How Reality-Based Budgeting Can Permanently Resolve State Budget Gaps

In 2012, numerous studies call necessary attention to the fiscal crisis in the states. State Budget Solutions’ third annual state debt study revealed that aggregate debt across the 50 states amounted to $4.17 trillion.

In October, the State Budget Crisis Task Force, co-chaired by Richard Ravitch and Paul Volcker, released their report on Illinois budget finding, “[s]tate budget practices make achieving fiscal stability and sustainability difficult” and noting that certain large expenditures, including Medicaid and pension costs, are growing at rates that drastically exceed reasonable expectation for revenues. The Pew Center on the States reported in August that, without major overhauls, state budget crises will linger. “Soaring Medicaid costs, woefully underfunded pension and health care benefits for state workers, eroding tax bases. All of these growing state liabilities will only worsen, if left unaddressed. And more trouble could lie ahead for state and local governments from measures Congress is considering to solve the federal budget crisis.”

These publications point to fiscal problems that will not improve if states maintain the status quo. If legislators do not act immediately and decisively, they will be facing an even greater crisis in the near future.

It is tempting for many legislators to address the issue in the usual ways with short term “solutions” such as across-the-board cuts, raids on money in non-general fund accounts, partial contributions to pension funds, and numerous accounting gimmicks. These actions temporarily patch state budget gaps, but states that fail to permanently solve the problems will eventually face devastating “structural deficits.”

The best time for legislators to address and end overspending is now. This requires fundamental reforms. It means tough decisions that impact powerful special interests in popular spending areas like K-12 education, higher education, Medicaid, and state employee salaries and benefits, including pensions.

Problem: Conventional budgeting or the “iceberg model”
Budgets drive all policy, making approving agency budgets the primary task for legislators. Governors and state agencies cannot spend one dollar without legislative approval.

Many state legislators start the budget process by focusing almost entirely on “inputs” (i.e., how much needs to be put in to sustain current programs and expenses). They take existing programs, adjust costs for inflation, add caseload increases, splice in a few new initiatives, and call this their baseline budget. This could also be called the “iceberg” model, where decades worth of spending and programs remain unseen and unexamined under the surface while the debate rages year after year over the small parts that stick up above the surface. In this model, the cost, effectiveness, and demand for existing programs is rarely considered. Focusing on program intentions as opposed to results, and who spends the money as opposed to who benefits, exacerbates the problem. Legislators become “enablers” for outdated and flawed programs and services. Conventional budgeting does not consider how to maximize tax dollars. It doesn’t analyze the efficiency, effectiveness and necessity of existing programs and spending. It rarely asks how a service can be improved or purchased differently, and virtually guarantees overspending.

When legislators discover their conventional baseline budget is higher than estimated revenue forecasts, they often focus on filling the budget gaps with program cuts, tax increases, and accounting gimmicks until spending lines up with expected revenue. Addressing long-term disparities in spending and revenue with accounting gimmicks and one-time money sources is a recipe for disaster. Quick fixes don’t resolve the deeper, structural financial problems. Eventually, only two options are left: tax more or spend less.

Today, most state economies are too weak to sustain tax increases. Raising taxes will likely result in even less revenue due to the negative impact on the economy. Typically, across the board spending cuts do not account for those dependent on services and do not address the wasteful, inefficient spending of many agencies.

Legislators can choose: They can continue to use broken conventional budgeting systems as long as possible, which will result in increasing budget gaps and increasingly desperate short-term “solutions.” Or they can stop deceiving themselves and taxpayers, get a grip on the depth of the problem they face, and do today what will someday be an urgent and unavoidable necessity: restructure their state spending.

Solution: Priority-based budgeting
State Budget Solutions recommends that state legislators take action in 2013 to resolve the serious state financial crises by changing their focus from inputs to outcomes by redesigning budgets from the ground up based on priorities and performance.

