April 2009 · Volume 91 · Number 3

Managing Your Budget: Making Tough Decisions in Tough Times

by Robert Bland

Local governments around the world find their budgets in the throes of a major recession, one that began as a crisis in the subprime mortgage market but has now morphed into a full-blown economic crisis of frightening proportions. Tough economic times require making tough decisions in order to preserve a balanced budget. What can local managers do to minimize the spreading impact of this crisis on their operating and capital budgets?

Leaders in local government know that a balanced budget is a moving target. Sometimes budget plans go awry, even when a local government has vigilantly pursued all the right financial management practices. Economies go through cycles brought on by recessions, inflation, or in recent years by overexpansion in a sector of the economy.

They also go through sectoral shifts brought on by changes in technology, economic development, and competition from domestic and international sources. Then there are the imponderables: natural disasters, epidemics, weather events, and terrorism. The current recession has pressed managers to the limit in mustering the skills needed to navigate the hardest-hit communities through these turbulent economic waters.

Figure 1. Local Government Expenditures as a Percentage of GDP, 1992–2010.

In 2008, the U.S. gross domestic product (GDP) was approximately $14.8 trillion, of which 10.9 percent was produced by local governments.¹ In other words, one in 10 dollars produced by the U.S. economy last year was generated by the nation's local governments.

When locally generated spending for education is netted out, local expenditures represent 6.7 percent of GDP (see Figure 1). Local government outputs have continued their gradual upward trend, paralleling the relative growth in combined government activity in the U.S. economy, which has grown to 36.6 percent of GDP.

Unlike spending by the federal and even state governments, local budgets are driven by personnel costs—salaries, wages, and benefits. And unlike the federal budget, managers in local governments must balance their budgets, meaning current expenditures for operations must not exceed current revenues, including draws from reserves. As a result, budget contractions inevitably impact the salaries and wages of local government employees.

Even more agonizing, the close connection between a local government's budget and its economic base means that prescriptions for dealing with budget imbalances must be tailored to each city or county. No two local revenue and expenditure streams have the same economic and political characteristics. Ultimately, the task of navigating through turbulent economic times falls squarely on the manager's shoulders. Success in maintaining a balanced budget depends on a manager's savvy at understanding the times and their effect on the community's revenues and expenditures, and then taking measured steps to mitigate the short- and long-term effects on the budget.

Top Priority: Base Decisions on Timely and Credible Information

In this age where information is the coin of the realm, good budget information—credible historical data, reliable budget forecasts, and informed interpretation of the findings—becomes the anchor for all other budget-related actions taken by the manager. Timely and credible budget forecasts can happen only in a budget office staffed by knowledgeable analysts with proven experience in forecasting and who understand the interplay between the economy and the local government's operating and capital budgets.

Good decision making requires credible and timely information. A commanding officer depends on credible intelligence about enemy strength, positions, and movements to formulate a successful defense. A manager must have reliable budget forecasts to navigate a local government through turbulent economic times. Cutting corners by not recruiting qualified analysts or acquiring the databases and technology to provide good budget numbers dooms the management team to relying on speculative forecasts to guide their actions.

All governments eventually encounter difficult budget conditions brought on by economic instability. Having timely and credible information on the budgetary impact of these developments gives the manager the leverage needed to take preemptive action to mitigate the adverse effects from economic turbulence. Good budget information involves:

• Year-end projections of actual revenues and expenditures, updated monthly, with an explanation of items that deviate from budget projections.
• At least monthly updates of projections for the subsequent fiscal year's budgeted revenues and expenditures.
• At least quarterly reports and analyses of the local economy, including economic trends of major indicators (unemployment, inflation, GDP, and interest rates) for the region, state, and nation that may affect the local economy, and projections for the next quarter of those major indicators for the state and region, if available.
• At least quarterly reports on performance indicators for key departments or activities that have an impact on the budget.
• Annually preparing a long-term forecast for up to five years of revenues and expenditures for all governmental and enterprise funds, with an analysis of how the local government should address any imbalance. This rolling forecast, updated annually, provides an early warning of impending gaps and gives managers an opportunity to take corrective action to mitigate adverse trends.

