Module 5

PERFORMANCE BUDGETING

GOVERNMENT OF ALBERTA

Module 5

PERFORMANCE BUDGETING
Overview For Workshop Participants

GOVERNMENT OF ALBERTA

Performance Budgeting: Overview

Module 5: Performance Budgeting An Overview For Workshop Participants

Faced with fiscal constraints and demands for more and better public services, governments at every level are discussing, experimenting with, and implementing new ways of budgeting. The budget is increasingly being seen as a tool to promote government accountability and effectiveness, rather than simply as a vehicle for allocating resources and controlling expenditures. Performance based budgeting has been defined as a system wherein managers are provided with the flexibility to utilize agency resources as required, in return for their commitment to achieve certain performance results. This was also the fundamental underlying philosophy of the business planning process adopted by the government of Alberta in 1993. Ministries were provided with fixed resource allocations and expected to fulfill program obligations within those parameters. In exchange, financial controls were relaxed and the authority to reallocate funds among programs was delegated to ministries. While no Canadian jurisdictions seem to have fully implemented performance based budgeting, many are putting in place the necessary prerequisites, such as activity based costing and performance measurement. In the US, a number of cities and states use this approach to budgeting; leading the field are the states of Texas and North Carolina. What the various approaches have in common is an emphasis on results. Budgets are based on agreed upon outcomes rather than historical efforts and good intentions.1 Initiatives such as these are often referred to as performance budgeting and are designed to help answer the questions: can issues and problems be solved with more money or might other measures be more effective.2

What is Performance Budgeting?

Performance budgeting is a system of planning, budgeting, and evaluation that emphasizes the relationship between money budgeted and results expected. Performance budgeting: Focuses on results. Departments are held accountable to certain performance standards. There is a greater awareness of what services taxpayers are receiving for their tax dollars. Is flexible. Money is often allocated in lump sums rather than line-item budgets, giving managers the flexibility to determine how best to achieve results. Is inclusive. It involves policymakers, managers, and often citizens in the budget discussion through the development of strategic plans, identification of spending priorities, and evaluation of performance. 3 Has a long-term perspective. By recognizing the relationship between strategic planning and resource allocation, performance budgeting focuses more attention on longer time horizons. 4

Common characteristics of performance budgets include: Agency identification of mission, goals, and objectives; Linkage of strategic planning information with the budget; Development and integration of performance measures into the budget; and Disaggregation of expenditures into very broad areas (such as personnel, operating expenses, and capital outlays) rather than more specific line-items.

Performance Budgeting: Overview

As shown in Figure 1, performance budgeting is an integral part of an ongoing process that focuses on government accountability and performance improvement.

Figure 1

Budgeting is Part of the Performance Measurement Cycle

Policy Evaluation
Programs & Activities

Planning

Measurement Performance

Budget

PBB-1

How Can Performance Information be Incorporated into the Budget Process?

Performance information can be incorporated into the budget process in three primary ways. Governments can: 5 Allocate resources based on results; Improve internal management of a given level of resources; and/or Use performance measures in financial reporting.

Although this training curriculum focuses on the use of performance information to allocate resources, there are clearly ways that individual managers can use and benefit from performance information even if their jurisdiction is not undertaking a broader effort. Individual managers are encouraged to turn to Module 4, Using Performance Results, for further information on how they can use performance information in managing internal resources and reporting to the public.

Contrast to Traditional Budgeting Methods

Performance budgeting represents a significant departure from traditional line-item budgeting. A line-item budget is primarily a tool for controlling expenditures. As shown in Figure 2, a line-item budget typically spells out the level of spending allowed for specific purposes. As the fiscal year progresses, departmental spending must be within these amounts unless formal budget amendments are approved. Underspending in one category cannot automatically be used to supplement another category.

Performance Budgeting: Overview

Figure 2

Sample Line-Item Budget

Department of Economic Development

FY1993
Personnel Costs Employee Benefits Travel In-State Travel Out-of-State Repairs and Maintenance Rentals and Leases Utilities and Communication Professional Services Supplies & Operating Expenses Transportation Equipment Maintenance Transportation Equipment Purchases Other EquipmentPurchases Total Expenditures $1,813,015 337,527 60,533 112,105 20,220 454,123 170,232 1,355,752 188,380 2,611 -013,278 $4,527,776

FY1994
$1,870,417 398,196 86,000 198,000 48,201 377,000 197,500 1,397,000 428,102 43,000 80,000 20,000 $5,143,416

While line-items can be useful in helping managers with internal control, they are not as useful as a policy or decision making tool. They assure elected and administrative officials that money is being spent only for approved purposes, but they do not show what is being accomplished with the money. Other major drawbacks of line-item budgets include: They promote inertia, with the focus being on making marginal changes from year to year. They can result in inefficient and uneconomical activities because management is not permitted enough flexibility to address changing situations and often must use it or lose it at the end of the year. They invite micromanagement, encouraging questions such as why are we spending so much on supplies? rather than how have our efforts increased manufacturing exports this year?

