.



Using Unit-Cost Analysis as a Tool

Unit cost analysis is a useful tool to verify costs and compare the cost of goods or services. Usually the common unit of measurement for such analysis is the dollar. Often, the “end product” produced from unit cost analysis is quite different from the initial assumption.

Framework for Unit Cost Analysis

Unit cost analysis is especially useful when assessing alternatives. It af-fords the opportunity to explore and chart the financial advantages and disadvantages of an intended action. When conducting such analysis, the analyst typically:

• Reviews expenditure trend data over a given time period,

• Utilizes unit cost data (for example, average costs and cost per unit of output),

• Looks at comparative information, and

• Forecasts outcomes.

Performance Outcomes

Unit cost analysis can also be a tool for determining performance out-comes by showing how much can be achieved for a given cost. Evidence from the analysis could suggest efficiency reductions in both personnel and equipment needs. For example, in an agency where the existing pho-tocopying equipment is old, requires costly maintenance, and needs staff oversight during peak production periods, the purchase or lease of faster and “user-friendly” copiers would likely:

• Increase productivity due to less down-time,

• Provide opportunities for equipment consolidation, thus generating savings through the elimination of costly maintenance, and

• Eliminate the need for attendants during peak production time.

Assessing Funding Requests

Unit cost analysis exposes details that would not otherwise surface. It can be most beneficial in assessing agency funding requests to purchase or lease equipment and in examining various options. Purchasing or leasing photocopiers, personal computers and related maintenance are examples of where unit cost analysis can be useful to the analyst in rendering rec-ommendations.



Costing Out Personnel Services

Costing out personnel services is a basic function of the budget analyst. It is commonly accomplished with one of two principal techniques. The first technique involves computing an average salary for the organization unit, program, or agency. The second technique involves utilizing a de-tailed compensation plan that lists the pay rates of agency positions by salary grade and step.

Calculating Average Salary

Average salary is computed by dividing the most recent expenditures for salaries by the number of filled positions during the same time period. Whenever possible, this average should be computed based on the same or a comparable unit of organization. For example, if calculating salaries for a data processing division, it is best to use the average salary for that division in the past or for a comparable organizational unit, rather than the salary average for the entire agency. The total personnel services cost is determined by multiplying the salary average by the total number of po-sitions and then multiplying the result by the appropriate fringe benefit fac-tor, plus an adjustment for scheduled salary increases.

Compensation Plan Technique

The compensation plan technique relies on a detailed compensation plan for the state or agency. The plan lists the rate of pay for each position in the agency and indicates the appropriate fringe benefit costs. For new po-sitions, if the agency does not provide the actual salaries of the most re-cent hires in the pertinent job classification, the appropriate strategy is to use the first step of the pay grade, unless the agency demonstrates it can-not hire qualified individuals at this salary level.

Assessing the Techniques

One of the two described techniques is common to the analysis of most budget proposals. The average salary technique is best used to analyze the cost of positions in a current or past budget, since it permits an esti-mate of the cost of vacant positions. The compensation plan technique is best when costing out entry level salaries for new positions or filled posi-tions.



Costing Out Nonpersonnel Services

This analytic approach can be described with a fairly standard framework for arriving at or verifying the estimated requirements for program costs other than salaries and fringe benefits.

Framework for Calculation

1. Cost Categories - Identify the normal categories of nonpersonnel ser-vices costs related to the program (for example, telecommunications, equipment, office space, contractual services).

2. Cost Drivers -For each cost category, determine whether the major cost driver can be identified (for example, client caseload, service re-quests, employee payroll).

3. Cost Driver Units - If the cost driver can be identified, determine the number of cost driver units anticipated for the program (for example, 2,000 clients, 10,000 information requests, 50 employees).

4. Unit Cost - Using historic or actual expenditure information from simi-lar programs, develop a per unit cost estimate for each cost driver (for example, $10 travel expense/client; $2 printing and office supply cost/information request; or $2,000 in office rent/employee).

5. One-Time or Continuing Cost - Determine whether any of the cost categories includes a one-time start-up or other unusual temporary program cost.

6. For each category of cost calculate:

Cost Driver Units X Cost per Unit X Life of Program =

(if continuing cost) Anticipated Cost

2,000 Clients $10 Travel Expense 2 Year Program $40,000 Travel Cost

10,000 Info Requests $2 Printing/supplies One-time cost $20,000 Printing & Supply Cost

7. For cost categories in which the cost driver is not identifiable, use his-torical or similar program expenditure information to estimate the cost as a percentage of some other related, known cost. For example, building maintenance and cleaning for similar office space tend to av-erage 10 percent of total rental charges.

This type of analysis is important for developing and verifying nonperson-nel services costs estimates for new or existing programs that have identifi-able workload measures and categories of cost.



Sizing Up the Implications of Capital Proposals on Operating Budgets

There are a number of factors to consider when analyzing how a capital budget proposal may affect an agency’s operating budget.

Operating and Maintenance Costs

Determining funding for existing buildings usually involves the use of prior year expenditures and other budgetary factors (salary regrades, one-time costs, inflation, etc.). To calculate the operation and maintenance costs to support a new building, the analyst will often base the analysis on some type of formula which includes total square footage or costs in-curred for similar facilities.

Personnel Identifying personnel-rated costs for a new building is a three step process. First, funding guidelines are derived by dividing existing assignable square footage in established buildings by the number of full-time equivalent physical plant positions. Second, this ratio is divided into the assignable square footage for the new building to yield the number of additional FTEs (full-time equivalents) needed to operate and maintain the new building. Third, calculation of personnel costs is based on the average employee salary, including benefits (generally based on a state compensation plan), multiplied by the required number of FTEs.

Nonpersonnel Services

The nonpersonnel services (utilities, property insurance, etc.) are typically based upon the historical cost of energy, supplies, equipment, and con-tractual services incurred by each agency or institution. In addition, in-dustry standards, staffing formulas, and review of similar facilities may as-sist in the determination of non-personnel operating costs required to sup-port a new facility.

New vs. Existing Facility

This approach is appropriate when trying to determine the operating costs associated with the construction of a new facility. Assessing historical op-erating costs can also help to determine if renovation of an existing facility (for example, to make mechanical or energy conservation improvements) will yield savings.



Assessing Expenditure Forecasts

Budget analysts do not often conduct formal expenditure forecasts. How-ever, they are often called on to examine such forecasts as part of their budget analysis. Forecasting expenditures is usually performed by using one of three methods: 1) exponential smoothing, 2) time series analysis or 3) regression analysis. The first two forecasting methods use only previous observations on the item to be forecast. The third uses information about other variables that are thought to have an affect on the item for which one desires a forecast.

Forecasting Methods

• Exponential smoothing is a sophisticated form of moving average that weights recent observations more than older observations and may take into account trends and seasonality in the historical data.

• Time series analysis includes exponential smoothing but also takes into account persistent temporal patterns in the data such as affects that take time to have their full impact or forecast errors in one period that are related to forecast errors in another period.

• Regression analysis is different from these other techniques in that it measures the relationship between the forecast variable and other variables. Then, expected changes in the predictor variables are used to calculate expected future values of the forecast variable.

Time series is preferred to exponential smoothing, mainly because it takes into consideration several additional factors not addressed by exponential smoothing. However, exponential smoothing is more appropriate in cases where there are insufficient data for time-series analysis, which re-quires a minimum of about sixty observations on the forecast variable. Regression analysis can produce the best forecasts, but it requires both the availability of data and good forecasts on other variables that are related to the forecast variable.



Finding Financing Alternatives

In an environment where programs compete for scarce resources, the abil-ity to find innovative financing alternatives can determine the success or failure of implementing an activity. This approach addresses steps helpful in finding financing alternatives.

Framework for Analyzing and

Reviewing Alternatives

The following steps are typically taken:

1. Analyze the activity to identify the activity’s beneficiaries, regulated entities, or “instigators” of the opportunity, need or problem addressed by the activity.

2. Analyze the activity to determine the true costs and to whom the costs belong.

3. Review how other state agencies, governments, and the nonprofit and private sectors fund the activity.

4. Review the revenue source codes in the state chart of accounts for ideas on possible funding alternatives (for example, general fund reve-nues, dedicated fees, or intergovernmental transfers, including grants and donations).

5. Determine the following characteristics of potential fund sources:

• revenue generating potential,

• ease and cost of administration and the appropriate level,

• reliability of the revenue stream,

• incentive effects.

6. Consider non-funding solutions such as privatization, outsourcing, re-ciprocal agreements, private sector market incentives, and volunteer-ism.

7. Determine the funding mechanism (for example, direct appropriation, pay-as-you-go or sinking fund, and debt financing).

8. If fees or taxes are the source, does the activity require seed money or a loan to cover the initial start-up?

This technique is appropriate whenever budget analysts are looking for fund sources for a new or expanded activity to support critical needs or to implement a governor’s priority. Such analysis can also provide for a new funding mechanism for current activities.



Analyzing Costs and Benefits

Cost-benefit analysis is a traditional method of determining the preferred policy choice in a world of limited resources by quantifying the advan-tages and disadvantages associated with each possible alternative.

Framework for Cost-Benefit Analysis

Cost-benefit analysis begins by outlining the current state of affairs and the desired end-result of a particular situation. Analysts then compose a list of all possible alternatives which might be pursued. For each alternative, the costs and benefits, both tangible and intangible are estimated and the methodology and assumptions used to arrive at those estimates are dis-closed. A choice is then made based on a comparison of both the total benefits and costs as well as the ratio of benefits to costs for each alterna-tive.

Applying Cost-Benefit Analysis

Cost-benefit analysis can be applied to many situations, but it is most use-ful where the costs and benefits are set out in financial terms, since the fungible, quantifiable nature of money lends itself to relatively easy com-parison. Cost-benefit analysis is less useful when applied to situations that are difficult to quantify, such as the benefits derived from preserving an endangered species, or the “inconvenience” cost of buckling one’s seat belt. In such situations cost-benefit analysis may not produce a clearly preferred alternative, but it may reduce an unwieldy problem to more manageable, though still not quantifiable, components.



Analyzing Organization Structure and Staffing

This analytic approach is appropriate for analyzing the impact of changes in workload, changes in the agency’s responsibilities, changes in the agency’s mission, consolidation of two or more programs or agencies, and budget reductions and downsizing. It can also be used when manage-ment problems are identified.

Framework for Analyzing Structure

and Staffing

The analysis of organization structure and staffing involves many standard analytic techniques. It involves determining the availability of information to be collected; collecting information from organization charts, personnel records, interviews, surveys, observation, and other research methods; conducting analysis; synthesizing information; and presenting findings to decision makers. A comprehensive analysis can consist of the following:

• What are the objectives of the analysis or what is the problem? These can include changes in workload, responsibilities or mission; consoli-dation of programs or agencies; budget reductions and downsizing; or management problems.

• What is the current staffing pattern and organizational structure? How many staff are employed in the various positions? How do they spend their time? What is the span of control for each activity? What is the chain of command? How many levels of hierarchy are there? What is the role of any regional and local offices? Is decision-making central-ized or decentralized? Is authority consistent with responsibility?

• What are the agency’s mandated responsibilities and priorities (includ-ing statutory provisions, federal requirements, executive orders, and other requirements)? Is the organizational structure aligned to reflect these requirements and priorities?

• What is the workload? What workload measures are used to deter-mine staffing needs? What processes and procedures are used to carry out the work? Is the work being accomplished effectively and effi-ciently? To what extent are the customers and constituent groups satis-fied with the quality, effectiveness, and timeliness of the agencies pro-grams and services?

• Are there opportunities to accomplish work more efficiently or effec-tively? What technology is available and how is it utilized? What



training and staff development opportunities are regularly provided to staff?

• What is the turnover and vacancy rate? What is the compensation structure? Are there opportunities for promotion? What is the organ-izational culture? Is it congruent with management expectations?

• Is the problem the organizational structure, staffing level, or manage-ment shortcomings?

• What resources are needed, or what savings can be generated, if changes in the organizational structure and staffing are made (includ-ing salaries and benefits, office space, technology, and training)? What activities can be reprioritized or eliminated, or to what extent is lower quality work acceptable?

Information from Others

Budget analysts do not often conduct detailed analyses of organization structure and staffing. Normally an analyst will use a portion of this ap-proach to meet a specific need or use an analysis conducted by the agency itself or another external party to support decision making.



Determining the Fiscal Impacts of Legislation

The states vary substantially in their approaches to fiscal impact analysis - the examination of proposed legislation to determine whether it would affect revenues, expenditures, or appropriations. In addition to account-ing for the direct impacts of legislative proposals, this analysis can also in-volve identifying indirect effects the proposal may have on other entities or revenue/funding streams.

Executive and Legislative Offices

Where the state legislature has extensive fiscal analysis capability, the ex-ecutive and legislative branches may run parallel analytic systems. The executive system may be designed to serve only the governor and his/her policy staff. In some states, the executive budget agency reviews for the governor only legislation proposed for his sponsorship and those bills that have been passed by the legislature, with a view to the governor’s ap-proval/veto decisions.

Governor’s Office Analysis

In states where the governor’s budget office analyzes the fiscal impact of all proposed legislation and has statutory responsibility to centrally man-age the review of every bill for fiscal impact, it also may compose policy-oriented bill summaries. Formal fiscal impact statements are written within several days of receipt of the printed bill and are distributed to the legislature, including finance and appropriations committees. The gover-nor, cabinet secretaries, and legislative committees often call for informa-tion on fiscal impact statements.

Agencies Provide Information

In some states, affected executive agencies provide information and fiscal estimates to the state budget office. Then, the budget staff may discuss the estimates with multiple agencies regarding their respective interpretations and estimates. The budget office staff issues the final estimate based on their independent judgment. Line agencies may be prohibited from issu-ing competing fiscal analyses. Budget office staff may revise fiscal impact statements at every revision of the bill.

Unanticipated Budgetary Effects

Some type of fiscal impact analysis related to pending legislation is neces-sary to avoid unanticipated budgetary effects of new laws. The locus, ex-tent, scope, and coordination of the fiscal analysis function varies among states. Most commonly, for bills determined to have a fiscal impact, the state budget office coordinates the analytic process and issues an authori-tative formal analysis.


Analytical Methods for Budget Analysis Competency Test

Competency Test Q1: What information does a newly assigned budget analyst need to un-

derstand the history, mission, legal requirements, and mandates as-sociated with an agency?

Q2: You have just received information that the state Supreme Court ruled in favor of federal retirees, that federal pensions are not legally taxable by the state. What information do you need to understand this ruling and what would you need to know to determine its finan-cial implications for the state?

Q3: What kinds of information do you typically need to conduct policy analysis?

Q4: The state agency responsible for disaster response and recovery pro-poses that the state fund hazard mitigation projects, a traditional lo-cal responsibility. More projects would be eligible for this funding than the agency request would cover. How would you go about identifying the issues and the political implications of this proposal?

Q5: What types of information does an analyst need to determine viable program or service delivery alternatives? Give some examples.

Q6: What steps would you take to analyze the information collected?

Q7: What factors would you consider in creating a list of states with which to make comparisons about state policies and finances and where would you go to obtain the data?

Q8: What information should be included in a budget submission?

Q9: What steps would you take to analyze an approved budget?

Q10: What is the value of variance and trend analysis? What does it tell you?

Q11: You have received a $10 million request to fund a new vehicle emissions program. In order for you to assess the proposal, identify the most important questions you would require the agency to an-swer.

Q12: An agency with a tight budget recently had a power surge that de-stroyed most of its personal computers, none of which were covered



by insurance. Describe how you would determine the most cost ef-ficient means of replacing the computers.

Q13: An agency head contends she has insufficient funds in her current budget to cover payroll. How would you confirm or refute this claim?

Q14: Your assigned agency has requested five new positions to initiate a quality assurance unit. How would you determine the cost of the five new positions?

Q15: Develop a two year nonpersonnel services cost estimate in the fol-lowing three categories for a five person payroll processing unit serv-ing a 5,000 employee agency. The following information is based on information from similar operational units.

1. Computer equipment at $3,000 per payroll processing em-ployee.

2. Office space at 100 square feet per payroll processing em-ployee at $10 per square foot.

3. Computer operations charges at 10 cents per bimonthly pay-check processed.

Q16: An agency requests a capital project for major improvements to its heating and cooling systems. How would you assess the impact on the operating budget, if any?

Q17: An agency requests a capital project for construction of a new in-structional facility. How would you go about calculating the addi-tional operating and maintenance costs?

Q18: For a given forecast variable, how do you determine the appropriate forecasting approach?

Q19: The state forestry association seeks a general fund appropriation to increase personnel and equipment for forest fire suppression. Their campaign is based on preserving forest resources for future genera-tions. What alternatives would you explore to finance such a pro-posal?

Q20: The governor is concerned with the capitol city’s increasing traffic problem, caused in part by his successful tax-reductions that have at-tracted businesses to the city. He asks you, as transportation analyst, to report on the situation and recommend, based on a cost-benefit analysis, a plan to solve the problem. How would you respond to



this request? What variables would be included in your analysis? What intangible factors are involved?

Q21: What factors affect an agency’s organizational structure?

Q22: How would you assess whether an agency’s staffing pattern is ap-propriate?


Module 7: Decision Making in the Budget Process

Overview State budgeting has several phases. Each involves literally hundreds of decisions: some are technical, others turn on analytical matters, and many are political. Theoretical models attempt to describe the complexity of budgetary decision making processes. They try to capture what is done and suggest what should be done. This module introduces the major de-cision points in the state budgeting process, examines the role and mo-tives of the participants during the various phases, and suggests ways for budget analysts to improve their comfort level in making decisions that demand more than technical expertise. This module also provides infor-mation analysts need to handle the technical problems that surface at critical decision points in the budget process. Technical issues influence micro budgeting decisions and, in turn, both affect and are affected by macro budgeting issues.

THEORETICAL MODELS OF BUDGETING ______ 93 TIMING AND THE BUDGET PROCESS _________ 97 MAJOR DECISION POINTS______________________ 98 THE TRADEOFFS ____________________________ 99 THE BASE BUDGET _________________________ 100 REVENUE AND EXPENDITURE FORECASTS ___ 101 AGENCY BUDGET SUBMISSIONS _____________ 103 BUDGET STRATEGY_________________________ 105 APPLICABILITY OF STRATEGIC DECISION

MAKING IN THE BUDGET PROCESS__________ 107 THE CHANGE IN STATE BUDGET OFFICES ___ 109 ESTABLISHING A COMFORT ZONE___________ 110 THE ROLE OF PROCEDURES AND GUIDELINES 111 THE NEED FOR TRAINING AND NETWORKS __ 112

Decision Making in the Budget Process Concepts


Theoretical Models of Budgeting A number of theoretical models attempt to describe how budgeting does

and should occur. Comprehensive rational models form the core of such techniques as Planning, Programming, Budgeting Systems (PPBS), per-formance-based budgeting, and zero-based budgeting. Incremental deci-sion making models provide the basis for techniques such as decremental-ism and target budgeting.

Comprehensive Ra-tional Models

Comprehensive rational models of budgetary decision making use the familiar assumptions of classical economics. Namely, voters are consum-ers with rather complete knowledge of what they want and how they might get it. Policy makers are producers that compete among themselves on relatively equal terms for the attention and support of voters. Both vot-ers and policy makers engage in rational decision making.

These models depict several steps in the decision making process. Typi-cally, they have the following elements:

Elements of Comprehensive Rational Models

1. Budgets allocate resources toward items of public value or objectives.

2. Each public objective should be defined as clearly as possible.

3. Each alternative policy should be viewed as a way of achieving objec-tives.

4. Each possible expenditure should be assessed in terms of its compara-tive contribution to objectives.

5. Each possible expenditure should be systematically considered in terms of its economic costs and benefits.

6. No decisions on expenditures should be made until all claims are in.

7. All decisions about taxes and expenditures should be made as part of a unified budget process.

Achieving the Ideal Obviously, this ideal is impossible to achieve. It is hardly descriptive of budgetary practice. Information is never as available, alternatives are never as well formed, means and ends are never as well connected, and tradeoffs are never as clear as the comprehensive model might suggest.

Incremental Models There have been numerous attempts to develop more “realistic” models of budget decision making. Incremental or “successive limited approxi-



of budget decision making. Incremental or “successive limited approxi-mation” models attempt to offer a better understanding of the various as-pects of the process. They acknowledge both voters and policy makers have incomplete knowledge of what is desired and how it might be ob-tained. They emphasize the halting, often incomplete nature of budget decision making and recognize the way in which political motives often shape decisions. They typically assume that budgeting will focus on only a small part of the expenditures to be allocated, precisely because the budget is enormously complex and the process is repetitive.

Characteristics of Incremental Models

Such models typically are:

1. Preoccupied with only the limited set of policy alternatives that are po-litically relevant and typically are only incrementally different from ex-isting policies embedded in the base budget,

2. Concerned only with those aspects of policies on which alternatives differ,

3. Structured such that policy is viewed as a succession of choices,

4. Concerned only with the marginal values of various objectives,

5. Composed of a mix of evaluation and empirical analysis, and

6. Centered on a small number of issues of importance.

As it turns out, even incrementalism has difficulty capturing the texture of budgetary decision making. Any number of researchers have shown that the budget base is not nearly as stable as incrementalists might believe. Agency budget shares can change dramatically over time. Legislators and governors frequently press for large spending changes. The base, espe-cially in fiscally tight times, is not beyond examination.

Micro Budgeting Models

Incremental decision making models often deal primarily with micro budgeting decisions -- decisions dealing with programs, activities, or line items. Budget analysts focus primarily on the technical aspects of the budget process. Most of the work is performed within a set of rules de-signed to guide and improve the decision making process in addressing individual agency requests for line-item and program expenditures. Technical issues are the stuff of everyday budgeting but also the under-pinning of larger macro budgeting success.