In the fall of 2008, the Dallas Independent School District discovered an operating budget shortfall of $85 million caused by poor budget controls and the lack of timely and credible budget information. For the two previous years, the district's leadership had worked successfully to move the academic performance of its students steadily upward.

But the basics of good management were ignored. During the spring and summer of 2008, the district hired 500 more teachers than its fiscal year 2009 budget was capable of supporting. The fall was spent reducing the workforce in a desperate measure to restore budget balance. The best management team cannot perform above the quality of data that it uses in decision making.

Figure 2. Strategies for Responding to Budget Crises.

Second Priority: Make Difficult Decisions Without Delay

Budget crises seldom materialize suddenly and without advance warning. Failure on the part of the leadership team to take corrective action, regardless of the pain, only delays the inevitable and narrows the range of actions available in the future. Sometimes political stalemate precludes the manager from taking corrective action.

Other times, a strained relationship with the council may have chilled a manager's ability to communicate difficult information to the council. And at other times, the manager may become the sacrificial lamb and persuade the council to take preemptive action only to then bear the blame for the controversial decision.

When commenting to the media on his city's growing budget woes in 2004, Pittsburgh Mayor Tom Murphy acknowledged that he had erred in not initiating a discussion sooner on modernizing the city's antiquated revenue policies. Although a top-notch budget team might not be able to anticipate all crises, it will have the expertise to propose a range of responses that fit with the community's economic and political characteristics.

When the budget office identifies a cloud on the financial horizon, transparency from the management team is advisable:

• Notify the council or other legislative body of the nature of the problem and its gravity in terms that they can understand.
• Explain the source of the problem to the best of your knowledge, if those sources can be identified without pointing fingers or implicating past leaders (if the problem is due to past negligence that will become apparent to all without having to drag their reputations into the dirt).
• Recommend a progressive series of steps to correct the problem, with a benchmark at each step to indicate progress and when additional corrective measures may be delayed or avoided.

The more quickly a local government responds to the crisis, the more likely that a serious budget gap can be averted, at least in the short term.

Third Priority: Determine the Type of Fiscal Crisis Your Government Faces

The late Charles Levine, a noted public administration scholar, developed one of the more useful typologies for how local governments deal with fiscal crises.² He segmented budget crises by their duration (short-term versus long-term) and intensity (low versus high) to formulate four types of budget crises in which local governments can find themselves: a fiscal crunch (short-term but low intensity), a fiscal crisis (short-term but highly intense), a fiscal squeeze (long-term but low intensity), and the worst scenario—a fiscal crush (a combined long-term and highly intense crisis).

Building on Levine's typology, Figure 2 displays the progression of actions a local government can take as it rides out the crisis. This figure provides a dynamic profile of the strategies—reducing expenditures and increasing revenues—that local governments use to deal with budget crises. Initially, managers look to expenditure reductions to realign revenues with expenditures. Here are actions that reduce spending:

• Reducing or eliminating overtime; the crisis may provide an opportunity to offer incentives for cross-training of personnel, then shifting those personnel to meet peak periods of demand.
• Making productivity improvements.
• Imposing a hiring or spending freeze.
• Delaying maintenance or capital expenditures.
• Seeking a voluntary reduction in salaries in order to avoid layoffs.

Revenue initiatives may include raising fees, particularly for activities in the general fund, such as recreation, that receive a tax subsidy; tapping budget reserves; or, more proactively, increasing selected excise taxes. Other measures include:

• Aggressively pursuing delinquent taxes, fines, and fees (one frequently used strategy is to introduce an amnesty program for delinquent parking fines, followed by aggressive enforcement of warrants for scofflaws).
• Review of partial and full tax exemptions granted under local law to determine whether any should be modified or eliminated.
• Adjusting fees for enterprise activities to ensure they recover both direct and indirect costs.
• Increasing broad-based taxes, such as property or sales taxes (this is usually a last resort).