In contrast, performance budgeting has more of a policymaking orientation. It: Connects plans, measures, and budgets; Forces departments and policymakers to think about the big picture; Provides better information about the impact of budget decisions on people; Gives departments increased budgetary flexibility and incentives for generating budget savings; Allows for ongoing monitoring to see if agencies are moving in the right direction; Strengthens legislative decision making and oversight;

Performance Budgeting: Overview

Enhances financial accountability to citizens, decision makers, and governmental monitoring agencies; and Supports better management and evaluation.

As shown in Figure 3, a performance budget tells the reader much more about what the department does and what it is expected to accomplish with the funds budgeted.

Figure 3

Sample Performance Budget

Health Department, City of Milwaukee Objective 1: To control the spread of communicable disease in Milwaukee by increasing the immunization level of two-year olds from 35 percent in 1993 to 90 percent by the year 2000. 1993 Actual Outcome Indicator: Percent of two-year-olds immunized 1993 Expenditure 1994 Estimate 1994 Budget

35.0%

$4,172,585

37.2%

$5,813,303

Source: Excerpted from Anne Spray Kinney, Mission, Management, And Service Delivery: Integrating Strategic Planning and Budgeting in Milwaukee, Government Finance Review, October 1995, p. 9.

Does moving to a performance budget mean that elected officials must give up all control over expenditures? No. Elected officials continue to have the authority to review expenditures at any time, although typically they do so only as a spot check or to resolve particular problems.6 And, most importantly, elected officials have the authority to hold department heads accountable for achieving the performance targets specified in the budgetand within the funds appropriated. Nevertheless, some governments make the transition to performance budgeting slowly in order to increase decision makers comfort with the new system. Some, for example, continue to appropriate by line-item, while giving managers more flexibility to move funds; others maintain general types of line-item control, such as ceilings on the number of job positions in each department.7

The Evolution of Performance Budgeting

The current interest in performance budgeting builds on previous budget research and experience. For example: The New York Bureau of Municipal Research of 1907, the Hoover Commission of the 1940s, and systems analysis of the 1950s introduced elements that have found application in later budgeting systems, including attention to developing measures of workload and cost effectiveness;

Performance Budgeting: Overview

The Planning-Programming-Budgeting system (PPBS), which was applied initially at the federal level and became more widely popular in the 1960s, strengthened and institutionalized program analysis, multi-year planning, and rolling multi-year budgets;8 Management by objectives (MBO), a technique that requires regular reports on departmental progress toward achieving agreed-upon objectives, became popular in the 1970sthough primarily as a management, rather than budgeting, tool; and Zero-based budgeting (ZBB), introduced at the U.S federal level in the 1970s, emphasized evaluating all programs each year rather than concentrating on budgetary changes at the margin. ZBB attempted to analyze the incremental change in a programs output at different levels of funding.

Clearly, performance budgeting is not an entirely new budgeting system. Elements of earlier systems that are reflected in performance budgeting include: The planning emphasis of PPBS is incorporated through strategic planning and the use of a program structure; Common to both MBO and performance budgeting are the setting of objectives and performance targets; and ZBBs determination of expected levels of performance for each level of expenditure and setting priorities on spending packages are concepts which a number of governments have incorporated into performance budgeting initiatives.

What lessons can be learned from these earlier efforts? Analysis by the Congressional Budget Office suggests that:9 Commitment to the measurement system at all levels is necessary if it is to be successful. Earlier efforts suffered from lack of clear agreement over goals and objectives. The data that are collected must be used. Each of the earlier systems produced mounds of paper which, for the most part, were not read nor used for decision makingbreeding cynicism among participants. The design of the budget systems must take into account the difficulties in linking the measurement of outcomes to budgeting

Implementation Steps
As you move towards implementation, be sure to give attention to the shortcomings that derailed earlier effortsin particular, take steps to help ensure that performance information will be used. Also, be aware that implementation is a continuous process; it evolves as improvements are made in performance measures and the reporting of performance.

Step One: Gain consensus and commitment from key players.

As discussed in further detail in Module 7, Creating and Sustaining a Supportive Environment, there are two basic approaches toward creating both a structure and attitudes that will support performance budgeting over the long-term. The top-down approach mandates these activities through resolution or legislation. The state of Arizona and the city of Austin, Texas, for example, both used legislation to kick-start budget reform. The bottom-up approach seeks to build consensus more slowly. Catawba County, North Carolina, took such an approach, asking departments to volunteer for a pilot program rather than mandating participation by all departments. The result has been a dual budgeting system in which some departments continue to develop a line-item budget, while other departments develop performance measures, have more budget flexibility, and focus on outcomes. Performance based budgeting is not envisioned as a reward and punishment system based on level of performance, but rather as an approach to evidence based decision making. The key intended benefit is to shift the focus and debate away from the level of program inputs, and focus on results. If the current level of results is unacceptable, the

Performance Budgeting: Overview

reasons for poor performance should be examined and if current strategies are ineffective, program changes may be necessary. 10 The relationship between all stakeholders is crucial for understanding and success. A lack of consensus between the branches is likely to result in either: Management viewing performance measurement as merely a paper exercise and failing to use the information for program improvement; and/or The legislature failing to see the value of performance information and continuing to rely on line-item budgeting.

