July 6, 2016

Budget Process Reform: Utilizing Performance Information to Produce Better Outcomes

Testimony Before the House Committee on the Budget
Key materials

Chairman Price and Ranking Member Van Hollen, I am honored to have been invited to testify before you on process and procedural options for reforming the budget process. 

I am a vice president at the Mercatus Center at George Mason University, where my work over the past 15 years has focused on mechanisms that would improve the quality of governance in America. Prior to this, I served as an elected member of the New Zealand Parliament and a member of the Cabinet of New Zealand and was then appointed New Zealand’s ambassador to Canada. The New Zealand government implemented a series of reforms to budget procedures when I served as a legislator. Canada made major changes to its budget processes during my tenure there. My comments today will draw on my research and experiences as well as on the research that other scholars at the Mercatus Center have done on budget procedures throughout the United States. 

Reform Strategy

My view on a successful reform strategy is to first create a concept of what this activity would look like in a perfect world. Once you are satisfied that you have identified what the very best new systems and procedures would look like, it is necessary to identify what it is possible to get done. You will then know what has been traded off to produce a solution that is doable. It is also possible to design today’s reform in such a way that it does not eliminate future desirable reforms that would cumulatively improve the process.

Ideas about Budget Reform

When thinking about reform, it is a good strategy to identify the goal or purpose of this particular activity. In the case of a nation’s budget, the document should be the most important strategic document the government produces each year. As the government’s most important strategic document, some thought should be devoted to prescribing what the document should include. The following points are my views of strategic goal areas that the government should set forth in its budget: 

  • policy priorities
  • debt strategy 
  • deficit strategy
  • revenue strategy
  • growth strategy
  • competitiveness strategy
  • and all of the above, extrapolated over a long horizon

Having set these strategic goals, the passage of the budget means the government now owns the commitments identified in these strategic goals. It also means that the spending and taxing decisions that come later must also respect these strategic goals.

There needs to be a formal process that commits the government to the above strategies so that it is possible to determine if the government is on course to achieve these objectives. As this process is a key function of government, there needs to be a significant consequence for not producing a budget.

In many countries, the above part of the budget is released and debated some months before the spending and taxing part of the budget process. The intention is to have some accord about policy priorities and fiscal-strategy objectives before considering spending and taxing decisions.

Spending and Taxing

Spending and taxing decisions are really about how policy priorities are to be achieved and in what quantity. The mechanisms for achieving these priorities are programs, but it is useful to think of them as tools—and when better tools are developed, the old tools should be discarded in favor of improved results.

Good spending procedures include the following assumptions:

  • The spending process should identify what is being purchased, expressed in terms of outcome (e.g., How many less people will be dependent a year from now?).
  • A quantified expectation of results at the time of appropriation dramatically improves the effectiveness of oversight and accountability (e.g., How much safer we will be a year from now as a result of improved security?).
  • Resources should go to activities that are most likely to produce the desired outcome.
  • Activities that address the same outcome should have to compete for a common pool of money.
  • Activities that cannot produce evidence of results, expressed in terms of outcome, should not be funded.
  • Activities that do not meet the results of the best activities should be eliminated.

Efforts to Reform the Budget Processes

Over the past 25 years, many national, state, and provincial governments have experimented with changes to their budget processes and procedures, with varying levels of success. In nearly every case, the objective of the reforms has been to develop a closer relationship between the outcomes of government spending and future appropriation decisions. While there are many instances where government agencies have significantly improved their ability to produce quality, outcome-oriented performance information, the initiatives have frequently stumbled at the appropriation decision level in the legislature. 

Not the least of these frustrations was the American experience with the Government Performance and Results Act (GPRA) and its later iterations. The Mercatus Center conducted an annual evaluation of the Annual Reports of the 24 Chief Financial Officers Act agencies for the first 10 years of GPRA. In the initial years, Annual Reports produced very poor quality performance information. But by the end of the 10 years, all agencies had dramatically improved the quality and the clarity of their reporting, with some agencies consistently producing excellent reports.

The disappointment with that initiative stems from the fact that this quality performance information was hardly ever used to inform the appropriation process. It is important to emphasize, then, that changed procedures will not, on their own, improve budget decision-making if the legislature does not change its practices as well. But better budget processes that more starkly demonstrate the options available to appropriators—and the consequences of each of the options—may well change the incentives for appropriators.

Controlling Duplicative Spending by Focusing on Outcomes

Maximizing the public benefit by successfully limiting duplicative and wasteful spending requires a change in the thought process behind budget decision-making. This means moving away from funding an activity or program and instead focusing on funding the outcome desired by the government.

