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BUDGETING FOR STRUCTURAL BALANCE
The past recession was very difficult for New York City and governments around the
nation. As the expansion of the 1980s ended and the recession unfolded, governments found
themselves in a process of reversing tax cuts or canceling new spending programs. One
obvious question was how long would this retrenchment be necessary: could laid-off workers
be rehired and tax surcharges canceled in two or three years? Or would they be permanent? To
address these questions, the New York Financial Control Board undertook an intensified effort
to rethink New York City's finances. The result of that process was an approach to budgeting
that we call structural balance. The most important characteristic of this approach is that stable
and reliable delivery of public services becomes the goal of the budget process.
Structural balance emphasizes that disrupting operating departments mid-year in order
to rebalance a budget is undesirable (see Box 1). First, risks are inherent in budget estimates so
that it should be expected that some revenues will fall short and some expenditures will exceed
estimates. It is the budget office's responsibility to anticipate the risks to budget balance and
formulate in advance sufficient reserves and contingencies so that reasonable risks can be
handled without undue disruption of services. Second, the business cycle is alive and well so
that one should acknowledge that revenue growth will peak and drop as economic expansions
turn to economic recessions. In essence, a well-structured budget should show surpluses when
the economy is strongest and deficits when the economy is weakest. It is the budget office's
responsibility to try to anticipate and identify cyclical surpluses and to avoid overexpanding
services to levels that will have to be cut back when the economic cycle turns down. It is also
the budget office's responsibility to set aside fund balances or tax stabilization reserves
sufficient to offset cyclical revenue drops with minimal need for temporary service cutbacks.
Neither of these first two principles can be easily executed unless one starts with a
sound budget and, equally important, has consensus on what constitutes a sound budget. For
example, it would be futile and counterproductive to set aside reserves and contingencies to
hold together a budget that is profoundly out of balance. Moreover, a goal of stabilizing a level
of services would be meaningless if elected officials cannot agree whether a particular service
level is excessive or inadequate. As a consequence, structural balance says that a necessary
prerequisite for stability is a sound budget that is grounded on a well-defined sense of basic,
fundamental services that should be provided at all points in the business cycle.
Structural balance provides an approach to help decision-makers to develop a sound
budget. It provides criteria to facilitate consensus on the appropriate level of fundamental
services. It also provides decision-makers with criteria to satisfy themselves that the revenues
necessary to support those services have been identified and are indeed adequate. Structural
balance then goes on to provide guidelines on ways to foster the stability and effectiveness of
those services.
Why Focus on Stability?
The structural balance approach began with a focus on stability because the costs of
instability were becoming obvious and unacceptable. Initially New York City officials wanted to
work toward stabilized service delivery so that they could anticipate employment needs better.
In particular, they found it counterproductive to hire employees in one year only to find that
they needed to reverse this action the next year with hiring freezes or layoffs in order to balance
a budget. Moreover, they concluded that they preferred that any expansion and contraction in
agency staffing be accommodated as completely as feasible through the more gradual process
of attrition with voluntary transfers among agencies in order to facilitate appropriate allocation
of workers. Other benefits of stability soon became apparent. In particular, the priorities
created in one year's budget could be sustained over time so that agencies could reasonably
plan service demands and manpower needs over a multi-year period. In doing so, stability
could minimize the sizable inefficiencies created by frequent program reversals.
Importantly for all governments, structural balance argues that an enhanced ability to
sustain priorities and to maintain stable service delivery permits substantially increased focus
on the purpose and mission of agencies and on the ability of the budget to accomplish that
mission, an important objective of performance measurement and total quality management.
Without reasonable year-to-year stability, repetitive budget-cutting exercises occur under
relatively short time frames. This common, last-minute orientation of budget offices permits
little opportunity to design expenditure reductions that can achieve the savings needed and at
the same time preserve the top priorities and mission of the agencies. Structural stability
therefore benefits managers because it makes it easier to manage an operating department. It
benefits the business sector because it gives businesses predictable tax and service policies that
are necessary for effective business planning. It also benefits other taxpayers because it lets
them reliably know their tax obligations and the services that they can expect from government.