Early involvement of stakeholders in the development of strategic plans and performance measures can go a long way towards building consensus and commitment. As discussed in further detail in Module 4, Using Performance Results, decision makers and other stakeholders are generally most supportive of performance measurement systems that they have helped to develop themselves. Not only are such systems most likely to address their needs, but they are also less threatening by nature. Indeed, many individuals feel very threatened when a performance measurement system is introduced, fearing that negative performance information will lead to budgetary or staffing reductionsor even program elimination. If managed well, in fact, performance budgeting may over time strengthen relationships between the branches of government. In Arizona, for example, the legislative fiscal office and the executive budget office have been brought into closer contact in conducting the in-depth program reviews required as part of the states budget reform legislation. 11

Step Two: Develop an implementation plan and timetable.

Development of an implementation plan can help smooth your transition to performance budgeting by addressing potential roadblocks, establishing clear expectations and responsibilities, and laying out a timetable to keep efforts on track. In developing such a plan, a number of jurisdictions have found it helpful to consult with both the developers and users of budget information. In Iowa, for example, the Department of Management conducted detailed interviews with all 26 department heads, surveyed 200 top officials, and conducted focus groups with legislative leaders and budget staff.12 The budget calendar should be an important element in your implementation plans. At a minimum, your calendar should indicate when:13 Budget instructions will be provided to departments; Citizen input will be obtained; Department submissions must be completed; Meetings will be held with department representatives to clarify submissions; The draft budget will be presented to the governing body; The proposed budget will be advertised; The budget will be formally adopted; and The budget will go into effect.

Be realistic in establishing your plans and timetables. It is important to recognize that it takes considerable time and effort to implement successfully a performance budgeting system. Most governments devote a significant amount of time at the front end to building support and expertise. Florida, for example, has established a seven-year calendar for phasing all agencies into a new performance budgeting system. Each agency is expected to take approximately one year to define its programs and develop appropriate performance measures. While this appears to be a long time, observes the National Association of State Budget Officers, most states undergoing this process realize that

Performance Budgeting: Overview

developing relevant measures and integrating them into the management of an agency is a change that requires both time and capacity.14 Smaller jurisdictions can expect to need considerably less time, although change can still not be expected to happen overnight. In Milwaukee, for example, lead time was needed in order to establish links between strategic planning and budgeting. First, a citywide strategic plan was developed in 1991. Agencies then developed strategic plans in 1993 prior to preparing 1994 budget requests under a new performance budgeting system. With some experience under their belts, the annual budget calendaras shown in Figure 4has been streamlined from what was initially required.

What will affect your timetable? The size of your jurisdiction and complexity of your budgeting process will have a significant impact on the amount of time needed. Other factors include: Need for legislation; Status of strategic planning efforts; Agency familiarity and experience with performance measurement; and Sophistication of existing data systems.

Your decision regarding whether to implement on a pilot or full-scale basis will also affect the time needed for implementation. As shown in Figure 5, there are advantages as well as disadvantages to each approach; local circumstances should be weighed heavily in your decision.

Performance Budgeting: Overview

Figure 4

Planning and Budget Calendar

City of Milwaukee
Date January-March March 23 April By second Tuesday in May* June 1-2, 9-10 July-September By September 28* October 7-28 By November 14* * Denotes legal deadline Source: Anne Spray Kinney, Mission, Management, And Service Delivery: Integrating Strategic Planning and Budgeting in Milwaukee, Government Finance Review, October 1995, p. 8. Activity Departments prepare plans and performance measures Departments receive budget materials and allocations Department plans and performance measures reviewed by mayor Plans and budget requests due Mayors public hearings on plans and budgets Mayors executive plan and budget review Plan and budget submitted to common council Legislative hearings Common council action on budget

If you choose the pilot approach, your next decision will be which agencies to select. Jurisdictions have used a variety of decision criteria, including: Receptivity to change: Many jurisdictions have asked for volunteers, choosing to begin with those agencies most receptive to change. Ease of measurement: Some jurisdictions have selected departments whose outcomes are most easily quantified (e.g., fire department; police department; transportation department), hoping to gain experience before tackling departments with more difficult measurement issues. Others have taken the opposite approach, reasoning that if they can succeed with the most difficult agencies (social services, for example), full-scale implementation should be a breeze. Size of budget: Budget size has been used as another selection criterion. Clearly, improving the performance of your largest agencies will result in the greatest overall impact.