Macro Budgeting Models

In recent years, macro budgeting has attracted greater attention with a fo-cus on high level decisions concerning spending, revenue, fund aggre-



Models gates, and relative budget shares.

Federal mandates with formula driven expenditures have combined with tighter fiscal constraints to increase the need to develop other perspectives on how state budgets can and should be constructed. While micro budg-eting issues remain fundamental to the process, the attention given macro budgeting signals a profound shift in both the focus of budgetary decision making and the concerns of budgetary actors. Strategic budgeting, for example, is a form of macro budgeting that views the budget from the top down within a set of macro concerns. It emphasizes such factors as the underlying demographics behind the budget and the performance and structure of the economy. It recognizes that federal initiatives, constitu-tional concerns and court actions are often fundamental to the shape the budget ultimately assumes.

Influence of the Mod-els

For all their inadequacies, the influence of simplified models should not be underestimated. Their theoretical and practical implications are evi-dent in the ways in which budget officials approach decision making. In-crementalists, for example, strive to see things as they are. They are often the budget realists -- skeptics about the prospects for large scale change and meaningful planning. Comprehensive budgeters put an emphasis on how decision making should be -- often dismissive of doing things the way they have always been done.

Contrasting the Mod-els

These are not differences without meaning. They help explain why the focus of budgeting may vary so much from one setting to another and from one time to another in the same setting. On the one hand, compre-hensive models provide the norms against which professional budget processes are often judged. Incremental assumptions, on the other hand, can help clarify why concrete budgeting problems are approached in the way they are. Why, for example, are some items “beyond the reach” of serious analysis? Why is it often implicitly assumed that there is more “fat” in larger budgets than in smaller ones? Why are requests that reflect stable growth often given greater credibility and less scrutiny than ones that are more volatile? Why are formula-driven requests often treated differently than ones that result from agency priority setting processes?

Difficulties with the Models

Despite their differences, both the comprehensive and incremental ap-proaches share a number of similar concerns. They usually focus on agency budgets or smaller program components and not on major func-tions or broad aggregates. Until recently, both approaches emphasized micro budgeting with concerns for operational and managerial controls. Neither really explains the underlying dynamics behind aspects of the budget which can make various items uncontrollable. Both tend to look



at the budgeting process too narrowly – focusing only on the agency re-quest, executive review, and legislative approval.

Numerous Ap-proaches to Budget

Decisions

In reality, budgeting usually involves both approaches and more. It is not a case of either comprehensive or incremental decision making. It is a matter of degree. The complex task of putting together a budget in a lim-ited amount of time requires a variety of techniques. It comes down to such questions as: How can the analytical tasks facing the analyst be simplified? To what extent can or should the process focus on marginal matters as opposed to long-term issues? What sort of message will a deci-sion convey? Will it establish a precedent? Does it undercut possibilities in the future? What behaviors will it encourage? How soon does this de-cision have to be made? Where should the focus of decision making lie? How well are the activities and performance behind the dollars under-stood? The answers to these questions are not easily modeled. They re-volve around a more general understanding of the budget process, the roles and motivations of its many participants, and the decision points that influence the final shape of the budget.



Timing and the Budget Process Budgets are bound to a certain schedule, usually an annual or biennial

fiscal year. The final budget is the product of many separate decisions, and each decision must be made by a specific date. The deadlines force action -- a highly prized commodity in any organizational setting. To a greater or lesser degree, each of these decision points is dependent on one or more of the preceding points. As a consequence, the action sur-rounding each decision occurs in short, often frenzied bursts well known to all budgeting veterans.

Budget Format and Budget Instructions

Decision points in the budget process require attention to both micro and macro budgeting issues. Budget format, for example, demands the closest possible attention. It typically establishes the way in which budget infor-mation is to be captured and reported. In many respects it involves the most mechanical decisions in the budgetary process and, as part of the technical underpinnings of the budget, may seem less important than the larger policy and financial objectives the budget is supposed to realize. Still, there can be little doubt that format profoundly affects the larger dis-cussion of the budget that will follow. Budget instructions specify not only what and how information will be reported, they also limit the range of possibilities that may be entertained. Specific dollar-level ceilings, and some required ranking of priorities among programs are increasingly popular ingredients guiding the preparation of agency requests. These elements have stark implications for ongoing budget deliberations.



Major Decision Points As a practical matter, some points in the budget process are especially

important. These decision points will vary from state to state, but typically include:

• Generating financial forecasts,

• Developing the governor’s strategic posture,

• Framing the parameters for agency preparation of their proposals,

• Setting the spending and performance baselines,

• Developing the agencies’ submissions,

• Producing the governor’s recommendations,

• Setting the legislative subcommittee allocations,

• Positioning for legislative conference and negotiations,

• Composing the executive veto,

• Issuing instructions for initial execution of the enacted budget,

• Providing the guidelines and procedures for implementation, and

• Establishing the framework for oversight and evaluation.



The Tradeoffs Each major decision point contains varying blends of technical, analyti-

cal, policy, communication, and political elements. Few decisions are solely technical. Most have larger implications than may be obvious. Consider, for example, a spending baseline. How are changing price lev-els to be treated? Are all non-recurring items excluded? What package of expenses is associated with various activities?

Policy Decisions and the Baseline

Yet just as clearly, some elements of the baseline emerge from policy judgments with significant consequences for the overall budget. The workload implications of current law and current administration are fre-quently a matter of some contention in constructing the baseline. Simi-larly, the interpretation of statutory requirements in constructing the spending baseline is often a matter of some controversy. When these mat-ters involve issues such as staffing new prisons or funding additional Medicaid caseloads, they can have substantial impacts on the shape of the final budget.

Making Judgment Calls

The need for judgment in the budget process cannot be eliminated. Of-ten, custom and practice limit the need for dramatic decisions. This is of-ten the case regarding financial forecasts, agency budget instructions, spending and performance baselines, initial execution of the enacted budget, and budget implementation. Each involves techniques for simpli-fying and resolving a complex set of issues. The techniques limit the range of decisions. Yet even these matters can become contentious at times when the implications of seemingly technical issues adversely affect the interests of participants in the process.

Discretionary Deci-sions

More frequently, decision points that revolve around the less technical, more discretionary aspects of the budget development are the most diffi-cult. These include developing the governor’s strategic posture, produc-ing the governor’s recommendations, positioning for legislative confer-ence and negotiations, and composing the executive veto.



The Base Budget The first significant spending decision in each budget cycle typically deals

with the “base budget.” The base budget is essentially the next fiscal year’s cost of implementing this fiscal year’s legislative decisions. As such, it starts with the current year appropriations, deducts current year non-recurring activities and annualizes partially-funded programs from the cur-rent year (for example, prisons that may have opened part-way through the fiscal year). Usually, a base budget will also provide the funds to op-erate institutions projected to open in the upcoming fiscal year and funds for official forecast population growth (for example, school population).

Baseline Spending Decisions

The base is the largest part of the state’s budget, and the decisions sur-rounding it are made almost entirely by gubernatorial and legislative budget staff. The decisions typically reflect long practice and custom, and may at times seem “automatic.” In fact, they are not. They are spending decisions. They represent an agreement on what kind of information is to be considered in subsequent decision making and how micro budgeting decisions are to be simplified. Although the concept of a base budget may offend and seem undemocratic, it does have the virtue of freeing elected decision makers to concentrate on new issues - whether they are reductions to the base or enhancements to it. The base is usually formu-lated early in the adoption phase and has its greatest utility in those in-stances in which both the governor and legislature agree about what is in the base.



Revenue and Expenditure Forecasts Revenue and expenditure forecasts are made throughout the budget deci-

sion making process. With the initial forecasts, the governor and legisla-ture begin to plan how available revenues will be used to address needs in different policy areas (for example, education, criminal justice, social services, and the environment).

The Big Picture Some revenue forecasts are used during the preparation phase to look be-yond the one-year horizon of the typical budget. These forecasts com-pare projected revenues against the future years’ cost of legislative deci-sions. While they are useful for painting “the big picture” for gubernato-rial and legislative decision makers, they are less useful for agencies. Such forecasts are designed to force answers from the governor and from legislative leadership to the question: “Given projected revenue growth, the impact of current law and practice, and historical spending patterns, what combination of revenue enhancements or spending reductions will be necessary to reach a balanced budget?” Of course, different answers should be expected from each actor.

Forecasts and Micro Budgeting Decisions

Revenue and expenditure forecasts shape and are fundamental to micro budgeting decisions in a number of ways. Comprehensive forecasts are composed of individual projections of various revenue sources and pro-gram spending. These projections become definitive and focused as the budget process proceeds. They become the benchmarks against which the prospects of activities funded from dedicated steams of revenues can be assessed. Expenditure forecasts become more refined as agency re-quests are received by the governor and legislature and even more so as the base budget is developed. After the base budget is completed, pre-liminary decisions on spending allocations to different policy areas are made. It is then possible to identify basic micro budgeting considerations such as the need to address shortfalls through fund shifts, reductions, or the use of fund balances.

Forecasts and Final Allocations

For states with a formal consensus revenue estimating process, there are usually two official forecasts - one is made just before the governor sub-mits his official recommendation and the other just before the legislature completes its appropriations bill. At these times, final allocations to each policy area are made and the budget recommendations (or, appropria-tions in the case of the legislature) are completed. Depending on the re-sults of the particular forecast, additional cuts may be made, additional priorities may be addressed, previous cuts may be “bought back”, addi-



tional revenue increases may be embraced, or some combination of all the above implemented.



Agency Budget Submissions The states treat agency budget requests in different ways. In some, the re-

quest is sent solely to the governor where it is modified for submission to the legislature. In others, it is submitted to both the governor and legisla-ture at the same time. Some states give the agencies broad authority to submit requests for the funding levels they consider appropriate; others place significant restrictions of the submissions. Agencies may be required to meet specific dollar level ceilings, to maintain only a minimum level of services, to include necessary program improvement or rank their priori-ties among programs.

Preparation and Adoption

An agency’s submission may seem a straightforward decision -- one geared to the budget instructions issued by the central budget office. In fact, it is not so simple. Each agency must decide how best to get through the preparation and adoption phases. Should the request be comprehen-sive (include all funding that is needed) or customized (include only fund-ing for those issues that are the highest priority)? Who is likely to support or oppose the request?

Comprehensive Requests

Comprehensive requests put a dollar value on all the needs of an agency. Since needs routinely exceed resources, comprehensive requests take on the appearance of “wish lists” with issues running the gamut from the mundane to the vital. However, comprehensive requests do have the vir-tue of providing a modicum of “cover” when things go wrong, as they in-evitably do. For example, when the Department of Corrections requests additional resources to improve the physical and personnel security at its prisons even though there is a scant possibility of funding, they have cre-ated a record of having brought the matter to the attention of relevant de-cision makers if escapes, riots, or other unpleasant actions materialize.

Disciplined Requests Disciplined requests, on the other hand, focus on a limited set of issues. Implicitly, this type of request acknowledges resources - either fiscal (in the sense that there is not enough money to do everything) or political (in the sense that there is not enough support to get a particular issue adopted) - are limited. This tactic expends less staff energy, but is riskier. It also re-quires more political skill. It is not necessary to “waste a priority” on is-sues that will likely receive funding despite agency action; alternatively, it might be wise to rank an issue highly in order to garner support from other actors.

Compromise Strategy Most agency submissions will opt for a compromise strategy that will list all agency needs (comprehensive), but specify what the agency priorities



for Requests all agency needs (comprehensive), but specify what the agency priorities are (strategic). As a technical matter, agencies will try to walk a fine line despite the instructions. Some items will be aggregated to obscure their meaning; others will be highlighted to promote a concern. Neither decremental budgeting techniques nor program-based performance meas-ures will resolve the need for further analysis by central budget and legislative staff. An agency’s submission is the result of series of agency decisions and must be given independent scrutiny.



Budget Strategy The heart of the budget process, arguably, lies in a detailed, systematic

attempt to ensure that expenditures achieve intended objectives. Even when the process is simplified, when shortcuts are taken and the demands of comprehensive rational decision making are not met, budgeting re-mains a painstaking process requiring an enormous effort. It must deal with a bewildering number of technicalities and handle literally hundreds of issues. Every budget analyst is immersed in micro budgeting detail. Yet details alone will not produce a budget that serves the wishes of policy makers, whether agency heads, chief executives or legislators.

Fulfilling Expecta-tions

Policy makers expect the budget to support their initiatives, fulfill their promises, and realize their priorities. Making this happen is no easy mat-ter. Each participant in the budget process has similar expectations. Each may influence the outcome to some degree, but few are in a position to insure the outcome will be entirely to their liking. In the toss and tussle of budgeting, what matters most is success. Good analysis, incisive policy and well-framed recommendations are not enough.

Need for a Thoughtful Strategy

It is precisely the realization that budgeting is such an untidy exercise that requires governors and other policy makers to develop a strategic posture toward the budget and the process by which it is enacted. A thoughtful strategy must synthesize numerous concerns and, in the best cases, will be applicable for several years. It will necessarily be founded on an analysis of the existing budget and the underlying dynamics that shaped it. It can-not ignore the major “drivers” behind spending patterns: demographic and economic changes, federal mandates, revenue performance, and the existing mix of programs. It must be sensitive to the opportunities and threats in the political setting. What, for example, is the manner of coop-eration among political leaders? How will the political calendar come into play? Do circumstances favor certain major initiatives? Every strategy must come to grips with the structural condition of the budget and contain an assessment of how the economic cycle might influence the prospects for action. It should be based on a financial forecast that provides both 1) assurance that the political problems, which might occur if budget short-falls were encountered during the short run, will be avoided, and 2) the foundation for accomplishing initiatives in the longer run.



Advantages Ideally, policy makers will adopt and stand behind an explicit, limited set of policy and financial objectives that will guide their approach to the budget over many years. This has several advantages. For example, it can help establish an administration’s attitude to issues such as the use of nonrecurring funds, fund balances, maintenance and repair, price level increases and the like. It will help create the general tenor of an admini-stration’s financial policy and set the general orientation toward matters such as the need for new programs, improved productivity and new reve-nue sources.

Strategic Posture It is possible, of course, that a policy maker’s strategic posture will not be set down consciously. Rather, it may unfold fitfully over time. Or it may be considered anew each year. These sort of approaches offer policy makers enormous flexibility, but they sacrifice all the advantages clarity provides. For a central budget office, for example, they expand the num-ber of decisions that have to be revisited and can undermine its credibil-ity. They also create greater opportunities for participants to intervene successfully in the process and may work to the disadvantage of the gov-ernor’s priorities.

Changing Circum-stances

Any strategy, of course, must be modified for changing circumstances. Nevertheless, chances are that great portions of it will not be altered sub-stantially. And as a general guide, an explicit strategy can help keep pol-icy makers headed in the right direction and protect them from tempting tangents and dubious practices. Perhaps as important, as it is changed to fit changing conditions, a strategic decision making process provides an explicit top-down framework within which financial, policy, and political factors can be reassessed and the prospects of various courses of action evaluated. For example, it offers a mechanism by which various alloca-tions among major items in the ongoing budget process can be antici-pated and assessed.

Strategic Considera-tions

In the best cases, a policy maker’s strategic posture relies heavily on analysis, but the analyses that it draws upon focus on the broad forces shaping the budget. Ultimately, strategic considerations support top-down decisions. Necessarily, these decisions may divert attention from particu-lar problems or preclude further consideration of some pressing issues. They may actually discourage the attention to detail that central budget offices hope to promote. Therefore, it is important that the rationale that supports a policy maker’ strategic posture is shared as widely as practica-ble. Budget analysts must understand how and where their efforts fit into the ongoing budgetary decision making process.



Applicability of Strategic Decision Making in the Budget Process

Strategic decision making is valuable only to the extent it helps produce the governor’s recommendations, set legislative subcommittee allocations, establish position for legislative conference and subsequent negotiations, and guide veto considerations.

Governor’s Priorities The governor’s budget recommendations involve a series of strategic and tactical considerations in which the central budget office is likely to play a key role. Central budget staff is usually most concerned with the major priorities on the governor’s agenda and with strategic financial considera-tions. However, the budget office often has statutory duties that transcend strategic considerations. As a consequence, they are likely to get involved on other issues as well. Such matters can have statewide impact. For ex-ample, the office will often make decisions dealing with the source of funds used to support an initiative, with the use of nonrecurring revenues, with statewide management issues, and with program efficiency and spending cuts.

Agency Priorities Agency heads may have a strategic agenda, but it is likely to be more spe-cific than that of the governor and the central budget office. The central budget office and the agency necessarily work together in preparing the governor’s recommendations, but their interests are not necessarily con-gruent. The strategic considerations of the central budget office may im-pair agency operations and services. In similar fashion, strategic consid-erations and gubernatorial priorities may also run counter to the interests of major constituency groups. These sorts of difficulties will arise and the budget process must include a means by which such issues can be raised in a timely fashion with the governor and other leading policy makers.

Legislative Priorities The budget and its underlying strategic vision must be able to accommo-date change. The legislature will try to put its own stamp on executive recommendations. While the legislative leadership usually has a well-developed set of strategic concerns, ultimately they must pass a budget that has support of the majority. Securing that majority can be difficult and demand considerable compromise. While the governor may not be an integral part of such maneuvers, his recommendations can set the stage for legislative deliberations. That possibility must be anticipated and built into the recommendations.

The Role of the Absent some acknowledgment of legislative prerogatives and preferences, the governor’s recommended budget is likely to be widely ignored. Of



Executive Budget the governor’s recommended budget is likely to be widely ignored. Of course, even such a fate can have significant strategic and tactical impor-tance. It is important here to remember the admonition of Dall Forsythe, former state budget director of New York. He cautions that “the legisla-ture will not pass a budget that is more fiscally responsible than the one (the governor) gives them.” The governor’s recommendations not only set priorities and suggest change, they also provide guidance about the fiscal practices that an administration tolerate. It is worth remembering that the legislative imperative to produce a budget involves a constellation of forces far more diverse than the ones facing the governor. This may di-minish the ability of the governor to prevail on some particular issue and even limit his ability to participate meaningfully at some stages of legisla-tive decision making, but it can also increase his ability to help forge an acceptable solution.

Budget Negotiations and the Veto Process

The governor’s role in budget negotiations and the extent of gubernatorial veto powers vary from state to state. Both budget negotiations and the veto process are extremely fluid periods. They require a nimbleness that may conflict with professional norms and violate technical maxims. It is worth remembering, however, that even during such times professional, technical, and analytical concerns have a part to play. They offer an in-structive benchmark that can be invaluable. Consequently, even when short-term, tactical considerations prevail, there is a need to maintain and reinforce the fundamental decision support mechanisms of state govern-ment.



The Change in State Budget Offices In recent years, state budgeting has undergone many changes. Tradition-

ally, accountants and business administration graduates dominated the staff of agency budget offices. Central state budget offices have assumed broader responsibilities, however, and staff in budget offices are now more policy oriented. The demand for a wider range of knowledge, skills, and experience has increased, and public administration and other pro-fessional disciplines are now represented more than in the past.

Expanding Responsibility

The change in budget office personnel and in the role of the budget office has implications for budgetary decision making. When budgeting was viewed primarily as a subset of accounting, expectations were clear. As budgeting changes, the scale and diversity of responsibilities expand, and the breadth of issues before state budget offices grows, analysts can rely less and less on familiar professional expectations and technical norms. The ground beneath decisions is therefore less familiar, but analysts are still expected to provide the best-possible information for decision making.



Establishing a Comfort Zone The search for “solid ground” in budgeting is not new. Budgeting has al-

ways been complex. Analysts have always sought concrete answers and tried to reduce uncertainty. In fact, most budgeting techniques are de-signed as ways to reduce uncertainty.

Gathering Informa-tion

Information gathering is the essential element of effective decision making, but no analyst can possibly hope to have all the information necessary. Except during the implementation phase, there is simply not sufficient time to obtain all the information necessary to support most decisions. At some point, the marginal value of increased information is outweighed by the energy and time necessary to acquire it. In the absence of complete in-formation and under the press of time, every analyst must have access to rules that can eliminate some problems and simplify others.

Accounting vs. Budgeting

Attempting to simplify the complexity of a decision by focusing on its for-mal details has often been employed in the past. This was both the allure and danger of the accounting approach to budgeting. Increasingly, pol-icy makers want a greater range of information and whole new sets of cri-teria applied to decisions in the budget. The certainty that the accounting approach brought to budgetary decisions has been lost; however, the need for certainty has not been lost. Most analysts on the central budget staff need a “comfort zone” if they are to work productively during the various phases of the budget. They must be able to make timely decisions without suffering from self-recrimination and doubt.



The Role of Procedures and Guidelines One time tested approach is to break down complex issues into discrete

decisions, some of which have less uncertainty than the issue in its en-tirety presents. This is the role of standard operating procedures, check-lists, policy guidelines, and decision trees. They have the virtue of simpli-fying decisions and imposing a certain amount of uniformity among dif-ferent analysts. Of course, they also introduce rigidity and unimaginative-ness into the decision process. When used properly though, decisional frameworks will filter out the technical and consensual elements of an is-sue, so that only the contentious and political aspects remain.

Decisions in the Execution and

Implementation Phases

Formal decisional frameworks are especially useful in the execution and implementation phases. The bulk of the political and policy decisions have been made, and many of the remaining decisions are primarily technical. What personnel classification should be used for new posi-tions? How much should be allocated to different regions or bureaus?

Decisions in the Adoption Phase

In contrast to the routine and technical nature of the execution and im-plementation phases, the adoption phase can only charitably be de-scribed as “messy.” It has all the dynamics of guerrilla warfare (but more civilized) – battle lines are not always clear and frequently change, you are not always certain who your friends and enemies are, and ambushes can be regular occurrences.