Expenditure Structures, Revenue Structures, and Structural Balance
In order to carry out this task one needs an understanding of the fiscal profile of a
government's expenditures. This profile is called the expenditure structure. One of the most
accessible ways to describe an expenditure structure is with data on historical and prospective
shares of spending and rates of growth. In developing that profile one soon discovers that
some expenditures tend to grow faster than others. Growth in total spending, therefore, can be
slowed by altering the relative shares of spending so that cutbacks occur in faster-growing areas
and expansion occurs in slower-growing areas. In other words, efforts to slow spending would
be more productive if they focused more on the faster-growing areas than on the slowergrowing
ones. It is not necessarily automatic that the budgeting process focuses on faster
growing items more than on slower growing ones. One of the advantages of structural balance
is that it provides another tool to mold the budget debate. In New York City, structural balance
was particularly useful in focusing attention on debt service, Medicaid, and employee health
benefits, the three areas driving most of New York City's budget problems. Before structural
balance became the basis for budget debates, these three areas were the ones least often placed
on the cutting floor during budget debates.
The identification of the expenditure structure most appropriate for a government is
heavily dependent on an understanding of what the government can afford. This is where the
notion of revenue structure comes in. The revenue structure of a budget is described by the
types of revenues, their shares in the total budget, and the varying reliability and rapidness
with which they grow over time. A structure dominated by tax revenue, for example, creates a
strong dependence between revenues and the health of the local economy. On average, local
governments around the nation raise about 40 percent of their revenues from taxes and about 25
percent from user fines, fees, and charges. Their reliance on federal and state aid averages 35
percent. Among the taxes they raise, local governments typically raise about 75 percent from
the real property tax, about 20 percent from sales and consumption taxes, and the remainder
from income taxes. This tax structure characterizes the traditional importance in public finance
that local government services and revenues need to be as stable and relatively unresponsive as
possible to the ups and downs of the local economy. Unfortunately, this structure will also be
relatively unresponsive to the economic recovery, placing tremendous pressure on local
government budgets for the remainder of the 1990s.
Structural balance describes the situation in which the structure of the revenue budget
and the structure of the expenditure budget are sufficiently complementary: of similar size and
growth rate over time. Different revenue and expenditure structures will respond to economic
expansions or recessions at different rates, so that, at different points in a economic cycle,
differently structured budgets may have larger or smaller deficits and surpluses than others. If
a government's overall finances are structurally balance, however, over time the surpluses will
offset the deficits.
Functionally, however, structural balance is more than just another way to count and
identify deficits. Structural balance emphasizes that a budget that effectively supports reliable
services must reflect a sound financial structure that can be shown to be functionally viable over
time. For revenues, a sound structure means that the way a government raises its revenues
assists, or at least does not harm, the economy that generates those revenues. For expenditures,
a sound structure means that all legally required services are provided and it can be shown that
an acceptable level of fundamental local services can be sustained over time without recurrent
need for substantial changes such as personnel layoffs, temporary cancellations of programs, or
tax increases.
Chart 1 is a simple analytic device to show whether a government's finances are
structurally balanced during the current economic recovery. The chart shows expected
cumulative rates of growth of expenditures and revenues over the next four years for New York
City. In a simple glance one sees that expenditure growth will chronically exceed the rate of
growth of revenues, evidence of structural imbalance that will lead to enlarging prospective
budget problems. Furthermore, the chart shows the effect on the level and growth of
expenditures and revenues of the city's February preliminary budget for FY 1995. Once again, a
simple glance shows that the FY 1995 gap has been closed and expenditure growth has been
reduced. Unfortunately, the expected growth of revenues has also been reduced, leaving a
continued, albeit smaller, "growth gap" that will perpetuate future budget problems. Thus one
quickly sees two important factors: (1) the expenditure structure is too fast-growing for the
current revenue structure and (2) efforts to balance the next year's budget make significant but
insufficient inroads on this disparity.