Performance Budgeting: Overview

Figure 5

Advantages and Disadvantages of Differing Implementation Approaches

Pilot Projects
+ + + + Provides opportunity to test and refine system Can anticipate problems prior to full-scale implementation Provides opportunity to build support among nonpilot departments Allows for more individual assistance and attention Results in longer overall time for implementation Initiative could lose momentum Difficult to run two budget systems simultaneously

Full-Scale Implementation
+ + + Requires less overall time for implementation Training and assistance can be provided uniformly for all departments Creates momentum for change

Difficult to devote significant amount of time to individual departments May result in costly mistakes

Source: Drawn primarily from Price Waterhouse, Best Practices in Performance Based Budgeting, for the Santa Clara County Office of Budget and Analysis, April 12, 1994, pp. IV-8-IV-11.

You may also consider selecting a representative sample of agencies. In designing its performance measurement pilot project, the state of Virginia chose agencies that represented all eight secretarial areas and also sought a balance of new initiatives and base budget programs.

Step Three: Provide training.

Training in performance budgeting will involve not only introducing new concepts to legislators, managers, and employees, but also introducing new budget forms that must be completed and new procedures that must be followed. You will need to consider the following levels of training: 1. Briefing sessions or workshops to introduce the concepts of performance measurement and strategic planning. At a minimum, both managers and policymakers should receive training on: The benefits of strategic planning and performance measurement; The strategic planning process and the mechanics of developing performance measures; and Information on ways to use performance information, including allocating resources, formulating and justifying budgets, performance contracting, and personnel management.15

In these sessions it is critical to allay any fears and misconceptions about the process. Legislative fiscal staff and agency budget analysts can be important allies. The states of Louisiana and Arizona are among those who have supplemented training workshops with written reference materials. Louisianas MANAGEWARE and Arizonas Managing for Results handbooks provide agencies with a solid grounding in strategic planning and performance measurement concepts.

10 Performance Budgeting: Overview

2. Development of budget instructions and guidelines. While the introduction of performance budgeting has typically resulted in an overall reduction in the number of budget forms that agencies must fill out, there are usually a number of new forms required to show linkages between budgets and expected performance results. In Texas, budget instructions have been pared from 125 legal-sized pages to 35 letter-sized pages. In addition, agencies are now required to complete only five rather than 23 budget forms.16 The city of Milwaukee has also eliminated many forms, although two new ones have been created to show links between funding, objectives, and activities. Department managers and employees will need specific instructions on how to complete any new forms. You may also want to take advantage of new technologies to enhance your instructional efforts. Agencies in both North Carolina and Maryland, for example, can access instructional material via the Internet. 3. Ongoing technical assistance and training. Performance budgeting will be a big change for most departmentsexpect to provide some hand-holding along the way. This task most often falls to the budget office. In Texas, for example, agency budget analysts have primary responsibility for follow-through and ongoing assistance. Keep in mind that networking can also be a valuable training tool. Virginia found peer networking to be a successful component of its performance measurement pilot program. 17 In the USA, state and local governments have taken a variety of approaches to providing training and technical assistance. Oregons approach was to provide training to all agency heads as well as to volunteer co-ordinators in each agency. These co-ordinatorswho also received ongoing guidance and assistanceserved as mentors and trainers for others in their agencies. Two videos were developed to supplement the training efforts. The videos featured testimony from the governor, agency heads, a union leader, and line staff on the benefits of performance measurement. Other state and local governments have relied on outside consultants or organizations to provide much of the training required. A member of the University of North Carolinas Institute of Government, for example, launched training efforts in Chatham County, North Carolina by making a presentation to the county commissioners and department heads. This was followed by separate retreats for each group, a joint retreat, and a question-and-answer session with a jurisdiction already using performance budgeting.

Step Four: Review/develop strategic plans.

Strategic planning is a powerful tool for setting priorities and making informed decisions about the future. As such, it can provide a long-term context for annual budget decisions. The observation has been made that although strategic planning has become popular in government in recent years, it is frequently difficult to see the connection between what a strategic plan says and what next years budget does.18 Performance budgeting initiatives can provide that important connection. In Texas, for example, agency strategic plans serve as the foundation for the states strategic budgeting system. In simple terms, an agencys appropriation request represents the cost of implementing its strategic plan over the following two years. Agencies identify costs associated with carrying out particular strategies which will help them achieve their goals, then list strategy options in order of priority. In appropriating funds to an agency, the legislature provides a lump sum for the implementation of a particular strategy, accompanied by a set of performance expectations. In Alberta, the view is that unless the costs of achieving varying levels of results can be identified, the effect of resource changes on outcomes cannot be assessed. With managers increasingly being held accountable for results, they will need information on the resources required to maintain or improve service quality and results. Similarly, information on the cost of achieving certain levels of results will help decision makers to decide if the desired outcome