Written Guidelines The chaotic character of some phases of the budget process limits the use-fulness of formal decision rules. Still, written instructions and specific guidelines can help. Most staffs adopt them. It is relatively easy to get agreement on issues like how vacant positions are to be treated and whether fuel price increases are to be granted. It is less easy to gauge what sets of items meet the criteria for a gubernatorial veto. Specific rules, in this case, must give way to a more general understanding of the strate-gic posture of the administration. If the strategy is coherent, relatively con-sistent, and widely distributed or understood, then it provides an anchor to analysts who might otherwise be adrift. A generally understood strategy provides grounds within which analysts can safely make judgements. It provides the common discipline that is often missing during decision mak-ing.



The Need for Training and Networks A well-developed strategic posture is helpful to budget analysts. But it is

unlikely to provide a firm basis for every decision that they must make. Even a well-articulated sense of direction cannot anticipate every issue. Lacking strategy, analysts will use various tactics to “get a handle on” the uncertainty inherent in decision-making in this phase. Some will work, some will not.

Developing Skills Extensive training can help, especially as central budget offices become more diverse. Training can help provide “footing” for unfamiliar settings and situations. In the same way, group exercises and focused debriefings will help analysts get their bearings. There is no single foolproof tech-nique, however. Ultimately, the only safe course is to ensure that each analyst uses and can rely upon an extensive network for counsel and consultation. Analysts must cultivate “comfort” in the measured advice of those who also are wrestling with the same problems and issues. As a re-sult, well-developed communication and interpersonal skills are key complements to technical proficiency and analytical expertise during the preparation and adoption phases of budget decision making.


Decision Making in the Budget Process Competency Test

Competency Test Q1: How do Comprehensive Rational Models of budgetary decision

making differ from Incremental Models?

Q2: Comprehensive Rational Models are often pointed to as the ideal to which budget analysts should strive. Why, given the obvious diffi-culties with the model?

Q3: How do the assumptions of incremental models implicitly appear in the decision making that analysts engage in everyday?

Q4: In what stages of the budgetary decision making are the assumptions of comprehensive rational models likely to be realized?

Q5: What features of the adoption phase make it the most difficult for most professional analysts?

Q6: Why is the role of the central budget office sometimes said to be pre-dominately negative?

Q7: Macro budgeting has become more important in recent years, yet micro budgeting remains the core activity of most budget offices. Why?

Q8: How does a well developed and widely shared strategic position help budget analysts in the various phases of the budget process?

Q9: Checklists and guidelines can be invaluable aids to a budget analyst, but they also can cause problems. Discuss the advantages and dis-advantages of such techniques in decision making.

Q10: State Budget Offices have changed over the last twenty years. How have these changes affected the comfort analysts have in making dif-ficult decisions during all phases of the budget process?


Module 8: Capital Budgets

Overview The capital budget is a spending plan for acquisition, construction, or im-provements of facilities, lands, equipment, or other infrastructure. It is a distinct spending plan that complements the operating budget. The focus of the capital budget tends to be longer term – both with respect to the type of facility or investment involved and with respect to the method of financing that may be employed. Capital budgets typically embrace the following: new construction, major renovation, reconstruction, major re-pair and major (deferred) maintenance, land acquisition, and site im-provements. Project elements typically also include the total cost of mak-ing a facility operational, including necessary initial equipment and fur-nishings, landscaping, utilities, parking, and road work. Capital budgets may or may not be prepared and evaluated by the same budget analysts who analyze operating budgets.

CAPITAL BUDGET DEFINITIONS _____________115 ASSESSING THE UNIVERSE OF NEEDS_________116 IDENTIFYING AND RATING PROJECTS ________117 CAPITAL PROJECTS AND POLITICS __________118 PERFORMING FINANCIAL ANALYSIS OF CAPITAL

PROJECTS _____________________________119 IDENTIFYING FUNDING SOURCES____________120 ANALYZING FINANCING OPTIONS ___________121 SCHEDULING, APPROVING, AND

IMPLEMENTING ________________________123

Capital Budgets Concepts


Capital Budget Definitions Both the capital planning and capital budgeting processes are typically

framed by a predetermined set of capital budget definitions most often set out in state statute. These definitions themselves may include a descrip-tion of the kinds of projects/investments to be considered as “capital” and/or the definition may be established by use of dollar thresholds (minimums) that denote a capital project. For state governments, the span of capital projects typically includes: state buildings, special use state fa-cilities such a prisons and mental hospitals, life safety, modifications to conform with the Americans with Disabilities Act (ADA), public infrastruc-ture such as water systems and wastewater treatment, and other basic re-quirements. In some jurisdictions, capital items also include major items of equipment, technology systems, and special use items such as aircraft.

Capital Budget Review Process

An essential part of the capital budget review process involves a thorough consideration of the best method(s) of financing to include long-term bor-rowing/debt, lease or lease/purchase options, interim financing, and out-right cash payments from a variety of funding sources. Finally, the capital budget, while distinct, cannot be properly evaluated without due consid-eration of its effects on the operating budget. A new building will require ongoing expenditures such as utilities, cleaning, and security which must be factored into operating budgets.



Assessing the Universe of Needs In every state the need for capital budget investments overwhelms the ca-

pacity to immediately fund those needs. Ironically, capital projects are viewed, on the one hand, as short-term and as “non-recurring” – while at the same time they in fact require long-term financing of often 20 years or more. The distillation and analysis of a great number of eligible projects that must be reduced, prioritized, and subjected to rigorous financial analysis is at the heart of the capital budget process.

Capital Planning Process

Often this process is informed by a capital planning process that is of greater breadth and covers a longer timeframe than the annual or biennial budget process. This planning process itself may have various subsets of analysis and priority ranking by agency or cabinet, institution, or facility. It may also be subject to a preset determination of policy priorities that would, for example, establish maintenance of existing facilities as a higher priority than new construction or expansion of existing facilities.

Prioritizing Projects The business of prioritizing capital projects typically begins with agency heads rank ordering their capital investment lists for the ensuing budget period. These agency priorities are then reviewed and may be changed as the budget analyst evaluates them. This evaluation involves a combi-nation of established statewide policy standards, personal knowledge and experience, and awareness of competing demands or pressures crossing agency lines. Ultimately, the analyst needs to determine what is afford-able and appropriate within the given budget period.



Identifying and Rating Projects Identifying individual projects for inclusion in the capital budget recom-

mendation is accomplished in a variety of ways. First, the budget analyst typically depends on his or her assigned agencies to communicate what the agencies identify as their specific wants and needs for the upcoming budget cycle. Governors, legislators, the media, and citizen groups also identify capital projects. Depending upon the timing in the budget calen-dar, these interests may work directly with the agencies to have their capi-tal project(s) included in an agency’s budget request. Other times the budget analyst must identify these projects on his/her own, through site visits, agency contacts, public testimony, or the media. It is always impor-tant for the budget analyst to know the reasons a particular group wants a capital project funded and also any group that might oppose a particular project. That way, policy makers can make an informed choice as to whether to commit limited state resources to a given project versus an-other equally meritorious project.



Capital Projects and Politics Many elected leaders are enamored with capital projects. These are the

tangible “bricks and mortar” that they can point to in their term of office or in their home district as a demonstration of their legacy or as proof that they are “bringing home the bacon." Often such efforts are derided as “pork barrel” by detractors and rivals. In actual practice, budget office attempts at an objective ranking of capital projects may run squarely into political reality. That is simply the system – the very nature of a democ-racy – that the budget analyst must come to terms with. For example, it is not uncommon for construction of a new state park project to become a higher priority than funding a replacement roof for an existing state park lodge. Often times it falls upon the budget analyst to rate capital projects in a way that attempts to preserve the state’s previous major investment in capital assets.

Rules for Prioritizing Capital Projects

A good rule of thumb is that “life safety” projects (sprinkler systems, fire exits, etc.) should have a high priority for funding. Following closely be-hind should be efforts to maintain and repair major systems of existing as-sets (roofs, heating, ventilation, and air conditioning, etc.). Almost always, new projects also will be considered.



Performing Financial Analysis of Capital Projects Budget analysts have a responsibility to subject capital budgets to a seri-

ous financial analysis that helps ensure that the government and citizens get the best value for their dollars once the set of capital project priorities has been established. This involves scrutinizing the specific financing plan and options associated with each capital project request. Once the analyst has determined the need for a capital expenditure, he or she must then determine the method of funding, terms of any debt issuance, and other important matters. The better the financial analysis, the more pro-jects and other spending priorities that can be supported from the same set of revenues and/or tax dollars. Therefore, the analyst must weigh the rela-tive benefits over the long-term as compared to the relative costs.

Criteria for Evaluating Requests

In some jurisdictions, there is a regular or prescribed cost benefit analysis model that is followed in evaluating capital projects. But many times the kinds of analysis and criteria brought to bear are more subjective and di-verse. When the final recommendations are made, the strength of the needs analysis, the financial analysis, and the ability to document that analysis will allow it to stand up to scrutiny from policy makers and staff in both the executive and legislative branches.



Identifying Funding Sources The identification of funding sources for capital projects is generally a

state-level decision. Agencies request individual projects to help accom-plish their mission and state decision makers decide on the most appro-priate funding source for the project. Funding for capital budgets is by and large a choice between utilizing cash or borrowing. Obviously, the level of available cash (whether from general revenues, fees, restricted ac-counts, etc.) and levels of previously incurred debt affect this decision. In many states, the fiscal constraints faced in the last 10-15 years have lim-ited the use of general fund appropriations for major capital projects.

Funds Earmarked for Capital Budgets

In some cases, a captive or earmarked source of funds may be available to support an array of capital budget activities. In some instances, these funds can be used only for particular kinds of activities. More often, how-ever, the use of the funds is more flexible. Potential flexibility must be as-certained by examination of the statutory underpinnings of the funding sources, regulatory restrictions, federal mandates, and competing policy and expenditure options.

General Obligation and Revenue Bonds

Most states use debt, including general obligation bonds and revenue bonds, as the primary source of funding for capital projects. General obli-gation bonds and revenue bonds are generally subject to some type of statutory, constitutional, or debt capacity (policy) limits. These are opera-tionalized as either maximum borrowing limits or as a percentage of debt service compared to a percentage of revenues. Moreover, it is sometimes necessary or advantageous to finance projects on an interim basis using methods such as bond anticipation notes or master note financings before permanent financing (bond sale) is finalized.

Borrowing for Atypi-cal Projects

In some states, financial conditions or increased demands in recent years have prompted them to borrow to finance projects which typically are not financed in this manner, such as major maintenance projects and major equipment purchases. Such uses can be justified if the major mainte-nance (for example, roof replacement) to be performed significantly ex-tends the useful life of the facility or, in the case of equipment, the term of the debt is scheduled to coincide with the useful life of the equipment. Finally, it is important to recognize and limit the impact of debt service on the operating budget, which if allowed to grow excessively, can limit fu-ture options.



Analyzing Financing Options There are basically four options to finance any capital project: 1) acquire

by gift or grant, 2) pay cash (state revenues or receipts), 3) borrow, and 4) privatize.

Acquiring by Gift or Grant

The first option generally requires the least analysis by the budget analyst. If policy makers agree that the project is worthwhile, and someone (an in-dividual, private foundation, or the federal government) is willing to either give the asset to the state or provide a grant to provide the funding for construction of the asset, then obviously this is a preferred option. How-ever, the policy/budget analyst must be aware that often the major "cost" of capital projects is ultimately the recurring maintenance and operating cost of the project. Projects acquired by gift rarely provide for this cost.

Pay Cash or Borrow Many well-established factors need to be considered before the final deci-sion can be made on whether to pay cash or to borrow funds. These fac-tors include sound financing theory, cost/benefit analysis, legal restric-tions, and philosophical or political preference. Among the financial con-siderations are the size/expense of the project, its useful life, and the cost of money (interest rate). Among the legal considerations are constitutional and/or statutory restrictions on the issuance of debt; the state's fiscal ca-pacity to issue debt (revenues vis-à-vis total outstanding debt), the state's current credit rating, and policy makers’ preference. Often policy makers simply prefer to pay cash regardless of what “sophisticated” financial analysis may support. The budget analyst needs to be aware of these considerations to ensure a complete and responsive presentation of op-tions to the ultimate decision makers.

Privatizing Projects Another option less frequently employed, but still viable for some projects and financings, is to essentially “privatize” the project. This concept goes beyond the common practice of contracting for construction, architect, and engineering services, etc. In many states, there is a statutory alterna-tive that allows a private contractor or developer to construct a facility ac-cording to general guidelines prescribed by the state. A Request for Pro-posal (RFP) is the common vehicle for soliciting competition for privatized projects. The “privatization” may involve as much as total construction, design, operation, and independent non-state financing of the facility or project. After construction is complete, the state then begins a long-term lease or lease/purchase arrangement with the developer. This approach may save time and money. It also avoids some of the barriers to state debt issuance and short-term state fiscal capacity such as some statutory limita-



tions and issues of public and political perception. Nonetheless, the true costs of privatization are also long-term and must be factored into the budget analyst’s recommendation as to the appropriate financing options.



Scheduling, Approving, and Implementing Many states have initiated multiyear planning processes to allow state-

level decision makers to be aware of capital needs beyond the annual or biennial budget request time frame. Typically, these capital planning processes involve a time horizon of five years or longer and become the first step in the scheduling, approving, and implementing process. Agency budget requests are received by the executive branch budget staff and, after analyzing, reducing, and (re)prioritizing they are recommended to the legislative branch based upon gubernatorial priorities and availability of resources using previously determined debt capacity or cash availabil-ity.

Comparing the Capi-tal Request with the

Multi-Year Plan

When states have long-range capital plans, the first step in the review of the agency capital budget request is a comparison to the approved multi-year capital plan. While absence from the multi-year plan does not nec-essarily disqualify a project, it does raise questions and suggests the need for a heightened level of scrutiny by the budget analyst.

Legislative Review and Approval

Subsequent review by the legislative branch results in an approved capital plan which comes back to the executive branch for implementation. The legislative review and approval ultimately takes place in the context of a regular or special legislative session. Capital budgets are subjected to in-tense review as to their priority, propriety, and funding sources. Often projects are changed. Timelines are also subject to review and alteration, and the source of funds or the mix of those funds can also be altered. New projects are added and projects recommended by the governor are sometimes deleted. This takes place within the context of legislative hear-ings which are public and involve testimony by executive branch officials and others as appropriate. A final set of capital projects is ultimately in-cluded in an approved appropriations act that becomes law.

Budget Execution or Implementation

After final legislative approval, the projects move into the next phase of the budget process called budget execution or implementation. If an ap-proved project involves debt, there is generally a requirement that action be taken by the formal debt issuing entity to approve the bond issue terms and repayment schedule. Actual contracting and construction of the pro-ject is usually administered and monitored by a centralized state agency such as a finance and administration department. This is to ensure that the project is completed in a timely manner, within the approved financial and programmatic scope, and in compliance with applicable construction and building codes. The budget analyst continues to monitor each stage



of the process – from the initial planning and programming throughout the review cycle and including all levels of implementation until the pro-ject is complete – whether that be quickly or years later.

Periodic Review As a capital project proceeds through its multiple phases of preliminary design, final design, construction, equipping, furnishing, and ultimately occupation, the project and process will often be reviewed periodically by both executive and legislative staffs. This kind of regular oversight en-sures that the project continues to move forward in keeping with its intent and authorization and remains within the dollars allotted. Sometimes a project may incur unexpected difficulty or increased costs along the way due to unanticipated conditions, or unresponsive bids, or for a variety of other reasons. The budget office and budget analyst may then be in-volved in the business of sorting through options to keep the project intact and the funding appropriate within the established statutory and policy guidelines.


Capital Budgets Competency Test

Competency Test

Q1: Identify the ways in which the capital budget is different from the op-erating budget.

Q2: What is the typical starting point for prioritizing capital projects?

Q3: Why are many political leaders strongly supportive of capital pro-jects?

Q4: Define the role of the budget analyst in reviewing capital projects vis-à-vis the agency initiating the budget request.

Q5: At what level are funding sources ultimately identified for recom-mendation to the General Assembly?

Q6: Briefly discuss financing options that may be available for a given capital project.

Q7: At what point in time does a budget analyst relinquish responsibility for a capital project that is requested or approved?


MODULE 9: Debt Financing

Overview Aging infrastructures and limited cash resources have led many states to increase borrowing to fund essential capital projects. States employ bonds and other instruments of debt as a means to finance long-lasting improve-ments to the state’s property and infrastructure. Debt financing mecha-nisms accomplish two major goals: 1) they enable the state to make capital improvements when they’re needed and before saving up all the necessary cash, and 2) they spread the costs of the projects over the useful life of the assets, thereby allocating part of the project cost to future beneficiaries. When making decisions about debt issuance, states must consider both the total amount of debt that can be incurred and the affordability of the an-nual debt service (principal plus interest). Interest rates paid on state debt are a function of general market conditions, maturities on the bonds, and the ratings assigned to the bond issuance by the credit rating agencies at the request of the state. Rating agencies evaluate the ability of the issuer to repay timely the principal and interest borrowed.

POLICIES FOR MANAGING DEBT_____________ 127 DEBT FINANCING INSTRUMENTS ____________ 128 INDEBTEDNESS AND CREDIT RATING ISSUES_ 130 RATING AGENCIES__________________________ 132 UNDERSTANDING BOND PRICING ___________ 134 STRUCTURING BOND ISSUES ________________ 135 REFINANCING OR REORGANIZING

EXISTING DEBT___________________________ 136 COMMON TERMINOLOGY_____________________ 137

Debt Financing Concepts


Policies for Managing Debt The purpose of debt management policies is to provide guidance in the

issuance and management of debt. The primary consideration is the amount of debt and annual debt service that is affordable. A sound multi-year capital plan, integrated with the operating cost of the facilities, is also part of a good debt management plan. The debt management plan sets targets for the overall level of debt and establishes pay-as-you-go standards. A properly formulated debt management policy can help avoid the im-proper use of debt to cover accumulated deficits for operating purposes.

Debt Management Guide lines

Several states have instituted formal debt management policies in recent years. The purposes of these policies are to:

• Establish general guidance for affordability,

• Link capital planning to debt policy,

• Strike an appropriate balance between cash and debt financing,

• Determine the appropriate use of debt,

• Coordinate multi-agency issuances of debt, and

• Target or limit the total amount of all types of debt.

For selected state examples of debt management policies, see NASBO’s publication Debt Management Practices in the States.

Debt Capacity One approach to monitoring and limiting the total amount of all types of debt is to establish a model for tracking “debt capacity.” This term is used by the bond rating agencies to mean the amount of debt that may be pru-dently authorized and issued in a given period of time without negatively affecting the credit rating of the issuer. The concept of debt capacity rec-ognizes that a governmental unit has a finite capacity to issue debt at a given credit level. Issuance beyond a prescribed level (such as when debt service exceeds five percent of general tax revenues) can cause an erosion in credit ratings. A debt capacity model is a tool for helping states strike the proper balance between capital needs and the ability and willingness to repay debt issued to finance these needs.



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Debt Financing Instruments

State governments are faced with the fundamental policy choice of which projects and activities are appropriate for debt financing. In addition, con-siderations regarding length of maturity, interest rates, bond pricing, and refinancing are important to the state budget.

Bonds and Notes There are several debt instruments available for both long-term and short-term financing. Long-term debt (maturities of more than one year) includes General Obligation Bonds, Revenue Bonds, and Lease-Purchase Bonds (Certificates of Participation). Each type has its own purpose. Some states use short-term debt (maturities of one year or less) to meet cash flow re-quirements, to close unplanned deficits at year end, or to generate needed cash prior to a longer term bond sale. Short-term debt instruments are of-ten referred to as notes and include Revenue Anticipation Notes (RANS), Bond Anticipation Notes (BANS), and Tax Anticipation Notes (TANS).

Traditional Types of Bonds

There are four general categories of debt issued by states:

• General Obligation (G.O.) Bond. Payments of maturing principal and interest (debt service) are secured unconditionally by the full faith, credit, and taxing powers of the issuing government. If the taxes levied initially are insufficient to meet the debt service requirements, the issuer is legally obligated either to raise the tax rate or to broaden the tax base in order to provide the necessary funds. G.O. bonds result in the high-est ratings and lowest overall borrowing costs.

• Revenue Bond. Debt is secured by the revenue of the project financed, or some other specific revenue stream. In the case of an inability to meet debt service payments, the issuer is not obligated to levy taxes. However, there is generally a lien in favor of the bondholders on the facility financed or some other collateral. Revenue bonds are typically rated by bond agencies one step below G.O. bonds.

• Special Obligation Tax Bond. These bonds pledge a specific tax, such as sales tax or motor fuel tax, to the payment of the debt service.

• Leasehold Revenue Bond. Commonly referred to as lease-purchase or certificates of participation, these are actually issued by an entity other than the state itself. The entity is typically an Ownership Authority Board established by the state. The revenue stream for the debt service is rental payments made to the issuing entity by the state itself. This can



be the most expensive form of borrowing and will usually receive one full letter grade rating lower than G.O. bonds.

Recent Developments

More recent developments in the use of debt financing include bonding unfunded pension obligations and delinquent tax collections. Pension bonds are issued by the state to generate cash which is placed in the pen-sion fund. The fund is able to earn a higher rate of return than the interest cost of the bonds. The state then reduces or eliminates the pension fund’s unfunded liability without a large one-time drain on general fund cash, but must pay off the bonds through appropriations. Delinquent tax collection bonds are issued to provide the state with cash needed immediately. They are repaid with the collected tax accounts receivable.

Another type of new financing method includes the issuance of "Transpor-tation Revenue Anticipation Notes," where states issue bonds and pay the debt service with a combination of federal highway funds and state general funds. This type of financing is relatively new and is made possible by re-cent statutory changes involving the use of federal highway funds for ser-vicing long-term debt.



Indebtedness and Credit Rating Issues

In determining whether to use debt financing, the type of debt, and the to-tal amount of indebtedness, states must consider:

• The affordability of the annual debt service payments,

• The overall level of debt relative to the size of the state,

• Legal limits on debt,

• The burden on future budgets, and

• Credit rating issues.