Defining priorities and performance is a simple endeavor. Priorities are determined by elucidating well-defined core functions that focus on what the government is responsible for achieving. Performance is the measure of how efficiently and effectively those priorities are delivered.

For example, to advocate a tax increase, a legislator must first articulate how it affects a core function that the government is responsible for achieving, and second, that increasing taxes is the most efficient and effective means for implementing that core function. This is, very simply, the job each legislator is elected to accomplish.

How it works: Asking the right questions
Priority and reality-based budgeting views state government — all of its agencies and functions — as a single enterprise. New proposals are evaluated comprehensively, in light of all of the endeavors the state is pursuing. Agencies and services no longer operate independently, but are evaluated in light of all other state functions. By promoting the ideal that no projects or agencies are sacrosanct, states can better streamline priorities and responsibilities.

Reality-based budgeting prompts governors and legislators to ask four key questions at the start of each legislative session:

1. What must the state accomplish?
2. How will the state measure success?
3. How much money is available to spend?
4. What is the most efficient and effective way to deliver essential services within available funds?

Question #1: What must the state accomplish?
The first step in responsible budgeting is to determine the state’s core functions: the essential services it must deliver to citizens, and prioritize those functions in order of most important to least important. We suggest developing a meaningful list of no more than ten core government functions.

Accomplishing this will require time, respectful discourse, and determination. The process will undoubtedly spark debate between both parties in the legislature, and perhaps all three branches of government. Many officials who publicly embrace reality-based budgeting may also vigorously oppose or inadvertently undermine the model in day-to-day operations.

Core functions will serve as a litmus test for the hundreds of agencies, boards, commissions, programs and services, as well as all future proposals. Lawmakers should base appropriations on the core functions that the agencies affect. If an agency or program does not advancing a core function, it should be abolished.

Question #2: How will the state measure progress and success?
After identifying the state’s core functions, legislators must define specific and measurable success, as well as benchmarks to measure progress toward reaching those results.

What does each organization do? Why? For whom?
The legislature should begin by requiring each agency to develop a mission statement supported by specific goals and objectives directly linked to one or more of the state’s core functions. By requiring agencies to focus on the specific ends necessary to achieving the goals outlined in the missions statement, it forces agencies to define overall expectations and outcomes. This exercise is done on a macro level, breaking down goals into small, specific action items that include measurable tasks and achievable results on a timeline.

Performance measures
Once the state and agencies have defined what it looks like to successfully achieve government’s core functions, legislators must determine how to measure progress toward those outcomes. Performance indicators are a key tool to making accountability possible by allowing legislators and agencies to answer the question: “Are we making progress toward our goals?”

Agencies need at least one performance measure (defined outcome) for each major activity they do, and utilizing immediate and intermediate measures are preferable (though not always necessary). If there isn’t a definable outcome, the activity should be eliminated. A good performance measure:

• Shows whether or not the activity is achieving its purpose and contributing to results;
• Is reliable, accurate and verifiable;
• Is understandable and relevant to citizens and stakeholders who may have little or no knowledge of agency operations;
• Is stated in positive terms (i.e., desired results);
• Is connected to challenging but achievable targets; and
• Can be obtained at reasonable cost.

The importance of a careful review of both the core functions of government and the outcome-based measures of success cannot be overstated. Once these are in place, agencies and programs can be prioritized based on how effectively they will help meet the state’s goals.

Question #3: How much money does the state have available to spend?
This is a superbly sensible question to answer before the legislative session even begins, but it is rarely asked even after the budget session begins. In many states, standing committees meet and pass legislation with little or no relevant spending framework.

States should not spend or plan to spend more than the forecasted revenue for the next budget period. We recommend forming a non-partisan revenue forecast council to provide a bottom line before budget discussion begins. And we recommend legislators designate two percent of the forecasted revenue for a reserve fund, allow this fund to grow to five percent, and then return anything in excess of that five percent to taxpayers.