It is this concept that led the New Zealand Parliament to reorganize its committees and change the Financial Reporting Act so that parliamentary select committees had direct oversight of sectors of the economy instead of departments and programs. Under this new arrangement, the Education and Science Committee examined all activity that was focused on education, regardless of which agency delivered the program. It oversaw all education programs; could identify which were the most effective and which were the least effective; and how much each cost per unit of success. This change enabled appropriators to strategically allocate resources to achieve the greatest public benefit.

To shift the budget focus to outcome achievement, appropriations are now converted to purchase agreements that spell out precisely what the government expects in outcome results for this investment. For example: this investment of X dollars will buy an increase of 10 percent in ten-year-olds who are reading at their biological age. Or, the purchase agreement is a binding contract between the CEO of the agency and the government. Or, the failure to deliver the commitments in the contract could lead to the termination of the CEO’s employment.

Reformed Capital Budgeting

The government owns a number of policy delivery organizations known as departments. Treating these as operational organizations that give the government the capability to be effective in a number of policy areas creates the opportunity to annually assess the government’s ownership interest in these entities. A reformed budget process also opens up the opportunity to approach the issues of capital investment and maintaining assets at peak operating efficiency. By requiring departments to have a balance sheet that identifies all the assets under the control of the department at market value, it is possible to price the purchase of outcomes to include the monies for asset maintenance.

The Government of New Zealand does this by funding capital maintenance through the purchase of outputs in the performance contract with the department. This process now requires the department to account annually on the ownership interest of the government in that agency. In plain English, that means the department must disclose whether the government’s ability to achieve its objectives through this department have improved, remained static, or deteriorated.

Idle capital can be a major waste of government resources that might be better deployed to higher-priority government activities. Through the identification of assets under the control of a department in the department’s balance sheet, it becomes possible to identify underutilized or idle assets. One strategy designed to free up surplus capital is to develop a “capital charge” across all of government. This works by requiring each department to pay a fee, based on a percentage of the current market value of those assets, to the Treasury for all of the capital assets identified on the department’s balance sheet. The appropriation process funds the department for the assets being used but not for the idle assets. The department must pay the fee on the idle assets from within its budget allocation, which can create a very strong incentive for the department to release those surplus assets back to the Treasury.

In other cases, it is possible to give decision makers a mechanism to compare different claims for capital investment by using a rate-of-return criterion that enables the government to compare the value of different capital investment options.

Overseas Trends

Governments in other countries, driven by dissatisfaction with outcomes from existing practices, have been debating and legislating different budget procedures. 

  1. Many are starting the budget process early by separating budget policy and economic strategy from spending by publishing a budget policy and strategy document as long as six months before the budget. The goal is to allow extensive debate on these issues before the appropriation process. 
  2. Some have shortened the time for the appropriation process (New Zealand’s is only twelve weeks), since many of the contentious issues have already been debated. As each of these countries has a parliamentary system, the consequence for not passing the budget is an immediate new election.
  3. There is a trend toward much greater transparency throughout these new procedures, and some countries have developed statutes that make it more difficult for governments to depart from established procedures and requirements. Some, like Ireland, have set up independent bodies to comment on how well the government is meeting its fiscal and budget requirements. 

The following summary of laws from different countries gives a picture of some initiatives (an appendix gives more detail on each of the laws referenced):

  • Australia: The Charter of Budget Honesty Act 1998. This was the Australian response to the frustration felt by incoming governments that the country’s fiscal position after an election was often much worse than had been portrayed during the election.
  • Ireland: The Fiscal Responsibility Act. This was a response to the perceived fiscal non-accountability of successive governments. This law did something extraordinary: it set up the statutorily independent Irish Fiscal Advisory Council. The council’s job, as laid out in the statute, is to comment quite specifically on whether the government is acting in a fiscally responsible manner.
  • New Zealand: The Fiscal Responsibility Act and the Financial Reporting Act. These laws, and a number of others, were responses to decades of highly inept fiscal management that led the country to the verge of bankruptcy in the early 1980s. “Having cleaned up the mess, don’t let it happen again” probably best describes the rationale driving the compendium of fiscal and operational laws passed in New Zealand.

Conclusion

A huge volume of research and real world experience now exists, both in the United States and overseas, on the subject of budget processes and procedures. My testimony has touched very lightly on a number of the initiatives currently in practice to identify options that might be attractive to the House.

What can be said with certainty is that more transparent procedures, a linkage between agency performance and future budget allocations, and a focus on measuring progress against outcome achievements all appear to be goals of these initiatives. It could also be said that there appears to be a cultural shift within these nations toward a greater appreciation of the importance of keeping spending and debt within predetermined parameters that define fiscally responsible behavior.