Annual debt service as a percent of general operating revenue (or expendi-tures) is the basic measure of debt service affordability. According to Wall Street bond rating agencies, a rule of thumb for states’ general obligation debt is that two percent or less is considered low and more than five or six percent is considered high. Because all states’ tax, fund, and debt service structures are different, each state must determine the affordability of an-nual debt service payments (or their “debt capacity”) based on their own circumstances.

Benchmarks for Manageable Debt

There are several methods employed to gauge the total amount of debt that is manageable for a state. These include debt per capita, debt per as-sessed (or market) value of property, and debt as a percent of personal in-come. Again, individual circumstances of a given state and other factors must be taken into account when looking at these measures, but the fol-lowing table displays some general benchmarks:

Low High

Per Capita Debt less than $500 more than $1,200

Debt as % of Personal Income less than 4% more than 10%

Source: Government Finance Review

Debt Limits Many states have legal limits on state debt in the constitution, state statute, or inherent in the budgeting and appropriations process. Often these limits determine what type of bonds (General Obligation Bonds, Revenue Bonds, Certificates of Participation) can be issued in specific situations. Budget analysts should be thoroughly familiar with these provisions.



Debt Service One way to reduce the burden on future budgets is to shorten the term of the bonds. Maryland and Utah, both states with the highest bond ratings, tend to use shorter term debt maturities. This has the advantage of decreas-ing total interest costs but increases annual debt service requirements on a given bond issue. It is important that states structure maturities to ensure that debt service is affordable over the length of the bond issue. The debt service schedules of existing bonds outstanding should also be factored in. In general, fairly even or level debt service schedules are desirable, avoid-ing large upward variations or balloon payments in the schedule.



Rating Agencies

Credit ratings are important because they help enable access to capital markets for the issuer and directly affect the interest rates for the bonds sold. The higher a bond is rated, the lower the interest rate; and therefore, the lower the cost of debt. There are also political considerations for main-taining or improving bond ratings: governors and legislators use high bond ratings as evidence of their own fiscal stewardship. There are three credit rating agencies that evaluate municipal credits: Moody’s Investors Service, Standard & Poor’s Corporation, and Fitch Investors Service. Their various publications provide important guidance to bond issuers.

Bond Issuances Evaluated

The rating agencies rate bond issuances, not issuers. Nevertheless, the per-formance and strength of the issuer is an important factor in the rating as-signed to an issuance. It is important to note that ratings are not limited to the initial issuance but are monitored and can be changed over the life of the issuance. Ratings are designed to inform the investor about the level of security of the investment. Bond holders want to know that their capital will be returned in full and that interest payments will be made. They also want to know that principal and interest payments will be made on time.

Rating Scale/Grade Each rating agency has a slightly different rating or grading scale. For pur-poses of illustration, the rating grades for long-term debt from Standard & Poor’s Corporation is described. Investment Grade ranges from the high-est rating of “AAA,” indicating the capacity to pay interest and principal is extremely strong, through “AA” and “A” to “BBB,” which indicates that there is an adequate capacity to make the payment. Speculative Grade ratings are “BB,” “B,” “CCC,” “CC,” and “C” indicating that there is some capacity for repayment; however, there are large uncertainties or major risks of repayment. Other grades and notations include a “D” rating which indicates payment default. The ratings from “AA” to “CCC” may be modi-fied by a plus (+) or minus (-).

Four Areas Evaluated

There are four general areas of performance that the rating agencies evalu-ate: debt, economy, finance, and management. The agencies use quanti-tative, objective measures to evaluate the security of an issue, but also must use subjective judgment to take into account individual differences be-tween states.

• Debt. Rating agencies assess first and foremost, an agency’s ability to repay. They also look at the total debt of the issuer, the legal authoriza-tion for the bonds, security provisions, debt term matching or not ex-ceeding the useful life of the projects, and expectations for future bor-



rowing. There should be a link between the capital plan and debt plan. They also look at the debt supported by taxpayers of multiple overlapping jurisdictions.

• Economy. The economy affects the ability of the state to levy taxes and generate revenue. Rating agencies view economic diversity as a strength because it promotes steady growth and protects against major downturns. Other significant economic factors include demographics and the tax structure of the state. The diversity of the economy can make the difference between a good rating and the highest rating.

• Finance. In this area, the rating agencies look for long-term stability of revenues rather than a year-end snapshot for any given year. Sound fi-nancial performance is essential to credit security. Factors considered include the affordability and range of government services, fund bal-ances and balance sheet strength, accounting methods, revenue and expenditure control, and general flexibility of state finances. The au-thority, willingness, and demonstrated history to raise necessary reve-nues are important to the rating agency.

• Management. Rating agencies also assess the strength and perform-ance of the state’s management team. The raters want to know if man-agement makes timely and sound decisions and swiftly solves a finan-cial problem or crisis if one arises. Raters are especially interested in the following: 1) existence of a balanced budget, 2) using one-time revenues for one-time needs, and 3) swift action to close deficits. Every management team must operate within certain constitutional and statu-tory constraints, and these are weighed by the rating agencies as limita-tions on financial flexibility. Management factors can be especially important in economic downturns.



Understanding Bond Pricing

Tax-exempt municipal bonds are generally attractive to institutional inves-tors or high-tax-bracket individual investors. Bonds are initially sold to an underwriter who then sells the securities to investors. The underwriter charges various fees that can be a discount on the purchase price or are reflected in the interest rate.

Competitive vs. Negotiated Sale

In a competitive sale, bonds are awarded to the lowest bidding underwriter on a specific day. In a negotiated sale, an underwriter is selected through a request for proposal process and then the issuer and the underwriter ne-gotiate interest rates and a purchase price on the day of pricing. While there is greater flexibility with regard to timing to adapt to market condi-tions in a negotiated sale, there is less competition to help achieve the best interest rates for the issuer.

Present Value The price of a municipal bond consists of the present value of the principal plus the present value of the interest. Plotting the interest rates by year on a graph is called a yield curve and determines interest costs over the life of the bonds. Certain types of bonds, known as zero coupon bonds, pay no interest but instead are sold at a steeply discounted price. Because of their lower purchase price, these bonds can be sold to smaller investors, such as individuals saving for college.



Structuring Bond Issues To prepare for a bond issue, the issuer should develop a competitive re-

quest for proposal for a financial advisor and bond counsel. The financial advisor provides extensive financial analysis to deal with structuring, tim-ing, and pricing the bond issue. The financial advisor can help evaluate the cost-effectiveness of alternatives and options. The bond counsel ren-ders an opinion as to the legality and tax ramifications of the bond issue. This team works to develop the official statement. Like a stock prospectus, the official statement describes the bond issue, security for the bonds, fi-nancial information about the issuer, and discloses risks associated with the investment.

Arbitrage Restrictions

Because municipal bond interest earnings are not subject to federal in-come tax, investment return on bond proceeds for the issuer are limited by federal law and the IRS. Bond issuers cannot issue bonds and invest the proceeds at a higher rate than the interest cost of the bonds. The invest-ment concept of excess interest earned over interest paid is called “arbi-trage.” Restrictions applied to bond arbitrage generally require expending bond proceeds within three years and limit interest earned over interest paid to 1/8 percent.



Refinancing or Reorganizing Existing Debt

Occasionally circumstances arise which require or suggest the refinancing or restructuring of existing debt. For example, bond market interest rates may change after bonds are sold. In addition, financial circumstances can change enough to indicate that a reduction in state debt is warranted. Most bonds have call provisions that enable the issuer to repay principal earlier than originally scheduled. New bonds, called refunding bonds or advance refunding bonds, can be issued at lower interest rates and the proceeds used to pay off the existing bond principal.

Defeasance Debt can also be reduced or removed from the balance sheet even if the bonds are not callable. Existing bonds can be defeased. That is, available cash from the budget and/or cash from issuing refunding bonds is placed in an escrow fund. Payments for the debt service on the original bonds are made from the escrow fund. The original debt liability is removed from the balance sheet. Freeing up reserve requirements or eliminating undesirable bond covenants can be another advantage to refunding debt.



Common Terminology Note: Debt financing is an area of state finances that has a highly technical and

legal terminology. Budget analysts should have a general understanding of these terms. The following glossary contains terms and definitions that have been adapted or borrowed from three works. The sources are identified in the following manner:

(no asterisk) Moak, Lennox L., Municipal Bonds: Planning, Sale and Ad-ministration, Municipal Finance Officers Association, 1982, pp. 345-362.

*U.S. Department of Agriculture, Economics, Statistics and Cooperative Ser-vice in cooperation with the Department of Agriculture and Applied Eco-nomics, University of Minnesota, Issuing Municipal Bonds: A Primer for Local Officials, U.S. Government Printing Office, 1977, pp. 17-20.

**U.S. General Accounting Office, Trends and Changes in the Municipal Bond Market as They Relate to Financing State and Local Public Infrastruc-ture, U.S. Government Printing Office, 1983, pp. 33-34.

Arbitrage. The gain which may be obtained by borrowing at a tax-exempt rate and investing at a taxable rate by a tax-exempt investor.

*Average Maturity. The number of years which marks the point at which half the principal remains unpaid. It is equal to the total bond years divided by the total number of bonds.

*Balloon Payments. Final principal payments that are much larger than the other principal payments.

Basis Point. One one-hundredth of one percent (0.0001). Used in the pricing of bonds and in discussions of the yield of a bond.

Bid. An offer to purchase securities at a given price or under other stipulated conditions. A bid may be submitted in either a competitive sale or a negoti-ated sale of municipal bonds.

Bond. A written promise to pay a specified sum of money, called the face value (par value) or principal amount, at a specified date or dates in the future, called the maturity date(s), together with periodic interest at a specified rate. The difference between a note and a bond is that the latter runs for a longer period of time and requires greater legal formality. The term bond has a sec-ond meaning in municipal bond finance, namely the par value of $1,000. Al-though bonds may be issued in any denomination, municipal bond dealers and others use the term to mean $1,000 par value, regardless of the actual de-nomination. Thus, a $25,000 bond would be referred to as “25 bonds.”



Bond Anticipation Notes (BANS). Short-term interest-bearing notes issued by a government in anticipation of bonds to be issued at a later date. The notes are retired from the proceeds of the bond issue to which they are related.

*Bond Counsel. An attorney retained by the state or municipality who assures the purchaser that the bond was legally issued. The bond counsel’s approving opinion is printed on each bond and states that in counsel’s opinion, the mu-nicipality has complied with all legal requirements in issuance of the bonds and that interest paid on the bonds is exempt from income tax.

Bond Discount. The excess of the face value of a bond over the price for which it is acquired or sold. The price does not include accrued interest at the date of acquisition or sale.

*Bond Resolution. An action of a governing body of a state or local govern-ment, or agency thereof, authorizing a bond issue. The bond resolution may be self-operative, or it may require further approval, for example, by the elec-torate or by other governmental officials, before bonds can be sold thereunder.

Call Option. The right to accelerate the redemption date of a bond which is reserved by the issuer at the time of sale. It is subject to the conditions in-cluded in the bond contract.

Call Premium. The amount the issuer has promised to pay in excess of par value when bonds are redeemed in advance of their maturity date.

*Capital Improvement Plan. A plan for capital expenditures to be incurred each year over a fixed period of years to meet anticipated needs. It sets forth each project or other contemplated expenditure in which the government is to have a part and specified the full resources estimated to be available to finance expected expenditures.

Coupon. That part of a bond which evidences interest due. Coupons are de-tachable and, as they become due, they may be presented for payment.

Coverage. The extent to which revenues pledged for a bond issue exceed (or are expected to exceed) the debt service requirements expressed either in terms of the highest year or average year’s debt service. Thus, a bond issue with a debt service of $1,000,000 per year that has pledged revenues expected to produce $1,400,000 per year is said to have a 140 (percentage) or a 1.4 times coverage.

*Current Yield. Annual interest payable on a bond divided by its current price, expressed as percent.

*Debt Limit. The maximum amount of debt that a governmental unit may in-cur under constitutional, statutory, or charter requirements. The limitation is usually some percentage of taxable valuation and may be fixed upon either



gross or net debt.

Debt Service. The amounts of money necessary to pay interest and principal requirements for a given year or series of years.

Debt Service Fund Requirements. The amounts of revenue which must be provided for a Debt Service Fund so that all principal and interest payments can be made in full on schedule.

Default. Failure to pay principal or interest promptly when due. It is also used to refer to a specific violation of other covenants made in respect to an issue of debt.

*Financial Advisor or Financial Consultant. A person who offers a broad range of services to states or municipalities seeking debt financing, including preparation of capital improvement plan, official statement, and other docu-ments; procurement of bond rating; and marketing.

General Obligation Bonds. Bonds for the payment of which the full faith and credit of the issuing government are pledged.

Gross Debt. The sum total of an issuer’s obligations.

Indenture. The formal agreement between a group of bondholders, acting through a trustee, and the issuer as to the terms and security for the debt.

Industrial Revenue Bonds. Bonds issued by governments, the proceeds of which are used to construct facilities for a private business enterprise. Lease payments made by the business enterprise to the government are used to pay debt service.

**Infrastructure. Structures and equipment owned by states and localities. This includes highways, bridges, buildings, mass transit systems, and public utilities such as water, sewer, or power systems.

Issuance Costs. The costs incurred by the issuer of securities incident to the planning and sale of securities. These costs include the spread for underwrit-ers, feasibility studies, printing, advertising, the fees of counsel, costs of presentations to potential investors, and the value of staff time and facilities required in the planning and sale of the bonds. They ordinarily do not include the costs of holding elections, when required as a part of the process of authorization. Issuer. The governmental unit in the name of which securities are issued.

Legal Opinion. 1) The opinion of an official authorized to render it, such as an attorney general or city attorney as to legality of a bond issue. 2) In the case of governmental bonds, the opinion of a specialized bond attorney as to the legal-ity of a bond issue.



Long-term Debt. Debt with a maturity of more than one year after the date of issuance.

Marketability. Connotes ability of the issuer to sell a security in the market-place on reasonable terms.

Negotiated Sale. A sale of securities in which the terms of the sale are deter-mined through negotiation between the issuer and the purchaser without com-petitive bidding. Includes sales of securities directly to commercial banks or consortiums of commercial banks as well as to investment banking firms or syndicates, private placements by issuers, or other sales to investors on other than a competitive basis.

Net Bonded Debt. Gross bonded debt less any cash or other assets available and earmarked for its retirement.

Net Interest Cost (Rate) (NIC). The average interest cost rate on a bond issue calculated on the basis of simple interest.

Official Statement. A statement issued by a governmental authority at the time of sale of its bonds or notes setting forth the pertinent facts concerning the issuer, the issuer’s financial condition, the security pledged for the securities being offered, the projected use of the proceeds of the sale, and other facts deemed necessary to enable the investor to judge fairly the quality of the securities being offered. Also known as the Disclosure Statement.

Par Value. The face value or amount of the principal of a bond or note.

Pay-As-You-Go Basis. (Pay-As-You-Spend) - A term used to describe the finan-cial policy of a government which finances all of its capital outlays from current revenues rather than by borrowing. A government which pays for some im-provements from current revenues and others by borrowing is said to be on a partial or modified pay-as-you-go basis.

Pay-As-You-Use. A term used to describe the financial policy of a governmen-tal unit which borrows to pay for its capital needs. Pay-as-you-use allocates costs among the users of each “generation.”

Paying Agent. A commercial bank or other institution acting as agent for the issuer in the interest or principal on a bond or note.

Preliminary Legal Opinion. A draft of a legal opinion presented by bond counsel in advance of the completion of all of the steps incident to sale. It of-fers an indication of the language likely to be included in the legal opinion to be issued at the time of the delivery of the bonds.

Premium. The excess of the price at which a bond is acquired or sold over its face value.



Principal. The par value or face value of a bond, note, or other fixed amount security, excluding accrued interest.

Qualified Legal Opinion. A legal opinion containing conditional, as distin-guished from unconditional, affirmations concerning the legality of an instru-ment used in borrowing and/or concerning the tax status of the interest on a debt instrument.

Rate Covenant. A provision in a bond indenture under which the issuer agrees to adjust rates charged for services being rendered in order to produce sufficient revenue to meet obligations under an indenture.

Ratings. Designations of the quality of bonds or notes issued by states and lo-cal governmental units. Ratings are provided by agencies or corporations that seek thereby to render a professional judgement concerning the quality of the security being rated.

**Refunding. A system by which a bond issue is redeemed by a new bond issue under conditions generally more favorable to the issuer.

Registered Bond. A bond where the owner is registered with the issuing gov-ernment (or its bank or trustee agent) and which cannot be sold or exchanged without a change of registration.

Regular Serial Bonds. Serial Bonds in which the annual installments of bond principal are about equal.

Revenue Anticipation Notes (RANS). Notes issued in anticipation of the re-ceipt of revenues, generally non-tax revenues -- especially revenues receiv-able from other governments.

Revenue Bonds. Bonds where the principal and interest are payable exclu-sively from earnings of an Enterprise Fund. The term revenue bonds is cur-rently used in the municipal bond market to include almost all bonds other than general obligation bonds.

Sale Date. The day on which a contract is executed between the issuer and the purchaser of an issue of securities.

Secondary Market. The market in which bonds are sold at a time following the initial sale in the new issue market.

Securities. Bonds, notes, mortgages, or other forms of negotiable or non-negotiable instruments.

*Serial Annuity Bonds. Bonds whose principal and interest payments are con-stant each year.

Serial Bonds. Bonds whose principal is repaid in periodic installments over the



life of the issue.

Settlement Date. The day on which the securities are exchanged by the is-suer for the purchase price, after taking into consideration the security deposit and the accrued interest on the bonds.

Short-term Debt. Debt with a maturity of one year or less after the date of is-suance.

Special Assessment. A compulsory levy made against certain properties to defray part or all of the cost of a specific improvement or service deemed to primarily benefit those properties.

Syndicate. A group of investment bankers and commercial banks who buy (underwrite) a new issue from the issuer and offer it for resale to the general public.

Tax Anticipation Notes (TANS). Notes issued in anticipation of collection of taxes, usually retirable only from tax collections, and frequently only from the proceeds of the tax levy whose collection they anticipate.

Tax-Exempt Bonds. Bonds where the interest is exempt from federal income taxes under Section 103 of the Internal Revenue Code of the United States or other federal legislation.

Term (of Bond Issue). The number of years for which the bonds are issued. Usually related to the number of years from date of issue to date of final matur-ity.

Term Bonds. Bonds where the entire principal matures on one date.

*Total Bond Years. The sum of all the bond years of a particular issue.

Unqualified Bond Counsel Opinion. A bond counsel’s opinion which contains no qualifications or exceptions concerning the legality of the bond issue or its tax-exempt status.

*True Interest Cost Bid (Rate) (TIC). Method of evaluating an underwriter’s bid which takes into account both the total dollar amount of coupon payments and the time pattern of coupon payments.

*Underwriter. The investment house (or houses) that purchase a bond offer-ing from the issuing government.

*Yield. The net annual percentage of income from an investment. See Cur-rent Yield and Yield to Maturity.

*Yield to Maturity. Percentage of return from a bond that takes into account



current yield and amortization of any premium or discount.


Debt Financing Competency Test

Competency Test

True or False

Q1: When a state considers issuing bonds, the sole consideration is the effect of the debt on the state’s credit rating.

Q2: If annual debt service exceeds two percent of general fund revenues, this is considered high.

Q3: Rating agencies apply only the same objective measures to all states when determining a credit rating.

Q4: A shorter maturity schedule for bonds has the advantage of lowering annual debt service payments.

Q5: States can brag about their high credit rating, but it has no financial benefit to the state.

Q6: As long as bond holders are repaid, they are satisfied.

Q7: If a state has good managers and follows generally accepted account-ing principles, then a diverse economy is not needed for a high credit rating.

Q8: The only way to refinance debt is to call the existing bonds.

Q9: In pricing bonds, a negotiated sale is better than a competitive sale.

Q10: The financial advisor renders a legal opinion about a state’s bond issue.

Q11: Revenue bonds have the lowest interest cost because they have a secure, earmarked revenue source backing them up.

Q12: States can issue bonds and invest the proceeds at higher interest rates for the purpose of making a profit for the general fund.

Q13: Short-term debt is always a negative financial factor for the credit rat-ing.

Q14 A high credit rating will ensure low interest rates for a bond issue.

Q15: Once a rating for an issuance is granted, it cannot be changed.

Short Answer

Q16: List the three municipal credit rating agencies.

Q17: What is the purpose of a debt management policy?

Q18: What four general areas do credit rating agencies assess when assign-ing a rating?

Debt Financing Competency Test


Q19: What is the primary difference between G.O. bonds, revenue bonds, and lease-purchase?

Q20: How does a state refinance debt if the outstanding bonds are not callable?

Multiple Choice

Q21: The State Debt Management Network is affiliated with:

A) the National Association of State Budget Officers

B) the National Association of State Treasurers

C) the National Council of State Legislatures

D) A & C

Q22: In general, states must spend bond proceeds:

A) within 12 months

B) within 3 years

C) within 7 years

D) anytime prior to bond maturity

Q23: Limits on state debt can be found in:

A) the state constitution

B) a state statute

C) a state debt management policy

D) the budget and appropriations process

E) all of the above

Q24: States can refinance or reduce debt through:

A) advance refunding bonds

B) defeasance

C) certificates of participation

D) Fitch Investors Service

E) A and B


Module 10: The Federal Budget

Overview Because a significant portion of state spending relies on federal funding, it is important for state budget analysts to understand the federal budget process, timetable, and issues.

