In the October 2013 PM cover story, authors Jon Johnson, Chris Fabian, and Cheryl Hilvert argue that in the coming “decade of local government,” city and county managers will not be able to return to the status quo that existed before the recession. We will instead need to “manage, use, and optimize resources in a much different way than has been done in the past.” (To review article, go to icma.org/pm and check “Archives” tab.)

The authors emphasize the importance of effective communication of financial information, developing a multiyear perspective on revenues and expenses, and framing budget decisions so that policymakers can set priorities for government services and programs.

I believe this advice is spot-on. The emphasis, though, is on the activities of the governing body, the chief executive officer (CEO), and the chief financial officer (CFO). How do we engage the rest of the organization in meeting the challenges of a new fiscal reality? Have budget and financial management systems changed to match what managers now know about effective leadership and management of organizations?

Age-old Traditions Hard to Shake

As we celebrate the 100th anniversary of the management profession, we can credit the strong financial management skills of the pioneering city and county managers, along with a public service ethic, for a large part of the success of the council-manager form of government.

But the way that budgets are managed has changed little in the past century. These steps in a budget cycle would be as familiar to the first managers as they are to those in present-day organizations:

• Departments prepare budget requests.
• The CEO or designee reviews the requests, which inevitably total more than the available revenue.
• Top management goes through a process of forcing the total of the departments’ budgets to balance to available revenues. Because this requires shaving the requests, this is typically referred to as a series of budget cuts, even if the net result is an increase in the total budget from one year to the next.
• The governing body receives the proposed balanced budget and goes through a series of work sessions and hearings that may result in some changes in a few areas, but leaves the bulk of the proposed budget untouched.
• Operating managers are given legal appropriations, and are told not to go over budget. They may even have limits at the line-item level.
• If general fund programs generate revenue, this revenue is typically accounted for in a separate place (the general fund “black hole”). Once the budget is adopted, operating managers focus on expenses, not revenues.

Good managers confronting this process learn to become experts at playing budget games. Tricks of the trade include padding of line items; over-estimation of revenues; the “Washington Monument” syndrome, which is defined as offering up popular services for budget cuts; and spend-it-or-lose-it behaviors, among others.

This kind of central control, top-down approach may have been okay 100 years ago when managers worked under the assumption that their employees avoided both work and responsibility. But we’ve learned a lot about people in organizations, especially during the past half century. From authors Douglas McGregor’s Theory Y (1960) to Daniel Pink’s Drive (2011), we know these things:

• People are intrinsically motivated to do good work.
• Individuals in an organization not only accept, but seek responsibility, and can exercise self-control.
• Operating managers and their employees need to have the tools and resources to get the job done.
• Direct feedback on performance, including financial performance, should go directly to the line managers who provide the service.

A top-down centralized budget management system is completely at odds with a management philosophy of delegation and empowerment. It’s no wonder it tends to produce such pathological behavior in managers and governing boards.

A 21st Century Budget Process

Over the past three decades, a number of governments have experimented with a variety of ways to change the rules of the budget game in order to bring budget systems in line with principles of good management. The pioneers include cities (primarily in the Southwest); the state of Minnesota; and even, on a pilot basis, some federal agencies. Some of the concepts were introduced in Ted Gaebler and David Osborne’s Reinventing Government, under the label “Expenditure Control Budgeting.”

In my 35 years of preparing city budgets, reviewing other governments’ budgets for the Government Finance Officers Association, and studying budget management as a doctoral researcher, I’ve drawn conclusions on how budget systems can be shaped to work with, and not against, good management principles.

Here is what a 21st century budget process might look like:

• Citizen input is at the front of the budget process, not the end. This input should take the form of expressions of values and priorities, not technical issues. Surveys and focus groups are good tools for soliciting this input.
• The governing board sets overall priorities and goals, per the advice of the authors of the October PM article “Embracing the `Decade of Local Government.’” In a continuing environment of fiscal scarcity, these will be difficult decisions. As managers, it is our job to provide good background information and help frame the decisions. And above all, we need to empower elected officials to own this policy domain.
• Based on the governing board’s priorities, the CEO sets the amount of general tax revenues (e.g., property, sales, and income taxes; franchise fees; state-shared revenue; and more) that will be allocated to each general fund program. Revenues for enterprise funds are limited by the utility rates approved by the governing board, and special revenue funds typically face similar limits.
• Costs for internal support services (administration, IT, human resources, and legal services) are fully allocated to the direct-service programs, including those within the general fund. Their customers—direct service managers—should have a say in the amounts of these budgets, and as much flexibility as possible in exploring such alternatives as using contractors or even other departments for IT services or facility maintenance.

