Performance Based Budgeting

Gerald Miller

• Publisher: Routledge
• Year: 2018
• ISBN:
  9780429978043
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Politics
• Index: Politics & International Relations

Performance Based Budgetingis the next volume in the ASPA Classics series. It covers the most influential, paramount research articles published on public budgeting and finance. The book will surely be of great interest and use to anyone concerned with public budgeting, and anyone enrolled in, or teaching, a course on this topic in an MPA program or a doctoral program in public administration, public affairs, political science, or economics/public finance.

Part I
Origins and Development

Introduction

Each route budget reform has taken has implied a rationale for budgeting and, therefore, a normative theory. This book first describes three basic normative theories for budgeting that have appeared. Lewis's "Toward a Theory of Budgeting" provides an economic rationale for budgeting. Lindblom's observations in "The Science of Muddling Through" yield a stark contrast to Lewis in creating an opposed administrative rationale for decisions (and, by implication, for budgeting). Finally, in "The Political Implications of Budget Reform," Wildavsky portrays budgeting as inherently political.

Beyond normative theories, accounts of actual reforms have appeared. In "The Road to PPB" Schick describes three stages of reform and provides a conceptual understanding of which normative theories gained ascendancy at what times. With a different view of reform and the routes taken, Wildavsky, in "Why the Traditional Budget Lasts," suggests less movement than a cursory observation would uncover.

Despite the ebb and flow of theory and reform, the bedrock question of what matters in budgeting remains: On what factors do budget outcomes depend? Grizzle, in "Does Budget Format Really Govern the Actions of Budget Makers?" surveys budget actors to determine whether the various budget reform frameworks or "formats" really have any influence on outcomes.

Budget reforms continue to unfold across the world, many taking the form of "results-oriented" budget processes. What is a results-oriented budget? Three observers provide answers. First, Schick looks at the reform movement in the West in "Budgeting for Results: Recent Developments in Five Industrialized Countries." Thompson delves deeply into federal budget reform in the United States following the National Performance Review in "Mission-Driven, Results-Oriented Budgeting: Fiscal Administration and the New Public Management" and proposes ways to make present budget practice "permissive, continuous, and selective." Finally, Cothran examines events at the local level in the United States, in "Entrepreneurial Budgeting: An Emerging Reform?"

Budgeting has often been the lever through which reform in government institutions, and particularly management practices, has sprung. Significant questions exist, however, about the present performance movement in government management and the place budgeting holds in its unfolding. Is results-or performance-oriented management—the new public management as Thompson called it—a reform that ignores budgeting? How friendly is budgeting as practiced with a performance or productivity emphasis? In various ways, Lauth ("Budgeting and Productivity in State Government: Not Integrated But Friendly"), Grizzle ("Linking Performance to Funding Decisions: What Is the Budgeter's Role?"), and Klay ("Management Through Budgetary Incentives") explain that budgeting at all levels of government exists for reasons of performance accountability as well as other, more fundamentally important reasons, such as control, particularly legislative control, of administration.

Section I.A
Theory, Conceptualization, and Critique

1
Toward a Theory of Budgeting

Verne B. Lewis

The $64.00 question on the expenditure side of public budgeting is: On what basis shall it be decided to allocate X dollars to Activity A instead of allocating them to Activity B, or instead of allowing the taxpayer to use the money for his individual purposes? Over a decade ago V. O. Key called attention to the lack of a budgetary theory which would assist in arriving at an answer to this question.¹ Pointing out that budgeting is essentially a form of applied economics, since it requires the allocation of scarce resources among competing demands, Professor Key urged that this question be explored from the point of view of economic theory.

The purpose of this article is to analyze three propositions which are derived from economic theory² which appear to be applicable to public budgeting and to be appropriate building blocks for construction of an economic theory of budgeting. In brief, the three principles are:

1. Since resources are scarce in relation to demands, the basic economic test which must be applied is that the return from every expenditure must be worth its cost in terms of sacrificed alternatives. Budget analysis, therefore, is basically a comparison of the relative merits of alternative uses of funds.
2. Incremental analysis (that is, analysis of the additional values to be derived from an additional expenditure) is necessary because of the phenomenon of diminishing utility. Analysis of the increments is necessary and useful only at or near the margin; this is the point of balance at which an additional expenditure for any purpose would yield the same return.
3. Comparison of relative merits can be made only in terms of relative effectiveness in achieving a common objective.

Part I of this article will be devoted to consideration of these principles. In Part II a proposal, which will be called the alternative budget procedure, will be outlined and analyzed in terms of the three principles. Primary emphasis throughout will be placed on the applicability of concepts developed by the economists to methods of analyzing budget estimates. The discussion is pointed specifically at problems of the federal government; the general ideas, however, should be equally applicable to state and local governmental units.

I

Relative Value. Budget decisions must be made on the basis of relative values. There is no absolute standard of value. It is not enough to say that an expenditure for a particular purpose is desirable or worth while. The results must be worth their cost. The results must be more valuable than the results would be if the money were used for any other purpose.

Comparison of relative values to be obtained from alternative uses of funds is necessary because our resources are inadequate to do all the things we consider desirable and necessary. In fact, public budgeting is necessary only because our desires exceed our means. The desires of human beings are virtually unlimited. Although the supply of resources has been greatly expanded in recent decades, the supply is still short in relation to demands. It would be nice if we had enough to go around, but we do not have. Some demands can be met only in part, some not at all.