According to budget scholar Allen Schick, “The federal budget is an enormously complex undertaking. It demands the active participation of the President and most members of Congress and the efforts of tens of thousands of staff persons in the executive and legislative branches. It en-tails thousands of big and small decisions, regard for countless rules and procedures, and conflict over how the government raises and spends pub-lic funds. The process could hardly be otherwise because so much is at stake when budget decisions are made. The budget controls more than $1.5 trillion a year in spending, an amount equal to almost one-quarter of the nation’s gross domestic product. Federal budget receipts are about one-fifth of the Gross Domestic Product. The budget deficit, which results from the imbalance between revenues and expenditures, makes the fed-eral government the largest single borrower in capital markets.”

This module provides an overview of basic components of the federal budget.

BASIC TERMS AND CONCEPTS ____________ 147 BILL ENACTMENT PROCESS_______________ 149 HIGHLIGHTS OF THE FEDERAL BUDGET

PROCESS ____________________________ 150 BUDGET TIMETABLE _____________________ 154 NEW STATE PERSPECTIVES: TRENDS IN

FEDERALISM _________________________ 156 PROBLEMS WITH THE CURRENT FEDERAL

SYSTEM _____________________________ 157

The Federal Budget Concepts


Basic Terms and Concepts The federal budget lexicon is extensive. Terminology and definitions dif-

fer from those used in state budget offices. The following terms and con-cepts are the most essential for state budget analysts.

Authorization Authorization is the substantive legislation that establishes the purpose and guidelines for a given activity and usually sets a limit on the amount that can be appropriated or spent. The authorization does not provide actual dollars for a program. Important elements contained in an authori-zation are the purpose for the program’s existence, funding formula and general program structure, including applicable percentage for administra-tion. Authorization bills are usually for a multi-year time frame.

Appropriation An appropriation is the amount of money that can be spent on a particu-lar program in a given year. Throughout the budget process, an appropria-tion is also known as discretionary spending because it is subject to the annual appropriation process. Generally speaking, appropriations are for one year time frames.

Entitlement An entitlement is a particular type of authorization that mandates that the federal government pay benefits to any person or unit of government that meets the eligibility requirements that are established for the program. An entitlement represents a binding obligation on the part of the federal gov-ernment; eligible recipients have legal recourse to compel payment from the government if the obligation is not fulfilled. Usually the authorization contains formulas or criteria that specify who is eligible for federal assis-tance. Therefore, once direct spending is authorized it will continue al-most automatically until revised through the authorization process. The question of how much will be spent is answered by the number of eligible people and what services they will receive. Attempts to control this spend-ing usually involve capping expenditures at a certain level, reducing eli-gibility, or limiting payments.

Discretionary Spending

Discretionary spending is a category of federal spending subject to the annual appropriations process. It includes such things as funding for transportation, environmental programs, job training, and education pro-grams.

Budget Authority

Budget authority is the permission granted by law to an agency or de-partment to make commitments to spend money. It is not the actual ex-



Authority penditure of cash. When Congress appropriates funds for a particular pro-gram it is enacting budget authority, not cash or outlays. However, for the purposes of deficit calculations it is the outlays that are measured and it is through levels of budget authority that Congress controls spending.

Outlays Outlays are the actual expenditure of cash. The difference between budget authority and outlays is most evident in construction projects that may have budget authority over a number of years without spending cash.

Deficit Deficit is the amount by which the federal government’s total budget out-lays exceeds its total receipts for a fiscal year.

Federal Debt Federal debt is the total accumulation of debt by the federal government. Federal law contains a statutory limit called the debt ceiling which must be periodically extended or else federal borrowing must cease. In the last federal government shut-down in 1995, the Secretary of the Treasury re-sorted to borrowing extensively from federal trust funds to prevent defaults on federal loans.

Mark-up Mark-up refers to meetings by congressional committees or subcommit-tees for the purpose of agreeing on the specific language of bills.

Firewall Firewall is the term to describe the prohibition of reducing domestic de-fense spending to fund domestic discretionary programs.



Bill Enactment Process

The following is a brief overview of how a bill becomes a federal law. In general, the House introduces and passes its appropriation bills before the Senate. The bill enactment process is usually as follows (assuming House action first):

• A bill is introduced and referred to the appropriate commit-tee/subcommittee.

• The subcommittee will hold hearings. It will then “mark-up” a bill and forward it to the full committee for action. The full committee will continue to “mark-up” the bill and report it out of the full committee to the floor of the House of Representatives.

• Generally floor votes are scheduled on the calendar. After a bill is placed on the calendar it goes to the Rules committee which deter-mines the parameters of debate, including the number of amendments to be allowed. (The House Rules Committee will often attempt to limit the number of amendments.)

• The floor debate occurs and the bill either passes, fails, or is amended.

• The bill is sent for action in the other house (in this example, the Sen-ate).

• The Senate bill is referred to committee/subcommittee.

• The bill is again marked up or amended by the subcommittee and sent to the full committee at which time it is marked-up.

• The bill is reported out of committee and sent to the floor of the Sen-ate.

• The floor vote is scheduled. Generally the Senate does not limit de-bate or amendments.

• If the bill passed by the Senate is different than the bill passed by the House, the bill is sent to a Conference Committee between the two houses. The Conference Committee agrees to a unified bill and each body votes on the bill (a yes or no vote only).

• A bill passed by both the House and Senate is sent to the President for signature.

• After enactment, a federal agency usually will implement the new bill and issue regulations.



Highlights of the Federal Budget Process

There are two main participants in the federal budget process -- the Presi-dent and Congress. Both the President’s proposal and Congressional proposals will attempt to meet the parameters of the Budget Enforcement Act of 1990. This act replaced the Gramm-Rudman-Hollings system of deficit limits and sequestration with caps on discretionary spending and pay-as-you-go requirements for new direct spending and revenue legisla-tion. These requirements are extended to the end of federal fiscal year 1998. Although not mandated by law, both the President and Congress are attempting through long range budget plans to reduce the federal budget deficit to zero by 2002.

President Submits Budget

The President submits a detailed budget plan usually the first Monday in February for the fiscal year starting October 1st. The budget presents the President’s budget message, which highlights major policy recommenda-tions and changes. It provides summary information on receipts, trust funds, credit programs, investment outlays, federal aid to state and local governments, federal borrowing and debt, and other financial matters. It presents expenditure data by functions, agencies, and accounts. For each annually appropriated account, it provides the text of the current appro-priation with proposed changes, and a narrative explanation of the ac-count’s programs and performance.

Budget Resolution

Congress holds budget hearings and attempts to produce a Budget Reso-lution by April 15th. Both houses will generally hold hearings but not jointly. The resolution will follow the same approval process as a bill, ex-cluding signature by the President and implementation by a federal agency. This is the one time Congress considers the federal budget as a whole rather than individual parts. Budget Resolutions set forth budgetary levels for the upcoming fiscal year and planning levels for the following four fiscal years. Spending must be within the existing statutory caps for discretionary spending. Budget Resolutions contain the following:

• Budget aggregates for total revenues, and the amount by which the total should be increased or decreased; total new budget authority and total outlays; total direct loan obligations and primary loan guarantee commitments; the deficit or surplus; and the public debt.

• Amounts which are allocated to each congressional committee. At no time in the Budget Resolution process are funds allocated to specific programs. The Budget Resolution can provide specific program as-sumptions but it must be remembered that these do not actually allo-



cate funds to a program. After spending totals are allocated to each committee, each committee divides the amount allocated to it among its subcommittees. This process is named after the sections 302 and 602 of the Congressional Budget Act. Monitoring this suballocation process is the first step in identifying possible program funding prob-lems. For example, if an appropriation subcommittee has a two per-cent loss in total funding, not all programs will get a two percent re-duction. It is much more likely that some programs will get increases and others decrease, but total subcommittee spending must meet the two percent reduction.

• Reconciliation instructions are given to authorizing committees direct-ing them to draft changes in existing laws in order to achieve specific dollar amounts within the committee’s jurisdiction. States should pay close attention to this because entitlement spending is revised by Rec-onciliation Acts which are subsequent bills enacted to complete rec-onciliation instructions.

• Congressional enforcement mechanisms have also been included in Budget Resolutions and have included pay-as-you-go and discretion-ary caps and firewalls.

Budget Enactment Budget enactment is generally through passage of individual appropria-tions bills. This process is described above. The appropriation process should be completed by October 1st. If a full year appropriation bill is not enacted, Congress and the President usually agree to short-term Continu-ing Resolutions to continue programs until the full year appropriation bill is enacted. Sometimes these bills are rolled together into one large bill for a full year Continuing Resolution or “CR.”

When tracking federal funds through the appropriations process, states should identify specific language in the committee reports that could di-vert funds to specific projects, thereby reducing total program funds avail-able for states.

Reconciliation First devised in the Congressional Budget Act of 1974, reconciliation was designed to allow Congress at the end of the fiscal year to enact legisla-tion, which could not be filibustered in the Senate, to fine tune revenue and spending levels. During the 1980s, reconciliation came to be used as a vehicle for implementing major economic and budget plans rather than just fine tuning. It was also the vehicle for major Medicaid expansions throughout the 1980s. In recent years, both Congress and the President have made it a high priority to reduce the federal deficit and reconcilia-tion has been a favored vehicle. The trend to use reconciliation as a vehi-



cle for entitlement changes continues.

Byrd Rule An important consideration should be kept in mind about the fast track procedures utilized by Congress for reconciliation. Items that can be identified as extraneous to reconciliation can be stricken from the meas-ure in the Senate under the provisions of the Byrd Rule. The Byrd Rule provides that an amendment or provision is extraneous if it: 1) produces no change in outlays or revenues, 2) increases outlays or reduces reve-nues and the reporting committee fails to achieve its instructed dollar change, 3) is not within the jurisdiction of the committee reporting the ti-tle, 4) produces changes in outlays or revenues that are “merely inciden-tal” to the non-budgetary components of the provision, 5) increases the deficit in any year beyond the years reconciled and such increase is not offset by other provisions in the same title, and 6) provides certain changes in the Social Security program.

Authorizing Legislation

Authorizing legislation generally has two main components: substantive legislation which establishes a program and prescribes the terms and con-ditions under which it operates, and the authorization for Congress to ap-propriate funds. This legislation is the first source for the description of a program. However, it is not the only source because appropriation com-mittees may offer language that will also direct the program.

The distinction between authorizing legislation and appropriations has been blurred by the following: insertion of legislative provisions in ap-propriation acts, extensive earmarking or specific dedication of funds, the growth of direct spending (entitlement) legislation, and the insertion of ap-propriation-forcing language in authorization legislation.

Additional Spending Limitations

Continuing in the same tradition as the Budget Enforcement Act of 1990, the 1994 Budget Resolution included limits on discretionary spending. The fiscal year 1997 Budget Resolution has also set spending limits through fiscal year 2002 with the defense/non-defense firewall in place through fiscal year 1998. The firewall is a specific limitation put in place to protect both categories of spending by limiting the amount of reduction that can take place in any given year.

Pay-As-You-Go Requirements

Mandatory spending is limited by pay-as-you-go provisions which were included in the 1994 Budget Resolution. A point of order can be raised by an individual member of either the House or the Senate, if the pro-posed legislation would cause an increase in the deficit over the next ten years. This provision in effect requires Congress to account for any new programs or changes to programs which result in increased direct spend-ing. For example, if Congress were to enact a program providing new



benefits to Medicare recipients, the increased costs would have to be paid for by a corresponding reduction in direct spending elsewhere or an in-crease in revenues.

Sequestration For direct spending and revenues, the Budget Enforcement Act of 1990 requires the Office of Management and Budget (OMB) to enforce a “pay-as-you-go” requirement. If OMB estimates that the sum of all direct spend-ing and revenue legislation enacted since 1990 will result in a net in-crease in the deficit for the fiscal year, the President is required to issue a sequester order reducing all non-exempt spending accounts by a uniform percentage to eliminate the net deficit increase. Social Security is exempt.

Line-item Veto Act of 1996

The Line-item Veto Act of 1996 gives the President authority to cancel wasteful spending and special interest tax breaks to reduce the federal budget deficit. The President has the authority to cancel any dollar amount of discretionary spending which is found in an appropriations act, any item of new direct spending, or any limited tax benefit. The law also provides for expedited legislative procedures which permit Congress to review and respond, if necessary, to the President’s use of this new author-ity by enacting a disapproval bill. If the disapproval bill is vetoed by the President, the Congress could override the veto by a 2/3rds vote.

Score Keeping “Score keeping” is the term used in Congress for measuring the budgetary effects of pending legislation in light of the Congressional Budget Resolu-tion and committee and subcommittee allocations made pursuant to it. The principal scorekeepers in Congress are the House and Senate Budget Committees. They provide official estimates that determine whether legis-lation is within the Budget Resolution’s allocations. Score keeping is not just an informational exercise. Its most important use is in sustaining or rejecting points of order against pending legislation.



Budget Timetable Date Action

5 days before President’s budget

submission

CBO sequester preview report.

1st Monday in Febru-ary

President’s budget submission (includes OMB sequester preview report and adjustments to spending caps).

February 15 CBO budget and economic outlook report.

Within 6 weeks of President’s budget

Committees submit views and estimates in the Budget Committees.

April 1 Senate Budget Committee reports budget resolution.

April 15 Congress completes budget resolution. If not, Chairman of House Budget Committee files 302(a) allocations; Ways and Means is free to proceed with pay-as-you-go measures.

May 15 Appropriations bills may be considered in the House.

June 10 House Appropriations reports last bill.

End of previous session to June 30

If an appropriations bill violates caps, OMB sequesters 15 days af-ter enactment.

June 30 House completes action on annual appropriations bills.

July 15 President submits mid-session review.

August 10 President’s notification on military personnel exemption.

August 15 CBO sequester update report.

August 20 OMB sequester update report (with adjustments in caps).

October 1 Fiscal year begins.

10 days after end of session

CBO final sequester report.


OMB final sequester report.


GAO compliance report.



New State Perspectives: Trends in Federalism

Several recent federal actions should be of particular interest to state budget offices:

• The Unfunded Mandate Reform Act of 1995 limits the imposition of unfunded federal mandates on state or local governments or the pri-vate sector without full and informed Congressional consideration of the effects of such mandates before enactment.

• The enactment of the Personal Responsibility and Work Opportunity Reconciliation Act of 1996 created a new block grant. This block grant made funds available to states to operate the Temporary Assis-tance to Needy Families (TANF) Program which replaced Aid to Fami-lies with Dependent Children (AFDC). From the state perspective, many of the nation’s governors wanted to replace the federal entitle-ment to welfare benefits with a block grant with increased flexibility.

• In April 1996, Congress enacted the President’s proposal for the Envi-ronmental Protection Agency’s Performance Partnership Grants, al-lowing states to combine several categorical grants for air, water, haz-ardous waste, or similar programs into an all-purpose environmental grant.

• New opportunities for program flexibility include the new Surface Transportaion Equity Act for the 21st Century(TEA21), Medicaid re-form and job training.



Problems with the Current Federal System

Although participants in the federal budget system, and others who study it, can undoubtedly identify numerous perceived problems with the sys-tem, the following issues are of particular note to state budget offices.

• Today the budget appears to be a limiting process, imprisoned in old priorities that narrow the opportunities available to government. Ac-cording to Allen Schick, it crowds out genuine choice and forces to-morrow’s programs to give way to yesterday’s decisions.

• Constant delays occur in meeting Congressional deadlines. A notable result of this was the actual shutdown of the federal government in 1995-96. The federal government has at times been an unreliable partner for state and local governments.

• The frequent delays in tackling politically-charged issues, such as defi-cit reduction, mean that timely achievement of fiscal policy is unlikely.


The Federal Budget Competency Test

Competency Test Q1: A state agency staff person has just told you that the federal govern-

ment has authorized $2.8 billion for a new discretionary domestic program. Should your state count on receiving your fair share of the $2.8 billion?

Q2: How is the new Temporary Assistance For Needy Families (TANF) different from AFDC?

Q3: When does the Federal Fiscal Year begin and what is the impact of this timing on state budgets?

Q4: The federal budget process is complex and fluid. What are the most essential aspects for state budget offices to know?


Module 11: Communicating Fiscal Issues

Overview Communication is the critical management process that can make or

break a budget analyst’s best technical and analytical efforts. A sound budget that is poorly presented may never achieve the attention it de-serves. This module focuses on effective communication with and among the budget players to achieve desired results. Topics include identifying the audience; selecting the appropriate vehicles to accurately and appro-priately present financial, operating, and policy information; recognizing and responding to politically sensitive situations; and using current tech-nologies and reliable resources to the best advantage.

IMPORTANCE OF COMMUNICATION TO

ACHIEVING BUDGET RESULTS __________ 160 AUDIENCE-SPECIFIC APPROACHES TO

COMMUNICATION ____________________ 161 SELECTING THE APPROPRIATE

COMMUNICATION VEHICLE ____________ 162 COMMUNICATING POLITICALLY SENSITIVE

INFORMATION _______________________ 163 PRESENTING FINANCIAL, OPERATING, AND

POLICY INFORMATION ________________ 164 PREPARING BUDGET DOCUMENTS_________ 166 USING GRAPHICS________________________ 167 EDITING YOUR OWN WORK_______________ 168

Communicating Fiscal Issues Concepts


Importance of Communication to Achieving Budget Results

Good communication in public budgeting has a constructive influence over the shape of government policy and public spending. The budget process is a decision making environment, and the quality and clarity of the financial, operating, and policy information communicated to the par-ticipants has an impact on the quality of executive and legislative deci-sions. Knowing facts, figures, policies, and procedures is not enough. To be effective, a good communicator must have a reputation for accuracy, clarity, honesty, and integrity.

Public Speaker and Negotiator

The budget analyst is sometimes required to be a persuasive public speaker and at other times is required to negotiate tough administrative policy positions through unreceptive channels. At any given time, a budget analyst may be speaking for the governor, budget director, or agency director or speaking to the governor, legislators, or the general public. To large extent, being an effective budget analyst depends on be-ing able to achieve results through effective communication.

Open Lines of Communication

Information is the life blood of the budget process -- a good budget analyst is informed. Having an open line of communication with agencies, inter-nal managers, and other budget players enhances the analyst’s ability to be knowledgeable and thorough. An effective budget analyst cultivates reliable contacts with agencies, seeks out agency publications, attends public meetings, and keeps apprised of ongoing activities to obtain accu-rate, timely information.



Audience-Specific Approaches to Communication

What is the purpose of the presentation? Who is involved? What do they want? Who else may use the information? Defining the audience, under-standing its expectations, and tailoring information to its particular needs will ensure that good communication occurs.

Tailor Message to the Audience

Audiences can range from the chief executive, members of the legislature, agency representatives, supervisors, managers, special interest groups, and the general public. The information must be understood by the audi-ence and also should be important to the audience. For example, mem-bers of a legislative body are concerned about their constituents and will want to know how an issue will positively or negatively affect their district. A department head is interested in the impact or outcome of an action rather than the technical details required to achieve it. The audience wants to know what the bottom line is and how it affects them.

For all audiences, long, rambling explanations are ineffective, and com-plex or very detailed information can be confusing. To prepare an effec-tive presentation, determine what needs to be conveyed, keep the presen-tation and materials simple and concise, and avoid jargon and acronyms. Being well-prepared is essential for communicating with confidence.

Anticipate Questions Prior to making your presentation, take some time to anticipate questions you will likely receive and how you will answer them. This will help en-sure that the extemporaneous portions of your presentation go as well as your formal, practiced presentation.



Selecting the Appropriate Communication Vehicle

In large measure, the complexity and urgency of what is being communi-cated, the required degree of formality, and the target audience will dic-tate the communication vehicle. Communications tools include budget documents, briefs, memoranda, messages, reports, media presentations, briefings, and issue forums.

Communications Tools

The most effective format for legislators may be a verbal presentation ac-companied by a handout of presentation highlights. A memorandum can be used in a variety of situations, such as in conjunction with a meeting where a budget analyst can verbally outline policies, recommendations, or timelines and receive questions or comments. A budget director, who concurrently monitors many detailed issues, may prefer to receive infor-mation in the form of budget briefs supplemented with reports and spreadsheets for further detail and future reference.

Choosing the Communication Tool

The information provided to the decision maker must be cost/benefit re-lated. Content, the needs of the audience, and the time frame for prepara-tion should be considered when choosing the tool to convey the informa-tion. A budget analyst should determine if there are preferred or standard formats for disseminating information. In the absence of a prescribed for-mat or a “feel” for how to communicate the message, consult with more experienced co-workers and the budget director. The goal is to effectively communicate pertinent information to improve understanding, not to add confusion.



Communicating Politically Sensitive Information

In the course of carrying out budget development, execution, and over-sight responsibilities, budget analysts are often entrusted with politically sensitive and sometimes confidential information. Even routine state budget information has the potential to be politically sensitive depending on how the information is used and what conclusions are drawn from it.

Responding to Inquiries

A budget analyst should know the office policy for dealing externally with politically sensitive issues. Who responds to inquiries from the legislature, citizens, and press? To effectively respond to inquiries, know the issues; anticipate the difficult questions; and recognize the extent to which infor-mation can be provided fairly and accurately. Requesting time to gather the facts or making a referral to the right person is far preferable to giving an erroneous, inaccurate, or inappropriate response. Personal opinions or editorial comments should not be aired, even in confidence to persons outside the analyst’s office.

Privileged Information

Budget analysts are often the recipients of privileged information and sometimes research fiscal and operational areas that ultimately lead to po-litically sensitive recommendations or outcomes. When assigned to a pro-ject, determine the level of sensitivity and confidentiality required and act with professionalism and diplomacy. Understanding the situation and handling it appropriately can effectively defuse a protective manager who might otherwise hinder research and analytical efforts.

While it may be expedient to simply forward an e-mail message to an out-side party, the sender should first determine if editing is necessary.

Handling Confidential Information

Confidential reports or analyses should have limited circulation and are often best suited to verbal transmission. Confidential working information should not be conveyed through means that are considered public do-main. Keep management informed of potentially volatile or sensitive is-sues to eliminate “surprises” among the executive budget staff.