Performance Budgeting: Overview 11

is appropriate given the costs involved. Costing outputs will link inputs with outcomes and provide decision makers and taxpayers with information on the relative cost of certain outcomes.19 As discussed in further detail in Module 1, Strategic Planning, there is no one best way to approach strategic planning. The strategic planning process can be undertaken at virtually any levela department, organization, program, and/or the entire community (a city, county, region, or province). Processes are often as simple as an annual retreat in which departmental staff or a city council goes away for two or three days to assess where they are, envision where they want to be, set goals, and decide among alternative strategies. On the other end of the spectrum are examples like Oregon Benchmarks and Minnesota Milestonesprocesses that were statewide in scope and involved complex, long-term organizational structures, staffing, and support. In between you can find numerous examples of city or countywide strategic planning processes. Regardless of the approach, successful, results-driven strategic planning addresses four major questions: 1. 2. 3. 4. Where are we now? Where do we want to be in the future? How will we get there? How will we measure our progress?

Organizations that have already undertaken a strategic planning process and developed related performance measures will be ready to review and build upon these efforts. Those that have not yet engaged in planning efforts will find it helpful to do so prior to moving into performance budgeting. The treasury/finance department typically plays a major role in overseeing planning and performance measurement efforts, helping to ensure that measures are meaningful and accurately reflect the jurisdictions priorities. Further details on strategic planning and performance measurement are provided in Modules 1 and 3 of this curriculum, Strategic Planning and Performance Measurement.

Step Five: Develop the budget and allocate resources.

Governments have taken a variety of approaches to developing performance budgets. Three of the most common approaches are described below. 1. Activity-Based Costing/Unit Cost Budgeting. A number of performance budgets are built around the concept of activity-based costing. This approach typically involves: Linking activities or strategies to performance outcomes; Prioritizing strategies; Identifying the costs of carrying out specific activities or strategies; and Budgeting based on desired levels of performance.

In the Alberta government, a two year pilot project in Activity Based Costing was undertaken by the Land and Forest Service, Environmental Protection in the Northeast Boreal Region. The project's goals were to:

Develop a "one key in" input system; Develop a methodology to cost out strategies and activities; Develop regional performance measures; Determine the true cost of outputs; Produce activity cost analysis; Validate the business plan.

12 Performance Budgeting: Overview

Several issues were identified in the implementation and expansion of Activity-Based Costing, such as the regional varability of priorities and degree of detail required at different project scales. Because of these and other issues, the pilot project has concluded and no further follow up is planned at this time. What is activity-based costing? As shown in Figure 6, it is a technique for identifying the full costs of service delivery, including not only direct labor and material costs, but also administrative and other overhead costs.

Figure 6

Activity-Based Costing
Cost Factors
Salaries of dept. personnel (including taxes, unemployment insurance, pension costs, and other fringe benefits) Other direct costs (travel, utilities, materials and supplies, printing) Equipment (rental, capital outlay, interest costs, maintenance) Operation and maintenance of buildings Insurance premiums (or claims paid if self-insured) Allocated administrative costs Allocated overhead cost of other executive and staff agencies Management/supervision/oversight Other cost factors TOTAL COST OF ACTIVITY=

Amount
________

________

________ ________ ________ ________ ________ ________ ________ ________

Source: Adapted from Privatization Assessment Workbook (Denver, CO: Office of State Auditor, 1989), p. 25.

Sunnyvale, Californias budget system is based on full-cost accounting. The city begins by determining the cost of providing certain levels of service in 300 different areassuch as road sweeping and library services. The budget then describes what level of service is going to be provided and how much money it will cost. The budget may say, for example, that the city will sweep 1,000 miles of roads and identify the cost of doing so. 20

Performance Budgeting: Overview 13

Similarly, Floridas Department of Health and Rehabilitative Service, the largest state agency in the USA, was an early pioneer in experimenting with unit cost budgeting in that state. Plans called for defining services, clearly identifying their costs, and basing budgets on achieving a desired level of service. An Office of Evaluation was established to examine what mix of services and associated costs would be necessary to achieve a specific outcome, such as reducing the incidence of child abuse. While implementation has proven to be more difficult than anticipated, the state continues to experiment with this concept. In a variation on the activity-based costing approach, some communities simply add up the budgeted expenditures for a service to arrive at a performance budget. This is certainly much simpler than full-cost accounting, though arguably not as accurate. While few governments currently have the cost accounting system that Sunnyvale, California has, more are moving in that direction. 2. Base Budget with Performance Incentives. Another approach that governments have taken to developing a performance budget is to add performance incentives (and expectations) to a base budget allocation. Alberta Advanced Education and Career Development has six targeted programs for post-secondary institutions in addition to the base operations grants provided. One of these programs is the Performance Envelope which rewards institutions based on progress towards accessibility, responsiveness, affordability, and for research excellence at universities. Nine measures of performance are the basis for funding which has a system-wide and institution specific component. All institutions are assessed on employment, graduate satisfaction, enrollment levels, administrative costs, and revenue partnerships. The three campus universities are also assessed on research performance which includes the level of research funding they receive from granting councils, the references to research in other publications, the development of community partnerships, and the involvement of research sponsors. Each institution is awarded points based on its performance against specific benchmarks. Total points are then used to determine funding level. Catawba County, North Carolinas performance budgeting process began with pilot departments receiving a budget allocation based on historical expenditure patterns, as adjusted for cost of living and general revenue increases. The budget office then negotiated performance expectations with each of the participating departments. In return for meeting at least 90 percent of their performance targets, the departments are given greater spending flexibility throughout the year and can retain half of any unspent funds or new revenues generated. The city of Milwaukee has used a similar approach. Beginning in 1994, each department received an overall budget allocation at the beginning of budget preparation based on policy priorities set by the mayor. Rather than focusing on budget cutting, budget review now focuses on assessing whether departmental plans and objectives are consistent with the citys strategic plan and whether the links between departmental planning objectives, activities, and spending are clear. 3. Program-Based Performance Budgeting. In the USA, a number of state and local governments have found that a program structure is well-suited to performance budgeting. In other words, expected performance is defined across broad program or functional lines (such as economic development or education) rather than departmental lines. Program areas represent the kinds of services that government provides.