Identifying a structural problem necessitates further work to isolate the particular
expenditure and revenue areas that contribute to structural imbalance. Table 1 is a breakdown
of cumulative expected growth rates that provides a simple starting point for structural
analysis. The table breaks revenues into tax, miscellaneous, and intergovernmental sources and
it breaks expenditures into major personnel and non-personnel categories. One sees the
"growth gap" phenomenon illustrated in the earlier chart from looking at the disparity in total
revenue and expenditure growth rates on the table. More importantly, from a table such as this,
one begins to gain an understanding of the issues the city will need to confront in order to bring
revenues and expenditures into recurring balance. On the expenditure side it is immediately
clear that structural balance will remain elusive until the cause and implications of city debt
service and Medicaid growth are confronted. On the revenue side, it is also immediately clear
that the causes of anemic growth in the tax base and of the decline in miscellaneous revenue
must be confronted if any notion of stable service levels is to be reliably supported and
sustained.
At the operational level, the orientation of structural balance toward the issue of
ongoing growth subjects routine budget requests to an examination process that emphasizes
the prospects for stability. The analytic devices provided by this chart and table are only the
starting points that are intended to prompt more thinking about the nature of a jurisdiction's
fiscal problems and the policy areas that deserve closer attention. Box 2 contains examples of
the types of questions that budget examiners should use to prompt a focus on stable and
reliable provision of services. In contrast, the more common approach to budget examination is
heavily focused on current year financial issues. For example, when assembling a budget that
shows a gap of $X to be filled, one common approach is to ask "what can we cut in order to save
$X this year."
The structural checklist in Box 2 suggests that a better approach to budget examination
is to look at existing programs from the perspective of the future cost of sustaining those
programs at current levels. Programs targeted for reduction would ideally be those which
would provide the highest and most likely ongoing savings. A similar scrutiny should be
applied to new programs. For example, a recommendation to introduce refuse recycling should
go beyond estimating first year costs and how to handle those costs in the immediate budget
year. Oftentimes this short-term focus leads to the introduction of ambitious recycling goals
that soon create budget problems or else lead to expensive abandonment of programs and
facilities after they have gone into operation. Instead, to evaluate this program from a
structural viewpoint, one should ask: How will costs grow into the future? Can revenue
growth keep up with this? What program is less important that we can drop it as recycling
costs grow? This sequence of questions ideally can foster a process that allows one to adjust the
performance expectations for a recycling program to a level that can be reliably funded into the
future.
Non-recurring or one-shot actions to balance budgets receive careful scrutiny under a
structural approach. Examples are asset sales, federal and state aid settlements, capitalizing
interest payments, and extraordinary debt refundings. Structural balance argues that a oneshot
has merit only if it buys time for a better solution to a budget problem. In particular, at the
same time the one-shot is being considered, the budget office ought to be actively developing
the better solution. The questions to ask are: What are we buying time for? Or are we avoiding
acknowledging and addressing the problem? Does this action help or harm the future?
Structural balance also emphasizes the linkage between capital spending and the
operating budget. It argues that capital spending will change the operating budget so those
changes should be anticipated at the time of capital commitment. In particular, can the
municipality afford all the costs of a capital project: the construction costs, the debt service costs,
the operating and maintenance costs?
In contrast to many budget processes, structural balance places a very different focus on
proposals to change taxes or fees. Since structural balance places responsibility on the revenue
budget for maintaining stable levels of services, it argues that a revenue source is effective and
useful only if it is able to grow at the same rate as the inflation inherent in the cost of providing
stable future levels of services. As a rule of thumb, if a revenue source is unlikely to grow at
least as rapidly as the consumer price index, reliance on that revenue will likely contribute to
future budget problems and to service cuts or tax and fee increases. In particular, the following
common revenue sources are undesirable from the perspective of structural balance because
they have limited prospects for adequate growth: gas taxes, bridge tolls, real property taxes
based on infrequent reassessment of property values, for example.
Finally, structural balance argues that the ability to afford additional employees should
be predicated on the ability of the revenue structure to keep pace with the certainty of future
growth in the costs of an additional employee. At times the availability of surplus funds leads
to consideration of adding employees, especially firemen and policemen. The real ability to
afford more employees is the answer to "what about next year?" Since growth in salary and
benefits are particularly difficult to avoid, this future orientation for evaluating new hires is
perhaps one of the more dramatic characteristics of structural balance.