Credibility The credibility of the budget office depends on open and honest commu-nication. Giving clear and accurate information in good times and in bad has the effect of bolstering trust among the participants. It is important to report and respond clearly, accurately, and with sensitivity to the political environment at all times.



Presenting Financial, Operating, and Policy Information

Budgets, policies, and laws are often based on information provided by the state budget office. The office has statewide oversight responsibilities for monitoring and analyzing fiscal conditions, operations, and policy compliance throughout state government. Budget analysts, through ac-cess to reliable information, are routinely required to amplify, add re-search, and report in written and oral formats for internal and external consumers.

Displaying Data Financial data is frequently displayed in tables, spreadsheets, charts and graphs. In choosing the right presentation tool, a budget analyst should consider who will be using the information. It is important to include a sufficient amount of detail and analysis to accurately represent a given is-sue. Columns of numbers must total correctly and supporting graphs should be meaningful. Notes, comments, and narrative should be in-cluded wherever necessary to explain or amplify financial reports. The date, and sometimes even the time should accompany the data.

Report Formats Operating and policy information is usually presented in narrative form and, like financial reporting, may have a prescribed format for presenta-tion. Budget analysts should be familiar with any standard report formats, both in terms of reports received into the budget office as well as informa-tion reported out from the budget office. Written reports should include the date, office and sources used, and budget briefs should include a con-tact person.

Presenting Information

The presentation of information should not be overwhelming, but should enhance what is being conveyed. Information should be prepared in a logical manner with adequate detail. When orally presenting fiscal data, use round numbers (particularly with millions and billions of dollars) and simple charts or overheads to create a visual image for the listener. Narra-tives and information should be brief and to the point, holding the atten-tion of the audience. Organizing reports, oral briefings, and presentations from the highest level of summary information to the lowest level of detail is helpful when presenting detailed information. This technique of “layer-ing” information will enable a budget analyst to gauge audience receptiv-ity and adjust strategies as needed.



Formulating Recommendations

The executive budget office is one of the few agencies with access to statewide information. Financial, operating, and policy information are tools used by decision makers in formulating a recommendation or course of action. Because information distributed from the budget office often has broad fiscal and policy implications, communications must be reliable and accurate.



Preparing Budget Documents

Preparing the governor’s recommended budget document is a primary function of the budget office. A great deal of time and effort is devoted to preparing detailed guidelines and schedules for the preparation cycle. Budget analysts are required to balance daily budget execution duties with intensive efforts to capture meaningful budget detail. Ultimately, a budget analyst must be able to blend agency requests, analytical efforts, and alternatives together into clear and concisely presented documents. The foundation and justification of a budget must be firm from the begin-ning. In the final analysis, how well the budget document is prepared – how well it is communicated and presented – will have an impact on how successfully it is received into the legislative approval process and whether it has a constructive influence on public spending.

Mission Statement

Effective communication of an agency’s or program’s mission, and the analyst’s understanding of the mission, are prerequisites to good budget formulation. A budget analyst should think in terms of outcomes and im-pacts, and about how the budget narratives and detail fit into the larger budget development process, providing a context for the agency and the services or products it provides. The end users of budget documents are fiscal analysts, budget professionals, program managers, and legislators. Remain aware that different people will have varying degrees of familiarity with the agency or program under review.

Resource Materials/Formats

A good budget analyst will keep reference manuals handy, refer to proce-dures and statutes when necessary, and be familiar with statewide policy memorandums or other directives originating from the executive branch. Central files and other reliable resources should be used to obtain current and historical fiscal information. The budget analyst should develop the appropriate documentation to refer to during the legislative session and in future years.

The appearance, structure, format, and content of standard budget docu-ments should be agreed upon in advance by all groups that will use them. Any deviations from the standard format should be noted where neces-sary for clarity and consistency.



Using Graphics

Designing an effective and attractive budget document can be a chal-lenge. Budget documents often contain complex fiscal data and narra-tives that do little to attract and hold the reader's attention. However, desktop publishing and other software packages have facilitated the abil-ity to produce budget information in more meaningful, interesting ways.

Visual Expression

Graphics are effective tools for enhancing a written or oral presentation. Visually expressing something can enhance text or verbal explanation. Spreadsheets, charts, and graphs can quickly reduce billions of dollars and complex components into a comprehensible, one page description. Use of boxes, boldface type, shading, and bulleted text help direct atten-tion to important information.

Design Elements

When adding graphics to budget presentations, some basic design ele-ments are: simplicity, balance, and emphasis on the most significant in-formation. Graphics such as charts and tables should be preceded in the text with brief narrative explanations. Graphs should quickly convey a point or concept and should not require a lengthy explanation. Prepared charts and graphs should be reviewed with peers before publication to avoid unexpected interpretations or conclusions.

Visual materials such as slides or overhead transparencies should focus on key points or ideas. A rule of thumb is that no more than five points should be made on a single visual, and words should be kept to a mini-mum. Visuals should enhance, not detract from, the oral presentation.



Editing Your Own Work

The accuracy of budget presentations, whether written or oral, has a tre-mendous bearing on the credibility of the budget analyst and the informa-tion. Because budget analysts generally work independently to produce analyses and reports on short deadlines, it is not safe to assume that there will be a subsequent review of work by a supervisor. A good budget ana-lyst will edit his/her own work and take responsibility for the final product.

Use Available Technology

Technology is available on almost all computer software packages to check spelling, punctuation, and grammar. Narrative should be reviewed to ensure that words are used correctly and appropriately. Spreadsheets should be double-checked to ensure that formulas are correct and that rounding errors do not occur. When time permits, a finished product should be reviewed a day or two later, with a fresh perspective. For ex-traordinarily important tasks, a co-worker should be asked to review the product.

Credibility Spelling errors and numbers that do not add up can destroy a budget ana-lyst’s credibility and that of the office. In the budget business, quality re-quires precision.


Communicating Fiscal Issues Competency Test

Competency Test

Q1: Who are the prospective audiences of a budget analyst?

Q2: Name four written or oral communications tools that are used to transmit budget information.

Q3: When responding to questions about politically sensitive issues, is it a good idea to tell everything you know about the subject?

Q4: What are common formats for presenting financial, operating, and policy information?

Q5: Briefly explain the importance of preparing effective budget docu-ments.

Q6: Name some ways to avoid careless errors in budget materials.


Module 12: Ethics and Standards of Professional Conduct

Overview Black’s Law Dictionary states that “What is generally called the ethics of

the profession is but consensus of expert opinion as to the necessity of professional standards.” Defined another way, ethics are the rules or standards of conduct governing the members of a profession. Ethics in-volves thinking systematically about the moral and professional duties one member of a group or profession owes to the other members of that same group or profession and to his or her clients. Public sector professionals must do more than “think about” ethics. They are called upon daily to “act” ethically.

ETHICS IN STATE BUDGETING_______________ 171 NASBO STANDARDS OF PROFESSIONAL

CONDUCT ______________________________ 173 ADDITIONAL INSIGHTS _____________________ 175

Ethics and Standards of Professional Conduct Concepts


Ethics in State Budgeting High ethical standards are an important component in state budget work.

Holding and maintaining the public trust is an absolute necessity that is judged more on what we do rather than what we say.

Ethics or standards of conduct are usually defined in relation to personal behavior (for example, honesty, integrity, and truthfulness) or in relation to the conduct of one’s official duties. Ethical dilemmas are not created equally and in nearly all cases there are consequences to any action that one might take. Rather than trying to avoid those consequences, experi-ence has demonstrated that it’s better to manage the consequences rather than have the consequences manage you.

Multiple Loyalties At the heart of state budgeting are multiple responsibilities and loyalties. For example, a budget analyst, like any other government employee, owes loyalty to the public, to elected officials, to superiors and coworkers, to friends and family, and to him or herself. These loyalties do not always line up neatly on one side of the line. As a result, it is important to think through and define the expectations and statutory requirements that apply to your position.

General Guidelines Many states have adopted standards of ethical conduct for state officials and employees. Typically, these standards contain the following general types of prohibitions:

• May not participate as an employee or official in a situations or activi-ties where they, certain relatives, or certain entities with which they are involved have an interest.

• May not participate situations or activities that involve a business entity in which they or certain relatives have employment, prospective em-ployment, contractual, or creditor relationships.

• In most instances, may not have financial interests in or be employed by an entity subject to their authority or the agency with which they are affiliated. This might even include nonprofit boards of directors having these relationships even if there is no compensation.

• In most instances, may not have financial interests in, or be employed by, an entity having or negotiating a contract with the agency with which they are affiliated.

• May not hold employment relationships which would impair their im-partiality and independence of judgement.



• May not intentionally use the prestige of their office for their own pri-vate gain or that of another.

• May not solicit gifts or knowingly accept any gift directly or indirectly from a person whom they know or have reason to know:

♦ Is doing or seeking to do business of any kind with their agency.

♦ Is engaged in activities which are regulated or controlled by their agency.

♦ Has financial interests which may be substantially affected in a spe-cific way by the employee, or

♦ Is a lobbyist with respect to matters within the employee’s func-tional jurisdiction.

• May not disclose or use for their own economic benefit, or that of an-other, confidential information acquired by reason of their public posi-tion.

The above-mentioned standards address situations where the ethical and unethical courses of action are fairly clear cut. Other situations may not be as easy to figure out. For example, what do you do when the rules re-quire a specified course of action but your compassion urges another? The National Association of State Budget Officers has developed stan-dards of professional conduct that should provide helpful guidance.



NASBO Standards of Professional Conduct The National Association of State Budget Officers (NASBO) has devel-

oped standards of professional conduct in order to enhance the perform-ance of all persons engaged in public budgeting. NASBO adopted this code from materials developed by the Josephson Institute on Ethics.

Honesty Be scrupulously and consistently honest by being truthful, sincere, forth-right, and candid where professional duties requiring confidentiality per-mit, so that persons are not misled or deceived.

Integrity Demonstrate integrity by: 1) exhibiting conduct consistent with core be-liefs and assuring that practices are congruent with principles, 2) honoring and adhering to the general principals of public service ethics, and the mission and values of the organization, and 3) expressing and fighting for your concept of what is right and upholding your convictions to the best of your ability.

Commitment Demonstrate promise-keeping by: 1) fulfilling commitments by making your word your bond, 2) discharging commitments in a fair and reason-able manner, 3) exercising prudence and caution in making commit-ments, considering that unknown or future factors might arise which could make fulfillment of them impossible, difficult, or undesirable, and 4) assuring that commitments made are clear to all parties.

Fairness Demonstrate fairness by: 1) making decisions with impartiality based on consistent and appropriate standards, 2) demonstrating a commitment to justice, the equitable treatment of individuals in all actions including re-cruiting, hiring, and promoting employees, 3) exercising authority with open mindedness and seeking all relevant information, including oppos-ing perspectives, 4) voluntarily correcting personal or institutional mis-takes and improprieties and refusing to take unfair advantage of mistakes or ignorance of citizens, and 5) scrupulously employing open, equitable, and impartial processes to gather and evaluate information necessary for decisions.

Respect for Others Respect others by: 1) acknowledging and honoring the right of those af-fected by official and managerial decisions to privacy and dignity, 2) treat-ing others with courtesy and decency, and 3) exercising authority in a way that provides others with the information they need to make informed decisions about matters within the scope of their professional duties.



Pursuit of Excellence Perform your duties with excellence by: 1) being diligent, reliable, careful, prepared, and informed, and 2) continuing to develop knowledge, skills, and judgment necessary for the performance of your duties.

Personal Accountabil-ity

Be accountable by: 1) accepting personal responsibility for the foresee-able consequences of actions and inactions, 2) recognizing your special opportunities and obligations to lead by example, and 3) making deci-sions that take into account long-term interest and the need to exercise leadership for posterity.

Loyalty Demonstrate loyalty by: 1) advancing and protecting the interests of those with legitimate moral claims arising from personal and institutional rela-tionships, 2) safeguarding confidential information without violating pro-fessional duties, 3) resolving conflicting loyalties to various parties by plac-ing obligations to the constitution, the institution of government, and fun-damental principles of representative democracy above your duty to indi-viduals, and 4) refusing to subordinate other ethical obligations in the name of loyalty such as honesty, integrity, fairness, and the obligation to make decisions on the merits, without favoritism, in the name of loyalty.

Public Office as a Public Trust

Treat your office as a public trust by using your powers and resources to advance the public interest.

Independent Objec-tive Judgment

Employ independent objective judgment in performing your duties, decid-ing all matters on the merits, free from conflicts of interest and both real and apparent improper influences while discharging lawful discretionary authority to the public/taxpayers’ best interest.

Public Accountability Assure that government is conducted openly, efficiently, equitably, and honorably in a manner that permits the citizenry to make informed judg-ments and hold government officials accountable.

Democratic Leader-ship

With a positive attitude, honor and respect the principles and spirit of rep-resentative democracy and set a positive example of good citizenship by scrupulously observing the letter and spirit of laws and rules.

Respectability and Fitness for Public Of-

fice

Safeguard public confidence in the integrity of government by being hon-est, fair, caring, and respectful and by avoiding conduct creating the ap-pearance of impropriety, which is unbefitting a public official.



Additional Insights The Josephson Institute has developed some very succinct ethical guide-

lines. These sometimes humorous maxims make the point in a few words.

• Everyone is ethical in his or her own eyes.

• Ethics is not about rhetoric - it is not about what we say, or what we intend. It is not a written code or a framed credo. Ethics is about ac-tions - it is about what we do.

• We judge ourselves by our best intentions, our most noble acts and our most virtuous habits. We are judged by our last worst act.

• The doctrine of relative filth - I’m not so bad as long as there are others who are worse.

• Would you do it if you knew your kid was looking over your shoul-der?

• Ethics is bigger than compliance. Compliance is about doing what you have to do. Ethics is about doing what you should do. Ethics is about doing what is right.

• Most of us overestimate the cost of doing the right thing and underes-timate the cost of failing to do so.


Ethics and Standards of Professional Conduct Competency Test

Competency Test

The following list of self-diagnostic questions concerning professional eth-ics is taken from the booklet, Applying Professional Standards & Ethics in the ‘80’s – A Workbook & Study Guide for Public Administrators. There are no right or wrong answers to these questions provided here. Rather, you have to look to yourself to provide the answers.

Q1: Do I confront difficult ethical decisions directly and attempt to think through the alternatives and the principles involved? Am I inclined to make decisions on grounds of convenience, expediency, pres-sure, impulse, or inertia?

Q2: Do I systematically review my behavior as an administrator and question whether what I do is consistent with my professional val-ues?

Q3: If someone asked me to explain my professional ethics, what would I say?

Q4: Have my values and ethics changed since I began working as a pub-lic administrator? If so, why and how have they changed? What are the primary influences that have changed my thinking?

Q5: Looking ahead to the remainder of my career, are there particular areas of my ethical conduct to which I would like to pay closer at-tention?

Q6: Do I ever find myself in situations in which providing equitable treatment of clients, members of my organization, or members of other organizations creates ethical conflicts? How do I handle such dilemmas? Can I perceive any consistent pattern in my behavior?

Q7: Where do my professional loyalties ultimately lie? With the Consti-tution? The law? My organization? My superiors? My clients? The general public? Do I feel torn by these loyalties? How do I deal with the conflicts?

Q8: Have I developed a distinctive loyalty to my professional group and its network of contacts? If it exists, how does this type of loyalty af-fect my decisions?

Q9: Do loyalties to other groups (ethnic group, union, political party, fra-ternal order, clubs, and others) influence my decision making or ap-proach to performance?

Q10: Do I ever confront situations in which I feel that it is unfair to treat

Ethics and Standards for Professional Conduct Competency Test


everyone in the same way? How do I determine what to do in those cases? How do I decide what is fair?

Q11: When I am responsible for some activity, which turns out inappro-priate or undesirable, do I accept full responsibility for it? Why? How?

Q12: Do I ever dismiss criticism of my actions with the explanation that I am only “following orders?” Do I accept any responsibility for what happens in these circumstances?


Module 13: Interpersonal Skills for Budget Analysts

Overview Budget analysts are more than “number crunchers.” They are information brokers: they find, give, receive, and use information. To effectively im-plement this important role, budget analysts must have well-developed interpersonal skills. This skill set will enhance a budget analyst’s ability to effectively work with others in the interactive environment of a budget of-fice. A budget analyst must also develop good communications skills to inform, persuade, and negotiate. Decision makers look to budget analysts for creativity in finding new and better ways to effectively deal with a wide range of individuals. Being open-minded, flexible, credible, and having a positive attitude are important attributes for meeting the challenges of the job in a dynamic, political, and ever-changing setting.

RELATIONSHIPS WITH OTHER PLAYERS IN THE BUDGET PROCESS _______________________ 179

CONDUCTING MEETINGS ___________________ 181 INTERVIEWING TECHNIQUES ________________ 182 BRIEFING HIGH-LEVEL OFFICIALS ___________ 183 THE ART OF PERSUASION___________________ 184 NEGOTIATING SKILLS_______________________ 185 DELIVERING BAD NEWS _____________________ 186

Interpersonal Skills for Budget Analysts Concepts


Relationships With Other Players in the Budget Process

Develop Relationships

A budget analyst interacts with a wider variety of people than most any other position in state government. From the governor, budget director, co-workers, agency directors, fiscal staff, legislators, the media, the private sector, federal and local government staff, lobbyists and special interest groups, there are many different people to interact with on a regular basis. Budget analysts must learn to develop and tailor working relationships to a variety of individuals. While working to develop and maintain relation-ships with others, a budget analyst must always understand that he/she works for the governor and be careful to reflect the position of the gover-nor, not personal opinions. Likewise, analysts must respect the philoso-phies, loyalties, and background of those working in other agencies and other branches of government.

Gather Information

In order to analyze budgets, an analyst must secure information from reli-able sources, often in a short time frame. Having developed relationships in advance will enhance information gathering. Likewise, information must be relayed to the governor, legislators, and the media. When a budget analyst has developed an open and honest relationship, the in-formation being presented is more readily accepted.

Serve as a Resource

Developing a strong working relationship with others requires budget ana-lysts to be a dependable resource. When asked for information, follow through and provide it. To avoid any misunderstanding, clarify what in-formation is available and a time frame in which it can be provided. In some cases, to ensure efficient flow of information, it may be necessary to guide the individual in formulating their request. A budget analyst should offer additional information and explanations if it would be helpful to do so. If specifically requested information is not available, suggest possible alternatives that are available.

Grapevines "Grapevines" are alive and well in most work settings, including state governments. Grapevines flourish when the demand for information is high and the supply is low. Insufficient, inaccurate, and misleading in-formation will feed a grapevine. A budget analyst should be aware of what is feeding the grapevine and, if possible, correct inaccurate informa-tion. However, an analyst should be careful not to “feed” the grapevine.



Communications Skills

Technical and administrative skills are certainly important to being a suc-cessful budget analyst, but human relations skills provide the ability to work with and influence others. Communication is one of the central skills needed. The better the communication, the better a budget analyst’s performance. In order to influence others, budget analysts must develop an accurate, two-way flow of information.



Conducting Meetings Budget professionals spend a considerable amount of time in meetings.

Often they are responsible for leading these meetings. This can be ac-complished most effectively if the analysts remember this -- most people do not like to attend meetings. The reason is that many meetings are un-productive uses of time, particularly if the purpose is unclear or the objec-tive is not accomplished. Following are ground rules for conducting meetings.

The Agenda The agenda should always be set and distributed in advance to all those invited to attend. The agenda should include the start time, and more im-portantly, the time the meeting will end. Setting an agenda will allow par-ticipants the opportunity to prepare for the meeting and also allow indi-viduals to determine whether their presence is really needed. Those in-vited should be asked to indicate whether or not they can attend. This will help avoid unproductive meetings because key people are not avail-able.

Leader’s Ground Rules

• Always start on time. Communicate this ground rule to colleagues.

• Introduce attendees if they do not know each other.

• Appoint a scribe to record major discussion items.

• Stick to the agenda and time limit. If necessary, appoint a time keeper.

• Draw out opinions from the shy and reserved.

• Control dominating attendees tactfully, yet firmly.

• Assign action items to responsible parties.

• At the conclusion of the meeting, recap decisions and assignments.



Interviewing Techniques

Budget analysts must continually tap the knowledge and expertise of oth-ers. Individuals with skills in particular areas are proud of their knowledge and are often willing to share valuable information. However, some basic rules should be followed before requesting information.

Rules for an Informational

Interview

• Research the topic in order to ask meaningful questions. A budget analyst should have a basic understanding and knowledge of the topic, including terminology. Determine whether information and an-swers to your question can be provided through telephone calls or mail (including e-mail), or if a personal interview is necessary.

• If an interview is necessary, make sure the time is convenient for the person being interviewed. If the interviewee is facing major deadlines or working on high-priority projects, time available may be limited.

• In preparing for an interview, it may also be helpful to "research" the interviewee. If the person is overly negative and skeptical, find out their interests in advance to help establish a positive exchange. If the person is disorganized or easily distracted, tactfully redirect them to stay focused on the topic.

• Prepare a basic list of questions to initiate the discussion. Allow re-spondents flexibility to expand on the answers, possibly opening up new ideas for discussion. Be open-minded and recognize that this is their area of expertise. Recap the discussion to ensure accuracy. If possible, ask if additional sources of information are available. This will help in separating opinions from facts.

• At the end of the interview or project, ask the individual to read the notes or fax a summary to them for review to ensure accuracy. This will improve the credibility of the information and may also provide additional insight on the topic. If the information is complicated, it may be beneficial for both parties to have a written record of the dis-cussion.

Finally, make sure that the expert receives credit for providing the informa-tion. Solidify relations by following up with a thank-you letter.



Briefing High-level Officials

High-level officials have limited time to receive and process information. Research shows that these officials can read less than one-third of the ma-terial they should, and that they remember only about 10 percent of the information they receive. So budget analysts have to be especially skillful as communicators.