14 Performance Budgeting: Overview

Examples at the local level include: The city of Indianapolis, Indiana, which has worked within the constraints of line-items (which are statutorily required) to develop a performance-orientation to its budget. Line-items serve as the building blocks for an activity-based budget, which builds to a program budget. Austin, Texas, whose budget is based on 10 priority areas that cross departmental lines. The program budget is developed by examining departmental budgets and allocating relevant portions to each of the 10 priority areas.

The state of North Carolina is taking similar steps to develop its Performance/Program Budget. Prior to establishing objectives and measures, North Carolina classified all its spending into program areas. A program was defined by common intended outcomes rather than by departmental organization. For example, as shown in Figure 7, a program entitled Groundwater became the classification for six budget entities in the Department of Environment, Health, and Natural Resources (EHNR) and one in the Department of Agriculture.

Performance Budgeting: Overview 15

Figure 7

Sample Performance/Program Budget

State of North Carolina

Source: NC Office of State Budget and Management.

The advantage of beginning with a classification of funds is that the common goals of otherwise separate units of government are revealed and addressed in the planning process. In addition, true programmatic costs and redundancies become clearer.

16 Performance Budgeting: Overview

The next steps in North Carolinas budget process will be to:

Identify objectives and measures related to identified program areas; Identify the activities/strategies that will be used to achieve the objectives; Identify the budget funds that support the activities/strategies so that reviewers can see the quantity of work purchased by the budget; and Display the linkages between spending, activities, and objectives.

4. Investment Budgeting. While not as common as the three methods described above, there is increasing interest in a concept known as investment budgeting. Like performance budgeting, investment budgeting focuses on outcomes. But, while performance budgets are based on the costs of desired performance outcomes, investment budgets are based on expected rates of return, assessing both long-term costs and benefits. In Texas, investment budgeting is seen as the next logical step for Texas to take in the evolutionary development of its strategic planning and performance budgeting system. In fact, May 1995 legislation directed the Governors Office of Planning and Budget and the Legislative Budget Board to develop a means of incorporating the concept of investment budgeting into the appropriations process for the 1998-99 biennium. 21

Step Six: Develop supporting data and accounting systems.

More often than not, governments embarking on performance budgeting initiatives find that there is a mismatch between their budgeting and accounting systems. While your accounting system can probably tell you how much you spent on salaries or travel last month, it is less likely to be able to tell you how much you spent on a particular planning objective or strategy. The result of this mismatch? As one observer notes, the departments time in determining how much to ask for in each category and the [elected officials] debate over the appropriation amounts [are] both meaningless.22 How can you address this problem? The most common approach is to establish cost centers, which essentially are separate accounts for each major strategy or activity in the budget. The accounting system can then be used to track expenses in each of these accounts. Accounting by cost centers can help provide a reasonably accurate monthly accounting for direct spending. However, it is difficult to account to the nickel for a couple of reasons. First, most governments do not allocate administrative and support costs to all their objectives. Second, a given expenditure may contribute to more than one strategy or objective. And third, some expenditures may contribute to minor objectives which are not worth the effort to formally define and measure. It is certainly possible to track expenditures for more than one budget formatcoding each expenditure so that it is assigned to both a line-item category and to a separate program or performance budget category. However, the cost of maintaining dual systems (in both time and money) is only justified if the time is taken to study, understand, and act upon the linkages between spending, program activity, and outcomes.

Step Seven: Monitor performance and report results.

Once appropriations are made, periodic analysis of performance information is needed to determine whether or not program activities are on track. In designing your monitoring system you should focus on answering the following types of questions:

Performance Budgeting: Overview 17

Are expected results being achieved? Does trend data show improved performance or is performance deteriorating? How does departmental or program performance compare with standards, targets, or the performance of others? What outside factors may be affecting performance? What is being done to bring performance back on track?