If the crisis continues or worsens, the options for closing the budget gap become fewer and more painful:

• Increasing taxes.
• Reducing salaries.
• Reducing the workforce.
• Closing facilities.
• Selling fixed assets.

Inevitably, during periods of economic decline, calls will be made to sell selected fixed assets of the local government, such as vacant land or parking garages it owns. The best time to sell such assets is during expansionary periods when market values have peaked.

The current housing market collapse has left local governments in some areas of the country holding foreclosed homes. Sale of these sorts of fixed assets, especially those that return property to the tax rolls, should proceed quickly. The sale of other assets, particularly property that may be part of a longer-term economic development plan, should proceed only after careful consideration and clear support from the leadership team. Consideration should be given to placing part of the proceeds from such sales in a rainy-day fund.

The ultimate recourse for a local government is to file for bankruptcy. Although rarely used, Chapter 9 of the U.S. Bankruptcy Code provides the statutory basis for local governments to petition the federal bankruptcy court to reschedule payment of their debts, including municipal bonds, accounts payable, and even salaries payable. Chapter 9 does not allow liquidation of a local government's assets or the dissolution of the local government although these options might be possible under state law.

Begin Now to Build a Foundation for a More Robust Economic Future

During periods of budgetary stress, the manager's attention is understandably riveted on getting through the crisis with as little damage to the organization or community as possible. But attention should also be given to laying a foundation for implementing financial and tax policies that can lead to a more robust economic future.

Recent experiences of local governments in the United States suggest that those with weakened economic bases experience progressively greater budgetary stress with each successive wave of economic contraction. The budget contractions have left these local governments fiscally emaciated with few options to reverse their economic fate.

One of the more common measures managers take to mitigate unforeseen events is the creation of rainy-day (or contingency) funds. Every local government should have at least one rainy-day fund. The more unstable the local or regional economy, the larger that fund should be.

The more stability a local government can bring to its annual operating budget, the more control it can exert over its economic future and indirectly over the community. A stable budget conveys to business leaders a favorable investment environment. Unstable budgets bring the greater potential for less predictable tax and fee rates and thus a less predictable environment in which to conduct business.

Another element of long-term financial viability is the development of a strategic plan to guide economic development initiatives. What are the local or regional economy's strengths and weaknesses? Are there clusters of related businesses or is there the potential to build clusters of related businesses (agglomeration economies)?

What threats exist to undermine the local economy? How do current tax and fee policies affect the economy? On the basis of this analysis, local leaders can develop a multiphase plan for building on the community's economic strengths and ameliorating its weaknesses, and for capitalizing on opportunities while mitigating the threats.

Interplay Is Key

The local budget represents the confluence of two independent resource streams—revenues and expenditures. Managing the local budget boils down to managing the interplay between these two streams. The rate at which budget problems develop depends on the differences in the sensitivity of these two streams to changes in the economy.

For managers, the challenge is to estimate accurately the relationship between these two streams for their city, town, or county. Understanding the revenue-expenditure interplay and having tools available for mitigating the gap are keys to effectively managing budgets in tough economic times.

¹Christopher Chantrill, compiler, “United States Federal, State, and Local Spending, Fiscal Year 2008,” www.usgovernmentspending.com.
²Charles H. Levine, “Police Management in the 1980s: From Decrementalism to Strategic Thinking,” Public Administration Review 45 (November 1985): 691–699.

Robert Bland, Ph.D., is professor and chair, University of North Texas, Department of Public Administration, Denton, Texas (bbland@unt.edu). Bland is author of two ICMA finance books: A Budgeting Guide for Local Government, 2nd edition, and A Revenue Guide for Local Government, 2nd edition.

Portions of this article have been adapted from A Budgeting Guide for Local Government, 2nd edition, and A Revenue Guide for Local Government, 2nd edition, both published by ICMA. The author gratefully acknowledges the comments of former manager Mike Conduff, The Elim Group; and Jon Fortune, assistant city manager, Denton, Texas.

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