Briefing Guidelines Briefings should be concise. You must prepare thoroughly, focus on the topic, know the time limit, know the audience, be concise yet thorough enough not to mislead, make it interesting by the use of graphics or ex-amples, and anticipate questions. Anticipating questions and being pre-pared to answer them is the most challenging aspect of briefing elected officials, the budget director, or the media. If you don’t know the answer, explain why the information is not available or offer to get back to them with the answer.

Things to Avoid The facts should not be clouded by personal opinions or judgments. Ac-ronyms or abbreviations should be avoided. Briefings should not be pre-sented inductively -- that is, building from facts and details to the conclu-sion. Rather, begin with the bottom line.

Differing Perspectives

Recognize that elected officials have constituencies with different perspec-tives on issues. When providing information, a budget analyst should recognize that his/her conclusions or opinions will not be shared by eve-ryone. Being honest, open, accurate, tactful, and thorough in presenting information will establish a relationship of trust and respect for the long term.

Practice New budget analysts may want to "practice" on co-workers before doing their first briefing to a high-level official. After a briefing, assess the effec-tiveness of the presentation and look for ways to improve.



The Art of Persuasion

Budget analysts will often find themselves in the position of persuading others to follow their recommendations and embrace their ideas. They are often in the position of persuading their supervisor, the budget direc-tor, the governor, legislators, or their co-workers.

Prepare a Plan To be successful in advancing an idea, a thorough and strategic plan is necessary. People are more easily persuaded if it is apparent that an ana-lyst is prepared and has a complete understanding of the idea beforehand. Some things to consider are:

• Be sure all aspects of the issue are thoroughly researched.

• Be prepared with several alternatives. Give your recommendation and explain why you selected that particular approach or solution.

• Think through all the "pluses" and "minuses" -- the supporters and the detractors. If possible, come up with ideas to mitigate the "minuses" -- and respond to detractors.

• Anticipate unintended as well as intended outcomes.

• Know the possible ramifications of not implementing the idea.

Present the Idea The art of persuasion includes presenting ideas at a convenient time and location. Schedule a meeting or appointment with the supervisor or offi-cial so there is ample time to present the entire plan or idea. If the idea is complex, providing information in writing, and in advance, may be help-ful. A follow-up meeting should be scheduled after others have had time to think about the concept.

Follow Through A budget analyst should be prepared to take on any responsibilities of the project even if the analyst’s recommendation was not the one selected.



Negotiating Skills

Budget analysts are frequently called upon to resolve outstanding issues with other agencies and constituents. Negotiating, or gaining agreement from different perspectives, requires a combination of research and inter-personal skills. When entering a negotiation, the key is to be prepared. Determine your bottom line in advance. Determine in advance the gov-ernor’s position on the issue and what points are and are not negotiable. Know the difference between a “must-have” and a “would like to have.”

Anticipate Questions/Act Ethi-

cally

Assessing the must-haves and the would-like-to-haves of the opposing side and anticipating their questions are also important pre-negotiation strate-gies. Determine in advance what information can or cannot/should or should not be divulged during the negotiations. Ethical communication is crucial when negotiating: avoid false "authorities," false information, dis-torted statistics, bribes, or false promises for improved outcomes.

Assess Needs During negotiations, it is best for a budget analyst to listen more than talk, be positive, think win-win, and trust intuition. Listening will allow better understanding of the issues important to the other side.

Research the Opposition

Very often in a negotiation, what people say they want and what they really want are two different things. Being clear on the desired outcome, and spending time in advance to research the needs of the opposition, will help a budget analyst successfully conclude an agreement satisfactory to all parties.



Delivering Bad News

Budget analysts, at some point, will need to deliver bad news to the budget director, agencies, constituent groups, and even the governor. Perhaps a new program cannot be funded, cutbacks of staff must be made to come within budget, or earlier revenue projections were inaccurate -- bad news can come in many forms. Occasionally the governor may ac-tually deliver the bad news to an individual or agency, but a budget ana-lyst may need to provide support, understanding, and explanations.

Be Direct and Honest

When delivering bad news, a budget analyst should always be direct and honest. It is important that the message is not "softened" so much that it gets lost. The analyst should provide as much information and explana-tion as possible about why the decision was made. The analyst should also try to empathize with the recipient of the news and allow the person to react to the news without taking the reaction personally. By truly listen-ing to the person’s concerns, an analyst can often defuse the situation. If the situation escalates to a point where the recipient of the news reacts unprofessionally, suggest the recipient take some time to think about the information, and set up a future meeting to discuss any further issues re-garding the news. A budget analyst should remain calm and professional at all times.

Outline Options Never leave a feeling of false hope, but if assistance or alternatives are available, be prepared to outline them. For example, if staff must be re-duced, will they receive severance pay? Is counseling available? Are job search services available?

Develop Trust Delivering bad news will never be easy. However, if a budget analyst has developed a relationship of trust with the individual or group affected, the person on the receiving end of bad news will continue to respect the budget analyst for the difficult decision.


Interpersonal Skills for Budget Analysts Competency Test

Competency Test Q1: A meeting agenda should include which of the following?

A) The number of attendees expected.

B) The time the meeting will end.

C) The minutes of the previous meeting.

D) The ground rules for the meeting.

E) None of the above.

F) All of the above.

Q2: When interviewing an engineer on the life cycles of building roofs, advance preparations may include:

A) Knowing the types and age of roofs that are on buildings cur-rently.

B) Researching roof materials available in your state.

C) Studying the historical building rules and regulations.

D) Climbing on many building roofs and taking pictures of them.



Q3: As part of a study on the school funding formulas, you have inter-viewed over 200 people in the state. Your study, which will be pub-licly distributed, includes your recommendation on potential changes to the current system. What, if any, information might you ask interviewees to review and comment on after their initial inter-view and prior to the release of the report?

A) Quotes or summaries of expert opinions.

B) Your recommendations.

C) Recommendations made by other interviewees.

D) Similar information provided by other states.



Q4: When providing information to elected officials you should:

A) Include your opinion on the subject.

B) Avoid the use of graphics or examples and stick to the facts.



C) Be direct about not knowing an answer, but offer to get back to them with information that is available.

D) Always use acronyms or abbreviations whenever possible to quickly acquaint them with existing programs.



Q5: The object of the negotiation is to:

A) Convince the other side to "see it my way".

B) Compromise with the other side.

C) Find a solution or common ground where both parties feel like they are getting what they want.

Q6: Which is more important in negotiations?

A) Win.

B) Collaborate.

C) Compromise.

Q7: What is the most effective and professional way to deliver bad news?

A) Send an E-mail.

B) Telephone.

C) Send a letter.

D) Personal visit.

Q8: You have to inform the director of an agency that the governor wants a three percent reduction in their budget. The agency director be-comes extremely agitated to a point where the professional relation-ship is jeopardized. The agency director does not respond to your calm demeanor and your attempts to empathize. What should you do?

A) Suggest the director contact the Employee Assistance Program for counseling.

B) Promise that you will get the governor to reverse the decision.

C) Suggest that the director take time to formulate their concerns regarding the reduction and contact you later.

D) Tell the director to contact the governor.

Q9: In the preparation of the governor’s budget, you present a recom-



mendation to the director of the budget and it is not accepted. Dur-ing the appropriations hearings, an influential member of the appro-priations committee expresses interest in the idea. How would you proceed?

A) Indicate to the appropriations committee that you have re-search material on the subject that they may be interested in.

B) Restate the governor’s recommendation and the reasons for that recommendation.

C) After the hearing, approach the member interested in the idea and indicate your support of the idea and that you have useful information on the concept.

D) Do nothing.

Q10: Highway funds are currently being used to fund highway patrol and radio communication. The Highway Department submits its budget without these functions and uses the funds for highway projects. As the Highway Department analyst, how would you proceed?

A) In the governor’s recommendation, provide funds for the Highway Patrol and radio communications and decrease funds for highway projects.

B) Contact the fiscal officer of the Highway Department and tell them to resubmit their budget with the highway patrol and ra-dio communications funded, and highway project funding de-creased.

C) Contact the fiscal officer of the Highway Department and ask for information on why the budget as submitted did not include money for the highway patrol and radio communications.

D) Ask your supervisor what to do.

Q11: If you receive a request for information from a legislator and you are unsure of the answer or even if the answer can be found, what should you do?

A) Inform the legislator you will have the information as soon as possible.

B) Ask them to go to their legislative fiscal staff to perform the re-search.

C) Indicate you will need to research the issue to determine what information is available and give the legislator a time when you will know more.



D) Give the legislator your best educated guess, let them know this is just a guess and tell them you will get back to them if the an-swer is different.


Appendix Competency Test Answers

Module 1: Fundamentals Of Budgeting A1: The federal government adopted its first formal budget process in the

Federal Budget and Accounting Act of 1921.

A2: Budgeting started with individual appropriation bills for departments or agencies with few line-items and no narrative program descrip-tions or performance expectations. It was usually an annual docu-ment with no concern for projections of future years. Many budgets now require program descriptions and goals with measurable objec-tives to achieve those goals. Performance measures are utilized and evaluated. Policies that drive budgets may be included in addition to payroll and other related costs from the prior year.

A3: Line-item budgeting establishes specific amounts for specific types of expenditures. There is no allowance for flexibility in hiring more people or buying more equipment, etc. The restrictions of the ap-propriation and the inability to allocate resources to meet emerging needs prevents agencies from creatively solving problems or citizen needs.

A4: Because line-item budgeting is easy to develop and understand, it is prevalent throughout state governments. However, it does not allow any management flexibility in managing the budget. Any necessary changes must be approved by the legislature so they retain the ulti-mate control.

A5: Program budgets must include program goals, program objectives, and performance measures.

A6: Program budgeting calls for a flexible appropriation versus a more restrictive line-item budget. The accountability in program budget-ing is on the outcomes -- whether goals and objectives were met. Accountability is not for the agency's ability to live within the line-item dollars appropriated (inputs). Legislative committees are more comfortable and have a better understanding of accountability through inputs. They are not necessarily comfortable with giving executive agency managers flexibility in spending their annual ap-propriation.

A7: The primary purpose of zero-based budgeting is to define the various programs and functions provided by an organization and rank them in priority order from the most critical to the least critical item.

A8: ZBB requires managers to define the programs and/or functions their organization performs. This requires review of various documents such as statutes, constitutions, federal laws and rules, etc. Most chal-



lenging, however, is establishing the priority order of those pro-grams. Some programs are at the top of the list and others are at the bottom and the manager must articulate this ranking to his or her employees.

A9: Performance budgeting is based on the agreement of decision mak-ers as to what the purpose and direction of an agency is to be. Once the purpose is defined, performance measures and budgets can be designed to determine whether that purpose is met. State-wide input as to what citizens and others deem important gives di-rection to agencies. Without this input, an agency may determine what its performance is to be measured on but they may not be in sync with what the people and other decision makers believe their performance should be directed toward.

A10: Advantages to a department or agency in obtaining appropriations under performance budgeting relate to their reported, measured per-formance. If decision makers want higher performance, the agency should get additional resources. If an agency excels but can prove it can do more, it can justify more resources. The decision process is focused on outputs and inputs determined by agreeing on a desired outcome. This focuses the budget debate into an entirely different arena. Also, if through a planning process, the citizens have spoken and indicated a desired level of performance, it is difficult for a gov-ernor or legislative committee to deny the resources needed to achieve that service level. To do so would be opposing the "will of the people."

Module 2: Operating Budgets A1: The operating budget represents the financial plan for the portion of

the budget addressing program activities and services.

A2: Operating budgets typically include personnel services (salaries, wages, and fringe benefits), contracted services, rents, travel, utilities, equipment, supplies, and other operating expenses.

A3: The governor is required to sign a balanced budget in 31 states.

A4: Operating budgets should generally be funded with ongoing sources of revenue such as income or sales tax receipts.

A5: Operating expenses generally continue year to year. They are ongo-ing and should be matched with ongoing sources of revenue. If funded with one-time sources, ongoing programs may have to be cut



in the next budget cycle or revenue may have to be diverted from other sources.

A6: Analysts need to use information on financial and economic trends to make informed recommendations on budget requests and revisions. Shortfalls in revenue collection may impact how the budget is admin-istered. For example, if the trend analysis indicates a shortfall, cost-controlling measures may be set into motion.

A7: Some states have established rainy day funds to provide a “cushion” if revenue shortfalls occur. Rather than reduce services, the state will fill the gap or a portion of the gap with money in the rainy day fund.

A8: Input measures focus on resources that go into or are appropriated to a program. Output measures generally report the number of activi-ties conducted or products generated. Outcome measures indicate more specifically if a program is meeting its objectives. For example, input measures for a job training program might measure number of dollars appropriated or number of instructors hired. Output meas-ures would record the number of classes held or number of students graduated. Outcome measures might address the number of students finding employment after training or employer ratings of satisfaction with the quality of program graduates that have been hired.

Module 3: Funding State Services A1: The response should compare a state’s distribution of taxes to the na-

tional averages which in 1995 were 31 percent from individual in-come taxes, 49 percent from sales taxes, 7.3 percent from corporate net income taxes and 2.4 percent from property taxes. The response should also contain reasons why their state’s tax structure is different or similar to the national averages. Some reasons might be constitu-tional restraints on tax sources, historical division of taxes between various levels of government, political/historical restraint, or eco-nomic conditions peculiar to the state.

A2: The response should list the state’s earmarked revenues. An evalua-tion of their effectiveness as a budgeting tool should also be in-cluded. Such an evaluation may consider the direct relationship be-tween those who pay the earmarked revenue and those that benefit such as highway users, the relationship between the revenue source and use to pay for remedial or preventative costs such as a tax on underground tanks and environmental clean-up costs, the complex-ity of budgeting and accounting for a myriad of small dedicated funds, the difficulty of changing the use of earmarked revenues even if costs and needs have changed, and the loss of accountability for



these programs if operated outside the general operating budget.

A3: No. Entitlements are open-ended federal funds based on the authoriz-ing legislation’s and states’ definition of who is eligible to receive ser-vices. Levels contained in appropriations bills are generally estimates of need and do not have the force of law to limit funding.

A4: The advantages include: new source of revenue, voluntary payment, not compelled by law; may provide competition for illegal gambling; provides in-state alternative to gambling opportunities in other juris-dictions; and there is no necessity to connect the source of the reve-nues to specific uses.

The disadvantages include: uncertain revenues, receipt level de-pendent on marketing effectiveness and strength of competition; in-creased social costs; and may divert family expenditures from basic needs.

A5: The distinguishing characteristics are: it is not a tax, it is a voluntary payment; although paid only by users, it has no natural constituency for programs funded from its receipts; and receipts can be volatile and unpredictable due to competition, the state of the economy, and the effectiveness of competition.

A6: Debt may become the financing source of regular, recurring expendi-tures. This may lead to an uncontrolled rise in debt and a layering of debt service payments that can place budgetary pressures on the re-mainder of the budget as debt service payments consume an ever larger proportion of budget resources. The cost of currently con-sumed items may be shifted to future taxpayers who will derive no re-turn or benefits from those expenditures. A debt financing policy can also provide the benefit of long-term affordability planning, in-cluding not only the capital costs of facilities, but also the annual op-erational costs required to maintain and operate these facilities.

A7: A policy on charging fees for services may include: charging rates that reflect the cost of providing the service for which fees are levied; that fees be borne by the beneficiaries of the service provided; activi-ties generally benefiting all citizens should be supported by generally imposed fees; fees may include a revenue generation component when used for licenses, permits, certifications, privileges, goods or services in competition with private enterprise.

Module 4: Economics and the State Budget A1: Economic forecasts are prepared for two main purposes: 1) to guide

the preparation of estimates of state revenues, and 2) to estimate



caseloads for health, welfare, employment, and corrections depart-ments.

A2: The most widespread method of estimating key economic variables of a state’s economy is to begin with a forecast of the nation’s econ-omy and then to scale this to the state. Few states maintain their own national forecast models. Most either simulate one of the several commercial models or simply accept the “most likely” forecast from one of these firms. Others use a consensus forecast such as Eggert’s Blue Chip Survey.

Once a national forecast is accepted, the scaling to the state begins by exploiting known linkages between national economic activity and that of the state. Generally, these relationships are estimated using a branch of applied statistics called “econometrics.” Each major indus-try’s employment would be estimated, using national and state eco-nomic variables, such as profits, personal income, unemployment, etc. Local inflation forecasts are similarly driven off national inflation forecasts.

Once the estimates of state economic variables are completed and agreed to by participating economists, they are made available to revenue, health, welfare, employment, and other departments to use as a basis for their estimates of the budget planning activities. Eco-nomic forecasts generally become the driving force behind many of the major policy decisions of the administration and legislature dur-ing the budget cycle of each state -- leading to many of the economic development proposals discussed above.

A3: Once forecasts are accepted and a budget is adopted, it is essential to track both the economic variables and revenues against actual re-sults. The task of tracking economic statistics is complicated at the state level by revisions, which can be large, and even involve a change of sign (reported increases can suddenly be revised to be-come decreases). In addition, revenue forecasting and analysis units need to be kept abreast of changing economic conditions, at the na-tional, state, and local level to ensure that they can prepare realistic estimates of future revenue and to understand economic sources of fluctuations in revenues from original forecasts. Health and welfare departments need the same information for analysis of caseload de-mand and need to be provided with cost of living indices for legis-lated adjustments to monthly welfare stipends.

A4: Typical economic indicators tracked by the economic research func-tion would include national, state, and local data. National data in-clude the levels and rates of change of: gross domestic product, em-



ployment, unemployment, income, consumer price indices, con-struction, exports, imports, deficits, interest rates, and investment. State data include the levels and rates of change of: employment, consumer price indices (where available), building permits, retail sales (where available), and a variety of state-specific measures of in-dustry employment. Industry output is not measured on a frequent basis at the state level. Thus, employment and personal income be-come key indicators of economic activity in specific industries as these are available on a monthly or quarterly basis.

A5: Demographics is the study of the level, composition, and changes to measures of population. In various forms, states perform their demo-graphic research function -- whether gathered into one department or distributed across departments. Some states perform their own popu-lation estimates, but most accept those made by the federal Bureau of the Census.

A6: Population estimates establish the amounts of some federal funds transferred to support various programs to the state, and the subse-quent redistribution of federal and state funds to local governments -- primarily for highways, health and welfare expenditures, and educa-tion. Some states have complex formulas for distributing education money to local governments and others have appropriation limits to the size of state government. Population is often one of the key pieces of data for all of these calculations.

Beyond overall state population estimates, demographic research functions may estimate city and county population, average daily at-tendance in public schools, inter-regional and international migra-tion, and other components of population levels and change. While some of these estimates are provided as a service to academic and industry researchers, most of the sub-state estimates are driven by tax redistribution programs.

A7: Overall, the federal government marginal profits tax rate is 35 percent for large corporations while for states, marginal rates are between zero and less than 10 percent. Federal marginal personal income tax rates peak at 39.6 percent, while states range between zero and less than 10 percent. Clearly, changes in federal business profits taxes will be several times more important to business decision makers than proportionate changes to state taxes. The extent that state per-sonal income taxes are deducted from household incomes subject to federal tax further reduces the ability of state tax policy to affect household behavior. Thus, if tax policy affects economic behavior, it



is federal tax policy for households or businesses. If sufficiently large, differences between state tax rates could affect the location of eco-nomic activity much more than the overall amount of activity.

A8: The major federal tax on businesses is the corporate profits tax. States can be affected by changes in federal tax law in three primary ways: 1) marginal tax rate changes, 2) administrative rules changes, and 3) tax expenditure changes. In each case, federal changes can be con-sidered preemptive in the sense that federal tax policies, rules, and programs seldom take into account the impact on state policies, rules, and programs. When federal marginal rates change, state tax revenues will be driven up or down by economic activity encour-aged or discouraged by changing tax rates -- if the state makes no corresponding adjustment to its rates. When federal tax administra-tive rules (for record-keeping, reporting, or timing) change, significant pressure will be put on states to conform their rules to federal rules to keep administrative costs for companies to the point where they will comply with state rules. The issue of conformity is most pressing for federal tax expenditure rules. If the state and federal government have similar, but different, tax credits or subsidy arrangements (differ-ent in terms of structure, not percentages or levels), states will usually find that companies will conform to federal law and frustrate attempts by states to conduct entirely independent incentive programs.

Personal income tax is also driven by federal rates, rules, and tax ex-penditure programs. Beyond obvious parallels with corporate taxes in each of these areas, one subject is of major significance: capital gains taxes. Over the last twenty years, the rate at which capital gains have been exposed to taxes has been the most volatile federal tax rule. In the early 1980s, the rate was halved and a rush of previ-ously-accumulated capital gains was exposed to tax. This rush was accelerated as discussions progressed later in the 1980s towards in-creasing the exposure rate of capital gains to taxes and ended with the higher exposure rate being implemented. The balanced budget act of 1997 will further impact capital gains.

State governments that did not conform their exposure rates for capi-tal gains to federal rates experienced significant growth in state per-sonal income tax revenues when federal rates fell. This growth ac-celerated towards the end of the ”window of opportunity” for house-holds. In the largest states, this revenue windfall approached $1 bil-lion per year. As the window closed, these states experienced reve-nue shortfalls of similar magnitude. This episode of capital gains taxation is one of the clearest examples of federal tax law’s impact on



the behavior of households and firms.

A9: The two main groups of policies are tax and expenditure changes. Tax changes are made to reduce the burden of taxes on businesses or households, making it more attractive to live, work, and invest in a state. Their purposes are similar: by changing government policy, private economic activity will increase. While the purpose of ex-penditure change is the same as for tax, it can take two forms. The first is direct purchase of goods and services by government. The second is tax expenditure: subsidies or tax credits.