It is particularly important to look closely at the reasons for performance differencesespecially if you are comparing your organizations performance to that of others. Are you really comparing apples to apples? Differences in performance and costs can result from a variety of factorsdiffering levels of service, differing demographics or clientele, differences in technology, and so on. Keep in mind that monitoring performance information will be less of a chore for everyone involved if performance reporting is integrated with any existing management information systems (MIS). As discussed in Module 4, Using Performance Results, one model that other governments can turn to in updating their MIS systems is the state of Minnesotas Performance and Outcomes Reporting and Monitoring System. The systemknown as PERFORMs manages performance data from agencies on a statewide basis. It offers the ability to produce both internal and external performance reports in a consistent format. The information database is capable of maintaining at least 40 years of information, enabling a comparison of actual performance against longterm goals, objectives, and measures.23 In Alberta, the Government Accountability Framework sets out the performance reporting mechanisms and relationships. As you move towards adopting reporting procedures, you will need to decide who needs to receive performance information, how often to report this information, and what specific information to report. As emphasized in Module 4, Using Performance Results, it is important to recognize that not all performance information will be useful to all users and decision makers. For example, what a line-manager finds useful will be significantly different from what an elected official will find relevant. And, while a line-manager may need to review performance on a monthly or quarterly basis in order to make mid-year program improvements, elected officials needs are often met by annual reporting. Because different audiences have different information needs, reporting procedures will need to be tailored accordingly.

Step Eight: Act on results.

It is not enough simply to undertake performance measurement activitiesperformance information must be used in order to be of value. Incentives (or rewards) are often provided to encourage agencies to use performance information to improve service delivery. As shown in Figure 8, potential rewards range from increased agency funding to expanded agency responsibilities. Unfortunately, linkages between the budget and performance are often not straightforward. In other words, an agency that fails to meet its performance goals may be dealing with a particularly intractable problem and not merely suffering from poor management. Reducing funding as a sanction for poor performance may move the agency even further from its goals. In order to address this situation, management should be given the opportunity to provide explanatory information as part of the performance reporting process. Reasons for poor performance should be examined by budget officers and decision makers prior to taking action.

18 Performance Budgeting: Overview

Figure 8

Potential Rewards and Sanctions

Rewards Increase agency funding overall Increase budgetary flexibility Exempt agency from certain reporting requirements Allow agency to retain any cost savings Publicly recognize agency for its achievements Provide employee bonuses Expand agency responsibilities Sanctions Order a management audit/develop a remedial plan Reduce or restrict agency funding Withhold or eliminate agency funding Cut directors salary Transfer agency responsibilities Place an agency in receivership by replacing managers or creating an oversight body

Source: Adapted from Karen Carter, The Performance Budget Revisited: A Report on State Budget Reform, Legislative Finance Papers #91 (Denver, CO: National Conference of State Legislatures, February 1994), p. 6.

Implementation Challenges
Implementation is not an easy task. Many state and local governments have taken steps to include performance measures in their budgets. In fact, the National Association of Budget Officers reported in 1995 that 30 states and the Commonwealth of Puerto Rico were already including some type of performance measures in their budget documents. However, studies have found that performance measures have been used more frequently to improve management than to allocate resources. In most cases, resource decisions continue to be driven by traditional budgeting practices. What challenges lie ahead? First, dont be surprised by resistance. A budgeting system that has been in place for a long time will generally be favored by policymakers as well as department headsit is both understood and predictable. Some of the following concerns may surface: Elected officials may resist relinquishing control over line-item expenditures. Performance data is particularly likely to be ignored where it is used as an overlay rather than replacement for line-item data.24 Managers may feel overburdened already and dread the additional chore of data collection. This is particularly likely where past data collection efforts have been paper generators rather than useful management tools. In these cases, there may be skepticism about whether elected officials and other key decision makers will actually use the data. Other managers may fear that the data will be used (or misused)to reduce budgets, to eliminate staff, or in other negative ways. Elected officials may fear that data will be misinterpreted by the public and used against them at the polls.

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Implementation Tips
What can you do to help realize the full potential of performance budgeting? Help elected officials and managers understand the importance and benefits of performance budgeting, but dont oversell the processrecognize that difficult budget decisions will still have to be made;25 Involve elected officials as well as managers in the design of the budgeting system and the development of plans and measures, maintaining effective communication throughout the process; Provide incentives, not just punishments, in return for accountability. Address the fear that performance measurement is merely a tool for budget cuts and staff reductions; Establish a realistic implementation timetable, recognizing that it may take several years to refine performance data to the point that they are reliable enough for budget and management control purposes.