How New York City Has Benefited
Structural balance as an approach to budgeting has changed significantly how New
York City establishes its budget priorities. While structural balance has not eliminated New
York's budget problems, it has markedly improved how it develops solutions to those
problems. In fact, it bears emphasizing that structural balance is not a panacea for fiscal
difficulties. Its benefit lies in focusing attention on better diagnoses and solutions to problems.
Structural balance, even once attained, is not permanent because revenues and expenditures are
constantly subject to changes beyond a government's direct control. Policy decisions and
priorities must be constantly reviewed as the needs of the citizenry change. However, a
budgetary process that contains structural balance as one of its objectives will continually
evaluate whether evolving expenditures, revenues, policy decisions, and priorities remain
compatible. In other words, can expenditures still be sustained by revenues or must further
changes occur? For New York City, structural balance is not yet within reach; however, as a
result of focusing on structural balance, New York has a much more effective command of its
finances than it had five years ago.
One of the first benefits of aiming toward structural balance has been that decisionmakers
are much better focused on the most critical fiscal problems that, if not confronted, will
continually produce budget problems. For example, structural analysis has dissolved the myth
that the persistence of New York's budget problems is caused by the welfare system. In fact,
welfare costs are not a major source of the expenditure growth that is forcing recurring budget
gaps. Instead, the process has identified debt service from the city's ambitious capital program
as the principal cause of recurring deficits, followed closely by elderly nursing home care and
Medicaid-financed homecare. The process has also demonstrated that growth in these areas is
crowding out basic services, an outcome clearly not intended by decision-makers.
Structural balance has also helped the city to develop fiscal actions that directly address
these particular problems. The citizenry and elected officials are now keenly aware of the
critical role enhanced labor productivity must play if basic services are to be preserved in the
future. It recently led to a pathbreaking agreement for the redeployment of workers to fill
vacancies in critical jobs. The approach has also led to adoption of enhanced spending controls
to keep mid-year budget problems at bay. In fact, newly introduced controls have led to over a
90 percent completion rate for billions of dollars of budget-balancing actions over the past three
years.
One of the most difficult and therefore most significant achievements of adopting
structural balance has been the increased integration of capital and operating budget decisions.
Contrary to the notion that elected officials are excessively short-term oriented, the elected
officials in New York City are making sizable and difficult reductions in the capital and
financing program today in order to achieve budget savings that will not be significantly
realized for five years. This long-term focus was the direct result of using structural balance as
the underpinning of decision-making. Today's capital spending decisions are now routinely
evaluated in terms of their effects on the budget over the coming decade.
Finally, structural balance has fostered an expanded sense of accountability for the
future fiscal health of the city. Before structural balance was adopted by the city in 1992, it was
commonly accepted that balancing the current year's budget could and should be achieved by
any means necessary. As a result, budgets were too often balanced by means that created
enormous additional costs for future years in exchange for immediate budgetary savings. Now,
because of the focus on recurring budget balance and eventual stabilization of service levels,
such deferrals of expenses or accelerations of revenues are rare and are roundly criticized
whenever they are proposed.
The Importance of Structural Balance to the National Task Force on Budgeting
The efforts to develop structural balance had been prompted by the concern at the
Financial Control Board that budgeting had become an end in itself rather than a means of
financing and delivering services. That viewpoint has also prompted a nationwide effort to
improve budgeting at the state and local level.1 This effort gained critical momentum with a
National Symposium on State and Local Budgeting sponsored by GFOA in January 1993.
Significantly, the symposium participants identified six key goals for improved budgeting that
are also goals emphasized by the structural balance approach to budgeting:
- Integration of long-term planning with the budget;
- Establishment of measures and on-going monitoring of performance;
- Obtaining citizen and other stakeholder involvement early in the budget
process;
- Effective communication of goals, assumptions, and tradeoffs to citizens and
other stakeholders;
- Provision of incentives and a sense of empowerment of managers and other
government employees to implement effective practices and achieve goals;
and
- Incorporation of realistic revenue and expenditure forecasts.