Once these steps are completed, the budget balancing process is essentially done. If the operating managers’ priorities are truly aligned with those of the governing board, as they will be in a well-managed organization, then the governing board’s job is done as well.

Operating managers work out the line-item details. For general fund departments, the available resources include the allocation of general revenues noted above, plus any carryover savings from the prior fiscal year and any direct departmental revenues.

Expenses include indirect support service charges as well as direct operating costs, including personnel, supplies and services, and operating capital. Each program should have a contingency account to eliminate the need to pad line items.

Note that the line-item detail is simply there to give operating managers a way to plan and manage their own programs. They are not subject to further review or approval by a central budget czar.

Each program within the general fund is self-balancing: Resources equal estimated expenditures plus contingency. During the ensuing fiscal year, the operating manager is accountable only for the bottom line: Expenses must equal or be less than resources.

If more money comes in—departmental revenues or carryover savings are higher than estimated—then the operating manager can spend more without interference from the finance department, or put more aside in contingency. Someone in the organization may need to amend appropriations to conform to antiquated legal requirements, but this would be done automatically.

By the same token, if resources come in less than estimated, the operating manager must make adjustments on the spending side.

Many Side Benefits

This process also has some side benefits. First, most budget games are eliminated, since there is no request process and no zero-sum game where operating managers compete with each other for a slice of the budget pie. The CEO must use skill and judgment in allocating general revenues, but this allocation is nonnegotiable.

As a city manager, I’ve been doing this for more than two decades, and it works. Department heads may think their allocation is too small, but if they have full freedom in how they manage their limited resources, the trade-off is worth it to them.

By allowing 100 percent of the savings—and revenue that comes in higher than estimated—to be carried forward, the spend-it-or-lose-it problem disappears. Knowing that they have flexibility in how to allocate the savings, operating managers constantly look for ways to reduce the cost of doing business.

A major benefit is that the governing board and CEO have now enlisted all the operating managers in the hard work of managing with constrained resources. I’ve been amazed at the innovative and thoughtful ways that operating managers have met the challenge of stretching resources to provide excellent services. I’ve also had to admit they know their operations better than I do; they can make tough decisions, and because they own them, they buy into them.

Another benefit is that with operating managers responding immediately and independently to external pressures on revenues and expenditures, there is little need to go through an annual budget process. Budgets can be adopted for a 24-month fiscal period.

The time freed up from number crunching can be used, in the off-year, for a thorough review of the government’s services and programs using best practices in performance measurement. And the next step in this evolution will be to eliminate budgets altogether and replace them with rolling forecasts, allowing the organization to make continuous fine-tuning adjustments to priorities and the allocation of resources. (For more on this approach, check out the work of the Beyond Budgeting Round Table at bbrt.org.)

The primary benefit of this system has nothing to do with finances at all. It simply reinforces the principles of good management—delegation, empowerment, alignment of goals—that managers follow or should follow in other aspects of leading an organization. Better budget decisions are a side benefit, but here are the ones that really matter:

• Ability of the organization to respond quickly to abrupt changes in the environment.
• Resilience of the organization to external and internal challenges.
• Adoption of creative or innovative solutions to problems.
• Alignment of the activities and output of the organization with the priorities of the governing board.
• Job satisfaction of employees.

Going for the “Best-Managed” Moniker

If we are entering the “decade of local government,” local governments may emerge as leaders in dealing with the challenge of providing government services, doing so more effectively than state and national government counterparts. But that’s a pretty low bar.

Wouldn’t it be nice if local governments emerged as the best-managed organizations, period? When author Jim Collins next speaks to managers at an annual conference, wouldn’t it be great if his presentation was based on a book highlighting cutting-edge leadership in cities and counties? That won’t happen if we continue to cling to a century-old budget management system.