Scarcity of resources in relation to demands confronts us at every level of public budgeting. Public services consume scarce materials and manpower which have alternative uses. If used for governmental activities, they cannot be used for private purposes. If used for Activity A of the government, they cannot be used for Activity B. Expressed in terms of money, the problem of scarcity arises in connection with appropriations. As individual taxpayers, we put pressures on Congress to hold down federal taxes so that a larger proportion of our already inadequate personal incomes will be available to satisfy our individual desires. In view of these pressures, Congress usually appropriates less than is requested by the President and interest groups. The President in turn usually requests the Congress to appropriate less than the total of the estimates submitted to him by agency heads. Rarely does an agency have sufficient funds to do all the things it would like to do or that it is requested to do by citizen groups.

Confronted with limited resources, congressmen and administrative officials must make choices. The available money will buy this or that, but not both. On what basis should the choice be made?

The economists, who specialize in problems of scarcity, have a general answer to this question. It is found in the doctrine of marginal utility. This doctrine, as applied to public budgeting, has been formulated by Professor Pigou as follows:

As regards the distribution, as distinct from the aggregate cost, of optional government expenditure, it is clear that, just as an individual will get more satisfaction out of his income by maintaining a certain balance between different sorts of expenditure, so also will a community through its government. The principle of balance in both cases is provided by the postulate that resources should be so distributed among different uses that the marginal return of satisfaction is the same for all of them. . . . Expenditure should be distributed between battleships and poor relief in such wise that the last shilling devoted to each of them yields the same real return. We have here, so far as theory goes, a test by means of which the distribution of expenditure along different lines can be settled.³

Other aspects of the marginal utility concept will be considered in later sections; here we want to note that this concept poses the problem in terms of relative values rather than absolutes. To determine the distribution of funds between battleships and poor relief we must weigh the relative value of the results to be obtained from these alternative uses. Is it worth while to spend an additional $1,000,000 for battleships? We can answer "yes" only if we think we would get more valuable results than would be obtained by using that $1,000,000 for poor relief.

When the economists approach the problem in terms of costs rather than results they arrive at the same conclusion. Fundamentally, as the economists indicate in their "opportunity" or "displacement" concept of costs, "the cost of a thing is simply the amount of other things which has to be given up for its sake."⁴ if Robinson Crusoe finds he has time to build a house or catch some fish, but not both, the cost of the house is the fish he does not catch or vice versa. The cost of anything is therefore the result that would have been realized had the resources been used for an alternative purpose.

Of what significance from the point of view of budget analysis are these concepts of relative value and displacement cost? They indicate that the basic objective of budget analysis is the comparison of the relative value of results to be obtained from alternative uses of funds. If an analyst is convinced after reading the usual argument supporting a budget request that the activity in question is desirable and necessary, his task has just begun. To be justifiable in terms of making the most advantageous use of resources, the returns from an expenditure for any activity must be more desirable and more necessary than for any alternative use of the funds. On the other hand, a budget request for an activity cannot legitimately be turned down solely on the basis that the activity costs too much. Costs and results must be considered together. The costs must be judged in relation to the results and the results must be worth their costs in terms of alternative results that are foregone or displaced.

Incremental Analysis. If the basic guide for budget analysis is that results must be worth their costs, budget analysis must include a comparison of relative values. How can such a comparison of values be made?

The marginal utility concept suggests a way of approaching the problem. The method, briefly, is to divide available resources into increments and consider which of the alternative uses of each increment would yield the greatest return. Analysis of increments is necessary because of the phenomenon of diminishing utility. This means, roughly, that as we acquire more and more units of anything, the additional units have less and less use value. If enough units are acquired, an added unit may be of no value at all and may even be objectionable. To illustrate, four tires on a car are essential, a fifth tire is less essential but is handy to have, whereas a sixth tire just gets in the way. Although a sixth tire will cost as much as any of the first five, it has considerably less use value. In deciding how many tires to buy, we must therefore consider the use value to be derived from each additional tire.

Because of the phenomenon of diminishing utility, there is no point in trying to determine the total or average benefits to be obtained from total expenditures for a particular commodity or function. We must analyze the benefits by increments. If one million bazookas make a valuable contribution toward winning a war, we cannot assume that the contribution would be doubled if we had two million. Perhaps there are not enough soldiers to use that many. No matter how valuable bazookas might be toward winning a war, a point would be reached sometime on the diminishing scale of utility where additional expenditures for bazookas would be completely wasted. Since we do not have enough resources to do all the things we would like to do, we certainly should not produce anything that will not or cannot be used.

But we cannot assume that we would make best use of resources even if we produced no more bazookas than could be used. Perhaps the manpower and materials consumed in producing the last thousand bazookas would serve a more valuable purpose if they were used for producing additional hand grenades or some other item. This reasoning leads us back to the basic criterion for deciding how much should be spent for each activity. We should allocate enough money for bazookas so that the last dollar spent for bazookas will serve as valuable a purpose as the last dollar for hand grenades or any other purpose. If more than this amount is spent for bazookas, we sacrifice a more valuable alternative use. Thus, as is suggested by the marginal utility theory, maximum returns can be obtained only if expenditures are distributed among different purposes in such a way that the last dollar spent for each yields the same real return.

The marginal utility concept also indicates that a comparison of incremental values is meaningful and necessary only at or near the margins. When analyzing the value of the returns by increments of expenditure near the margins we would ask: How much will be sacrificed if proposed expenditures for Function A are reduced by $1,000? Can efficiency be increased so that output will not have to be reduced? What would be the consequences of lowering standa...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• Tables and Illustrations
• Introduction
• PART I ORIGINS AND DEVELOPMENT
• A Theory, Conceptualization, and Critique
• B Recent Budget Practices Revealed
• C Evaluation of Budgeting for Performance
• PART II PERFORMANCE-BASED BUDGETING
• A Strategy
• B Performance Management
• C Pay for Performance