Question #4: What is the most efficient and effective way to deliver essential services within available funds?
The first three questions in the reality-based budgeting framework deal with prioritizing efforts and developing measurable goals within a budget.  The fourth question focuses on determining the role of government in providing the function, and how competition can be used to control costs and enhance quality.

Utilizing the mission statement and performance measures drafted by government agencies, lawmakers can categorize each agency’s effectiveness, accountability measures, and appropriations. Once agencies submit a budget, legislative policy committees should carefully review all agency priorities to determine whether or not they comply with the adopted core functions of government.

Make or buy?
As lawmakers review agency goals and confirm they are core functions, they should consider whether government must actually deliver the services that accomplish those goals, or whether government’s duty is simply to ensure the goals are accomplished. In some cases, outsourcing services to private organizations proven successful may be the most efficient and effective measn of ensuring a core function is realized.

As legislators follow this process, a government “buy list” is created, focusing the discussion and debate away from “cuts” and on to “purchasing outcomes.” Agency budgets become less about requesting funding, and more about offering to deliver specific results for a specific price.

Example: Washington State
In 2003, Washington state successfully used priority-based budgeting to close a $2.8 billion deficit without raising taxes. The state’s economy was recognized by both political parties as too weak to withstand a tax hike. So legislators and the governor joined efforts to prioritize services within available revenue. They asked the question: What are the most important things we can buy with our limited funds?

Washington’s core functions, which are simply an example from one state, are as follows:
1. Improve student achievement in elementary, middle and high schools.
2. Improve the value of postsecondary learning.
3. Improve the health of Washingtonians.
4. Improve the security of Washington’s vulnerable children and adults.
5. Improve economic vitality of businesses and individuals.
6. Improve statewide mobility of people, goods, and services.
7. Improve the safety of people and property.
8. Improve the quality of Washington’s natural resources.
9. Improve the cultural and recreational opportunities throughout the state.
10. Strengthen government’s ability to achieve results efficiently and effectively.

Using these core functions as a guide, Washington legislators then considered revenue from all sources (not just the general fund) and assumed that no spending commitments or proposals were sacrosanct. They then chose which services to purchase and add to the budget in order to accomplish the state’s core functions, and they prioritized activities within those functions.

Reductions in spending were not haphazard or routine; they were driven by what legislators had determined were the highest and lowest priorities. Agencies were directed by the governor to provide more details on the specific services they delivered, such as who would benefit, how much the services cost, and what they would achieve. Agencies were required to categorize all of their activities as high, medium or low priority, with at least one third of the activities in the low priority category. This enabled the governor’s budget staff to create a priority list comprised of activities across all agencies, and then propose a budget to the legislature that funded the activities that contributed most to the state’s overall goals.

The good results born of this process surprised nearly everyone, even those who initially thought it was just another public relations gimmick. Its success scared agency directors, unions, many lobbyists, and lots of lazy legislators who suddenly realized they had to pay attention and say “no” to special interests who couldn’t prove high value for each dollar spent. The state resolved a $2.8 billion dollar deficit without raising taxes. Unfortunately, Washington’s subsequent legislators and governor have not applied this process since, and the state now faces another yawning budget gap.

Conclusion
Reality-based budgeting ensures government delivers essential services as efficiently and effectively as possible. It maximizes the value of each hard-earned tax dollar and protects vulnerable programs from election-year rhetoric. It provides a logical place for legislators in cash-strapped states to begin meaningful debate and restructure spending.

Moving to reality-based budgeting is not a partisan issue. For years, the Democrat Leadership Council lobbied its members to embrace outcome-based budgeting. We all want as much value as we can get from each dollar we spend, including what we spend on government. Our public institutions must learn to work harder, but more important, they must learn to work smarter.

Once a budget is written, legislators should adopt and implement legislation requiring the final budget is posted on a website for 72 hours before a vote (see ALEC proposal). After a budget is signed and adopted, we urge legislators to develop a transparency website where citizens can see how and where dollars are being spent.