A10:Breadth is a measure of how widespread are the direct benefits of a proposal. If a tax reduction is broad, it would apply to many sectors of the economy or most households (or both). If it were narrow, it would encourage growth by a narrowly-defined sector of the econ-omy or households with specific characteristics. The breadth of tax reduction or expenditure may be as important as the dollar magni-tude. When governments reduce taxes for selected industries, they create incentives for profit-maximizing firms and investors to shift re-sources from other industries, regions, or countries. To the extent that the expansion of the industry receiving the specialized treatment is offset by resources simply shifting from other industries in the state, such an economic development strategy may result in no net gain to the state.

A11:Today, states experience stiff economic competition from other con-tries as well as other states. Some states trade as much or more out-side of the U.S. as with other states. It is important to note that trade data are among the weakest economic data commonly used. Inter-national exports are measured two ways: by port activity and by point of manufacture. Port data measure the dollar volume of ex-ports (and imports) that flow through a port. Point of manufacture export data (but not available as ‘point of final use’ for imports) are also kept. These data attempt to connect exports from any port (in the state or in another state) that come from a particular state.

A12: Global competition can affect a state’s economy and policy deci-sions in a variety of ways. Plant location arguments for economic development policies may be based as frequently upon global as in-terstate comparisons. Policy questions may be raised concerning the efficacy of opening trade offices in foreign countries. These offices make state administrators responsible for expenditures made in for-eign currencies and exposed to foreign inflation rates -- a complex environment for the uninitiated.

A13: While the term “economic conversion” can be applied to any struc-



tural change to a state’s economy, recently it has been applied al-most exclusively to the conversion of military facilities to private economic activity. The idea behind economic conversion is to ex-ploit the physical plant and laid-off staff left behind by the base clo-sure to encourage the growth of new businesses. By offering land or buildings at less-than-market cost, an implicit subsidy is created to encourage new business activity on the base. Some states may also subsidize labor by means of direct subsidies or tax expenditures.

A14: Opportunity cost is the value of the tax or expenditure resources ap-plied to their next best use. Each claim of successful economic con-version must be considered in terms of opportunity cost. All tax ex-penditure programs cost tax dollars that otherwise would not have to be raised or that could have been used for other purposes. The op-portunity cost of lost revenues from providing base facilities at less-than-market rental rates and tax expenditures from explicit or implicit subsidies of labor should be considered in the cost-benefit analysis of conversion programs - as should the expected reduction in social welfare costs.

Module 5: Revenue and Expenditure Analysis and Forecasting

A1: It is important to monitor general fund revenues because they are vital to a state’s fiscal health. Although major revenue sources, such as income and sales tax, are generally stable over time, they com-prise nearly three-quarters of the revenue base in most states. So even a minor deviation from the forecast can have significant impact on the state’s ability to fund services. Budget staffs need to have “early warning” systems in place so that action can be taken when revenues change, especially in a negative direction. Tracking actual revenue collections against forecasts is one such early warning sys-tem.

A2: As a general practice, budget analysts should forecast the general ex-penditure trends of all their programs. It is imperative, however, that the major spending drivers be forecast, because they account for such a large portion of the budget. In nearly every state, most budget growth is accounted for by three programs: Medicaid, cor-rections, and K-12 education.

A3: The primary types of forecasting techniques are econometric analy-sis, time series analysis, mathematical models, and ad hoc methods. The more sophisticated methods, such as econometric or time series



analysis, can be used when the variables to be predicted have a long history and stable relationships with respect to economic, demo-graphic, or policy drivers. As a variable’s history shortens or as basic structural relationships become less stable, more sophisticated tech-niques are less useful compared to mathematical or ad hoc methods.

A4: Important analytical skills include the ability to understand and communicate abstract concepts, good basic math skills, creativ-ity/flexibility to apply lessons from experience and training, and an understanding of statistical methods.

A5: Mainframe and/or personal computers are required, along with soft-ware that can accommodate the skill levels of the analysts doing the estimating. Access to national data bases and sources through the Internet is also useful.

A6: Estimates should be updated when preparing a budget, and when actual experience begins deviating significantly from projections.

A7: Analysts can prepare decision makers for forecast deviations by clearly communicating the normal risks inherent in forecasting, pro-viding historical overviews of actual experience compared to fore-casts, producing cycle forecasts, and continually monitoring and re-porting on the accuracy of current projections.

A8: It is important to clearly explain the assumptions or origins because they may differ from the preconceptions that decision makers or other parties may have on an issue.

A9: The primary criteria are tax incidence, equity, stability, revenue yield, sufficiency, and simplicity. Budget analysts should realize that deci-sion makers will view each criterion through a political lens to con-sider the likely reaction of constituents to revenue policy changes.

A10: Ideal elements of fiscal reference documents include a descriptive and quantitative historical perspective of revenue and expenditure patterns, a thorough description of the current base and rate of ma-jor revenue sources and the current elements of major spending programs, a forward-looking perspective, and a “menu” of estimates of the impacts of potential structural changes on citizens.

A11: Nationally recognized criteria of a good forecasting process include direct participation by governors, use of academic and business ex-perts to help determine assumptions, monthly reporting of actuals against projections, flexibility of timetables and procedures, and public disclosure of all budget-related information.

Module 6: Analytical Methods for Budget Analysis



A1: A newly assigned budget analyst should invest time in several infor-mation gathering efforts including interviews; review of planning and financial documents, special studies by or about the agency, re-lated constitutional provision, laws, and regulations; and state and federal court decisions and attorney general opinions. The analyst should understand the importance of information from the National Center for State Courts, National Governors’ Association, National Association of State Budget Officers, Council of State Governments, National Conference of State Legislatures, as well as their ongoing publications such as Governors’ Bulletin, State Budget and Tax News, and State Policy Reports. Finally, the national associations are also good sources of information for many substantive policy is-sues.

A2: This response would be similar to A1 above, but more concrete and narrowly focused on the implications of legal issues. This response calls for the analyst to show an understanding of the purpose – to determine whether the legal mandate is in conflict with current poli-cies, the extent of the conflict (policy and fiscal), and changes needed to comply. The response should indicate familiarity with the information gathering process, including meetings and exchange of information with the affected line agencies, Office of the Attorney General, and other legal staff. Knowledge of the related laws, acts, regulations, state and federal court decisions, and attorney general opinions is also necessary. Finally, national association contact is appropriate to establish whether there were similar events in other states.

A3: Policy analysis ideally relies on data and information from several perspectives, both empirical and political: 1) information about cur-rent policies and objectives, including formal goals and objectives, legal mandates, and the distribution of financial resources, 2) data about current and emerging problems, including the expressed needs of the affected interests, 3) information about how other gov-ernments are dealing with the problem, and 4) an assessment of the likely support and opposition for each alternative.

A4: The analyst needs to be aware of legislative and interest group, espe-cially local government, interest in the proposal; study the proposal to understand the criteria for funding to estimate who would benefit the most; carefully discuss with the state agency, local government associations, and the association of disaster recovery professionals, the issues of concern to them and the positions they are likely to take on the provisions of the budget and/or legislation. The analyst



also needs to examine the history of the proposal, including whether it was previously considered, and the extent to which it involves is-sues that are the object of partisan differences, legisla-ture/administration conflict, intergovernmental conflict, and even personality issues.

A5: The initial approach to analyzing program and service delivery alter-natives is to ensure that the program and service goals and objec-tives are not in dispute. If there is a conflict, a policy analysis would be more appropriate. If there is agreement and the programs and services are consistent with agency mission, the analyst should be-gin the exploration of efficiency and effectiveness through detailed information about the consumption of financial, personnel, and capital resources; the levels of service provided; and the level of ef-fectiveness of the services. For comparative purposes, information from other states and from national data bases can provide impor-tant information. It is also important to understand how programs and services work, by visiting them and talking to their staff and cus-tomers.

A6: An analysis of alternatives is appropriate to uncover opportunities for increased efficiency and effectiveness. This relies on the information provided in A5 above, plus calculations and estimation of the total cost of services, which may not be available from accounting or budgeting information systems.

A7: The most common approach to select comparison states is to include those which are contiguous or which have similar population size or personal income levels, or which belong to a commonly used re-gional designation. Other criteria are appropriate, depending on the substance of the comparisons that will be made. For example, these might include number of shoreline miles, square miles, population density, percent urban population, or acres of parks. The important thing is that the comparison groups be established based on data that are reliable and generally available.

A8: Budget submissions should provide information on the finances, per-sonnel, and capital assets in a meaningful format for analysis that supports decision making by the chief executive and presentation to the legislature and the public. It should provide information appro-priate for assessing current and proposed policies, programs, and fi-nances.

A9: This response should reflect understanding of basic budget analysis by focusing on trends and comparisons between appropriations and expenditures. Substantial trends and unexpected patterns need to



be explained in terms of service demands, legislation changes, mandates, or one-time or unexpected events. The response should also reflect familiarity with the idea of finding excess funding in budget requests, including overfunded personnel costs and failure to remove amounts for purposes already accomplished. The response should also reflect familiarity with the differences between general and nongeneral fund appropriations. The basic analysis of agency historical spending patterns provides the foundation for subsequent analysis of the efficiency and effectiveness of public programs.

A10: Variance and trend analysis often become the basis on which a budget analyst focuses questions about the agency’s finances. The agency’s explanation of variations between expenditures and budg-eted amounts and of trends over time are often the most illuminating explanation of the agency’s financial situation.

A11: A complete response to this question would involve two perspec-tives. The first is the extent to which the proposal represents a criti-cal public service or essential to the operation of state government, is legally required, or is a governor’s policy priority. If the first issue is resolved, the analyst needs information that may or may not be part of the official request. These types of information include work-load measures, increased personnel needs, an explanation of the methodology used to calculate spending needs, performance meas-ures to evaluate future performance, and an explanation of why the agency cannot absorb the cost within existing resources. The ana-lyst should plan on recalculating all cost figures submitted, basically rebuilding the proposal.

A12: An appropriate response to this question would first indicate that the situation provides a good opportunity for a fundamental assessment of the long-term needs for personal computer capacity. The basic analysis should analyze the total cost of replacing the computers for each of several alternatives. Alternatives would most likely include either leasing and purchasing as well as several alternative computer systems. The final total unit cost on which comparisons are made should be based on total costs over the estimated life of the com-puters. This is sometimes called life-cycle costing. It captures pro-curement costs, operating costs, training, maintenance, and insur-ance, and the costs extend beyond a single budget period.

A13: The initial examination of this issue would be to determine year-to-date expenditures for salary, wage, and fringe benefit costs to deter-mine the percent of the appropriation amount spent. If nongeneral funds are involved, planned vs. actual revenues received to date would also be examined. In addition, it is important to account for



major increases or decreases in personnel spending that have oc-curred or are known to be coming up later in the year.

A14: The response should include reference to starting the calculations with rates of pay at the bottom of the pay scale and applying the standard fringe benefit calculation. It is important to be conservative in terms of the number of months each position would be filled, as delays in advertising and hiring new positions are very common. Turnover may also be appropriate to the calculation if there is actual experience with this type of position. A secondary analysis might use the actual experience of similar work units as a test for reason-ability.

A15: The likely answers include: Computer equipment: $3,000 x 5 Employees = One time cost of $15,000 Office space: 100 square feet x 5 Employees x $10 per square foot x 2 years = $10,000 Computer operations charges: 10 cents/paycheck x 5,000 employ-ees x 24 pay periods x 2 years = $24,000

A16: Three items could be reviewed to assess the impact on the operating budget: 1) a comparison of energy costs of the proposed new heat-ing and cooling system versus the costs associated with the existing system, 2) a comparison of estimated routine maintenance costs (annual service contracts) associated with the new systems versus the old system, and 3) a review of repair costs associated with the ex-isting system over the past year.

A17: Four items could be reviewed to determine the additional costs: 1) maintenance costs, 2) custodial costs, 3) grounds care, and 4) utility costs. There are national standards that set a range of 1 1/2 to 2 1/2 percent of replacement value for maintenance costs. National stan-dards are available for determining the utility costs (which are gen-erally determined on a per square foot basis). For institutions of higher education, grounds care is figured on a per acre basis for in-stitutions of higher education. Also helpful are comparisons of costs for other similar facilities.

A18: A complete response to this question would include discussion of exponential smoothing, time-series analysis, and regression analysis in relation to the availability of forecast variable data for the past and in relation to other data about the past and future that are related to the forecast variable. The appropriate response for a budget analyst, who is not normally a forecasting expert, would at least include ref-erence to time-series analysis, where past experience is the primary information on which the forecast is based and to regression analysis



that uses predictor variables to calculate the forecast.

A19: The first and most basic issue in this example is the extent to which the beneficiaries of the proposal are the general public or specific individuals and organizations that gain special benefits not available to the public. When beneficiaries are determined, it suggests where the cost burden should lie.

The respondent should mention the importance of knowing the ac-tual cost of the proposed program, examining how other states fund the activity, determining its revenue generating potential, and de-termining the appropriate funding mechanism -- general fund ap-propriation, dedicated taxes, user fees, or a combination of these sources.

A20: A good response to this question would generally conform to the following logic:

Identify the problems such as bad roads, employee benefits, envi-ronmental concerns, etc.,

Prioritize the problems by cost, cause, and value implications (from most critical to least critical, cost, interelatedness of problem, if solution of one problem will increase or decrease others, bene-fits of solutions, and how much will it cost),

Specify the set of potential solutions for each problem based on cost, cause, and value (for example, political feasibility, imple-mentation time, identification of solutions with the best poten-tial for realization),

Locate, analyze and interpret information needed to forecast out-comes (quantifiable as well as intangibles),

Identify stakeholders (for example, citizens, taxpayers, customers, and regional areas),

Estimate costs and benefits (for example, revenue increases or de-cline to stakeholders, expenditure to stakeholders, opportunity costs, intangible costs, burdens, and cost effectiveness),

Estimate risk and uncertainty (for example, adjust assumptions and attempt to identify costs and outcomes that are measurable and those not measurable),

Establish decision criteria (for example, choose a combination of cost, benefit, implementation time, and stakeholders), and

Recommend best alternative.



A21: Generally, a good response would refer to the homogeneity or vari-ability among the agency’s objectives and the functions it performs; geographic locations; the type and location of its customers; and the level of stability or turbulence in its environment, which is often af-fected by the need for coordination with other agencies, levels of government, the private sector, and interest groups.

A22: The respondent to this question should discuss the alignment of or-ganizational structure with the factors in A21 above, plus discuss the current structure in terms of levels of hierarchy, span-of-control, workload, lines of communication, and the location of decision making authority.

Module 7: Decision Making in the Budget Process A1: Comprehensive rational models use the familiar assumptions of clas-

sical economics. They assume that voters are consumers with rather complete knowledge of what they want and how they might get it, policy makers are producers that compete among themselves on relatively equal terms for the attention and support of voters, and both voters and policy makers engage in rational decision making.

Incremental models acknowledge that both voters and policy makers have incomplete knowledge of what is desired and how it might be obtained.

A2: The model is grounded in a broadly accepted model of problem solving. The model minimizes the risks of decision making in several ways. Perhaps most important it emphasizes technical and analytical skills. These skills usually do not involve obvious policy or political judgments. In the politically charged atmosphere of public budget-ing, they provide the safest possible ground on which to make a de-cision.

A3: Invariably, analysts do not have the time needed to adequately exam-ine an issue. They need and take shortcuts. Typically, they restrict their attention to very small segments of the total problem. They look for aspects of an issue that are different than their expectations. Im-plicitly, they adopt many of the assumptions made by the incrementalists.

A4: The execution and implementation phases are the most technical and least constrained by time. It is typically easier to approximate the ideal in these phases. Elements of the preparation phase also ap-proximate the ideal. However, even in these phases, decisions in-volve considerations not found in the rational models.



A5: The adoption phase often revolves around policy and political con-siderations. They tap into underlying political values. The concepts and tools in a typical analyst’s kit are not intended to provide the values pursued by a democratically accountable leadership. In-stead, the values used to implement decisions must be procured by the analyst from policy makers in some fashion.

A6: Many observers argue it is the role of the central budget office to en-sure that fiscal realities are imposed on those in the agencies and the legislature who have strong incentives to increase the size of the budget. Also, the central budget office must insure that the chief ex-ecutive has the political and fiscal capital to be effective. Nothing erodes political capital faster than budgetary problems and impru-dent fiscal practices. Finally, every governor wants the financial room needed to fulfill campaign promises and personal priorities.

A7: Basically, the information needed for macro budgeting is produced in the scores of micro budgeting decisions that must be made. Moreover, public officials have special responsibilities to account for and control their use of funds. This puts enormous demands on the level and type of detail of information needed in the decision making process.

A8: Checklists, guidelines, and policy statements go only so far. They cannot anticipate the full range of issues with which analysts deal. Analysts need a sense of the overall strategy which lies behind deci-sion making to address the gray areas that always exist. To the extent analysts understand the overall strategy, they can function more ef-fectively in the decision making process.

A9: Such techniques simplify decision making enormously. They help establish settled expectations about decisions and they lower con-flict. They also promote uniformity in decision making. Such tech-niques can be arbitrary, however, and cut off necessary analysis. They work against a textured consideration of the issues and limit the appearance of imaginative solutions.

A10: Once, most budget analysts were accountants or business school graduates. Today, a broad range of disciplines are represented in most budget offices. While this diversity helps budget offices meet their increasing responsibilities, it has had some adverse effects. Specifically, the common discipline that analysts once brought to budgeting issues has disappeared. Analysts do not necessarily have similar expectations about the ways certain problems are to be han-dled. This development, together with the greater demands on the offices, increases the need for intensive training and extensive net-



works of communication.

Module 8: Capital Budgets

A1: The capital budget is different from the operating budget in the fol-lowing ways: they focus on different things (operations vs. infrastruc-ture), the capital planning process often is of greater breadth and covers a longer time frame than the annual or biennial budget proc-ess, a variety of funding methods may be employed for capital pro-jects, and the capital budget may be viewed as being more political than the operating budget.

A2: The response should indicate either a capital planning process that is multi-year in its scope or note that agency budget requests and prior-ity lists are typically the beginning point for budget analysts’ exami-nation. A number of other responses, including personal experi-ence, media reporting, legislative hearings, and the like are also ac-ceptable.

A3: The response could include their need or desire to solve a problem or prevent a problem from occurring, or to present tangible evi-dence of achievement to constituencies.

A4: The analyst’s knowledge and responsibility is directed toward identi-fying the best option(s). The agency’s focus is on needs and priori-ties.

A5: The correct response is statewide or gubernatorial staff with a state-wide perspective.

A6: A correct response would include some or all of the following: gift or grant, cash, borrowing, or privatization.

A7: He or she doesn’t. The process is continuous and cyclical, but does not really ever end. Many capital projects span multiple budget cy-cles. Further, the capital budget feeds into the operating budget, and vice versa.

Module 9: Debt Financing True or False

A1: False

A2: False

A3: False

A4: False

A5: False



A6: False

A7: False

A8: False

A9: False

A10: False

A11: False

A12: False

A13: False

A14: False

A15: False

Short Answer

A16: The three agencies are Moody’s, Standard & Poor’s, and Fitch.

A17: The purpose is to provide guidance in the issuance and manage-ment of state debt.

A18: Credit rating agencies generally assess debt, economy, finance, and management.

A19: The primary difference is the level of security of the bond. G.O. bonds are backed by the full faith and credit of the state. Revenue bonds and lease-purchase are backed by a pledge such as a specific revenue stream, annual appropriation, or the asset itself.

A20: The state would refinance debt through defeasance, which is putting cash aside in escrow to earn interest and meet debt service require-ments.

Multiple Choice

A21: The answer is B.


A23: The answer is E.

A24: The answer is E.

Module 10: The Federal Budget A1: All things being equal, and assuming that the formula that distributes

funds does not adversely harm your state, the correct answer is no.



The authorization is not an appropriation and in many cases the au-thorization is often much more than the appropriated level.

A2: TANF is a block grant, not an entitlement like AFDC, which gives states more flexibility and caps expenditures.

A3: The Federal Fiscal Year begins on October 1st. Because state fiscal years typically begin on July 1, states must carefully forecast and monitor federal funding decisions.

A4: The most important aspects of the federal process for state budget of-fices to know include: 1) the decision timetable, 2) characteristics of entitlement programs, especially funding formulae, 3) administrative cost reimbursement rates, and 4) anticipated changes in discretionary appropriations.

Module 11: Communicating Fiscal Issues A1: The analyst’s prospective audiences include the governor, legislators,

budget director, managers, agency heads, technicians, and cowork-ers.

A2: Communication tools that are used to transmit budget information include budget briefs, the budget message, reports, spreadsheets, media presentations, and issue forums.

A3: No. The budget analyst should be honest, but should provide only necessary and appropriate information.

A4: Common formats include charts, spreadsheets, reports, and memo-randa.

A5: The budget document is one of the primary vehicles for communicat-ing the governor’s budget recommendations. It will be read by legis-lators, agency heads, lobbyists, citizens, and others. The success of the budget is in part attributable to the quality and understandability of the budget document. It is, therefore, critical that the document be clear, concise, and accurate. Tables and other graphics should be used to help present complicated data in an easy-to-interpret fashion.

A6: Ways to avoid careless errors include: developing budget reports and documents which are easily documented and supportable from mul-tiple sources, double and triple checking reports, manually spot checking spreadsheets for formula or rounding errors, using all elec-tronic tools available (spelling, grammar and usage checks), and call-ing on a coworker to help review critical items.



Module 12: Ethics and Standards of Professional Conduct

There are no right or wrong answers to these competency test ques-tions. An excellent approach for obtaining feedback is to pose some of these questions to your professional peers and coworkers and, as a group, discuss your responses.

Module 13: Interpersonal Skills for Budget Analysts A1: The answer is B.

A2: The answer is A.

A3: The answer is F.

A4: The answer is C.



A7: The answer is D.