The Symposium recommended that a task force be formed to decide whether and how
to proceed with a nationwide effort to foster these goals. The National Task Force on State and
Local Budgeting was formed, met in October 1993, and issued its recommendations in February
1994. In its report, the National Task Force determined that guidelines should be developed in
conjunction with documentation of a range of approaches taken by governments around the
nation to achieve these goals. Structural balance seeks to provide one approach to achieve these
six goals in budget preparation and implementation.
As a result of the recommendation of the National Task Force, the GFOA is in the
process of forming a national advisory council to oversee the development of guidelines for
effective budgeting. GFOA is seeking the active involvement and endorsement of all the major
professional associations involved in budgeting, ranging from the League of Cities to the
National Conference of State Legislatures to the National Association of Towns and Townships.
If these efforts are successful, an important process will have begun to address the budget
problems that finance officers chronically face.
Creation of the advisory council and the development of structural balance are different
yet parallel responses to concerns articulated by the GFOA Standing Committee on Budgeting
and Management. In their well-known white paper of January 1992, the committee concluded
that government finance professionals need help in identifying, learning, and executing better
ways to turn the resource allocation business of budgeting back toward a problem-solving
orientation. The following excerpt from that report is an appropriate summary of the goals of
structural balance and of the incipient advisory council on budgetary guidelines: "The problem
is not that processes and tools [for budgetary practice] are not available, it is that the
practitioners and potential users have concerns as to the relevance of much that is currently
available; there is not adequate incentive to consistently use them; there is little training; there is
no mechanism to promulgate; there is little consistency either over time or between
governments; and there is little integration of the various processes."
Structural balance is New York City's effort to try to address these concerns. Successful
formation of and support for the Advisory Council and the recommendations of the National
Task Force on State and Local Budgeting will provide an added resource to improve budgetary
practice and enhance reliable provision of effective government services.
_________________________________________________________________________
Allen J. Proctor is executive director of the New York State Financial Control Board. Formerly
deputy budget director for New York City, he is a member of GFOA and serves on GFOA's
Committee on Governmental Budgeting and Management as well as the National Symposium
and Task Force on State and Local Budgeting. The project, Structural Balance, received the 1993
Louisville Award for Innovation in Government Finance. Copies of the project are available by
calling 212-417-5046.
Box 1: LET MANAGERS MANAGE
Structural balance argues that the responsibility for assembling a budget that
remains balanced during the year lies with the budget office, not with the
operating agencies. Therefore the budget office has three obligations to
operating departments:
Identify what is expected:
Establish the performance objectives and measures that department managers are to achieve.
Fund It:
Identify the resources really needed to do the job -- or else redefine the job to a level that can be
funded. (Under-budgeting is NOT a good incentive system for managers.) Responses to
economic slowdown should also be anticipated in establishing what core level of services can be
guaranteed.
Don't Interrupt It:
Ensure that multi-year efforts have a multi-year funding commitment. Plan for the certainty
that there will be budget problems, anticipate their likely size and timing, and prepare a
response that does not require suspension of core service programs. One important aspect of
good anticipatory planning is the budget office's obligation to establish and fund adequate
reserve funds, fund balances, or other contingency plans.
Box 2: STRUCTURAL CHECKLIST FOR BUDGET REQUESTS
Service levels:
What services will be provided today?
What will they cost next year?
How will we pay for them?
One-shots:
What service will be cut or what revenue source will be increased when it
expires?
Capital spending:
What does it imply for future O&M and debt service spending?
Tax or fee proposals:
What are their future growth prospects?
Hiring:
Is revenue growth adequate to support salary and benefits growth?
Box 3: APPLYING STRUCTURAL BALANCE TO YOUR BUDGET
QUESTION THE FUTURE IMPACT
Tax and Revenue System:
What do we have?
What changes are we proposing?
What will that buy us in the future?
Service Delivery System:
What can we guarantee for the next three to five years?
Can we control costs by enough to hold taxes and services at today's levels?
FOCUS ON SOLVING RECURRING PROBLEMS
What problems keep cropping up?
What are the contributing factors?
Is our budget process addressing these factors each time we balance the budget?
©2002 Allen Proctor LLC
1 December 1992 Government Finance Review, New Directions in Budgeting and Fiscal Planning.
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