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Suggested Readings for More Information about Performance Budgeting

Anderson, Bridget. Performance Accountability System: Identifying Services and Costs. KPMG Government Services Newsletter, May 1993. Axelrod, Donald. Budgeting for Modern Government. New York: St. Martin's Press, 1988. Canary, Hal W., Jr. Linking Strategic Plans with Budgets. Government Finance Review, April 1992, pp. 21-24. Carter, Karen. The Performance Budget Revisited: A Report on State Budget Reform. Legislative Finance Papers, February 1994. Catawba County, North Carolina. Summary of Reinventing Government, unpublished. Cavenaugh, James L. and Koelsch, John M. Strategic Budgeting. MIS Report, Volume 25, Number 8, August 1993. Craymer, Dale K. Strategic Budgeting: The Shotgun Wedding of Strategic Planning and Performance Budgeting. Presentation to the Tennessee Society of Certified Public Accountants, June 10, 1994. Congressional Budget Office. Using Performance Measures in the Federal Budget Process. Washington, DC: Congress of the United States, July 1993. Ehrenhalt, Alan. Performance Budgeting, Thy Name Is... Governing, November 1994, pp. 9-10. Epstein, Paul D. Using Performance Measurement in Local Government. New York: National Civic League, 1984. Grifel, Stuart S. Organizational Culture: Its Importance in Performance Measurement. Public Management, September 1994. Grizzle, Gloria. Does Budget Format Really Govern the Actions of Budgetmakers? Public Budgeting and Finance, Spring 1986, p. 61. GSTN, Reinventing the Budget Process, Catawba County, NC. Videotape 526-0008, Money Watch, April 1994. Hatry, Harry P. Determining the Effectiveness of Government Services. Handbook of Public Administration, James L. Perry, editor. San Francisco: Jossey-Bass, 1989. Ikerd, Judy. Catawba County Redesigns Its Budget System. Public Management, September 1994, pp. S22-S23. King, Laura. Operating and Capital Budget Reform in Minnesota: Managing Public Finances Like the Future Matters. Government Finance Review, February 1995, pp. 7-10. Kinney, Anne Spray. Mission, Management, And Service Delivery: Integrating Strategic Planning and Budgeting in Milwaukee. Government Finance Review, October 1995, pp. 7-11. National Association of State Budget Officers. Performance Measures Resources. Information Brief, Volume 3, Number 2, June 30, 1995.

Performance Budgeting: Overview 21

National Association of State Budget Officers. Restructuring and Innovations in State Management. Washington, DC: NASBO, April 1996. Osborne, David and Gaebler, Ted. Reinventing Government. New York: Addison-Wesley, 1992. Performance Government at the City Level: An Interview with Tom Lewcock. The Long-Term View: A Journal of Informed Opinion, January 1994. Price Waterhouse. Best Practices in Performance Based Budgeting, for the Santa Clara County Office of Budget & Analysis, April 12, 1994. Lynch, Thomas D. Public Budgeting in America. Englewood Cliffs, NJ: Prentice-Hall, 1985.

Skardon, C. Philip. Texas Exploring Novel Budgeting Process Highlighting Values. Creating Excellence in Government, Winter 1996, No. 16, pp. 27-28. Swiss, James E. Public Management Systems: Monitoring and Managing Government Performance. Englewood Cliffs, NJ: Prentice Hall, 1991. Tiller, Carl W. The Demise of PPBS. Federal Accountant, Vol. 21, June 1972, pp. 12-13. US General Accounting Office. Managing for Results: State Experiences Provide Insights for Federal Management Reforms. Washington, DC: GAO/AFMD-93-41, December 1994. Wolfgang, Donald. Performance Budgeting/Measurement. Internet@www.nps.navy.mil/~jlmccaff/donrev.html.

22 Performance Budgeting: Overview

Laura King, Operating and Capital Budget Reform in Minnesota: Managing Public Finances Like the Future Matters, Government Finance Review, February 1995, pp. 7-10. Alberta Treasury, Measuring Performance, A reference guide, September, 1996, p.33 Price Waterhouse, Best Practices in Performance Based Budgeting, for the Santa Clara County Office of Budget & Analysis, April 12, 1994, p. II-2. Anne Spray Kinney, Mission, Management, And Service Delivery: Integrating Strategic Planning and Budgeting in Milwaukee, Government Finance Review, October 1995, p. 7. Congressional Budget Office, Using Performance Measures in the Federal Budget Process, July 1993, p. 7. Budget Preparation and Enactment, County Government in North Carolina, p. 173. Ibid. Carl Tiller, The Demise of PPBS, Federal Accountant, June 1972, pp. 12-13. Congressional Budget Office, Using Performance Measures in the Federal Budget Process (Washington, DC: CBO, July 1993), pp. 26-27. Alberta Treasury, Measuring Performance , A Reference Guide, September, p. 32 National Association of State Budget Officers, Restructuring and Innovations in State Management, April 1996, p. 27. Price Waterhouse, pp. IV-4-5. James L. Cavenaugh and John M. Koelsch, Strategic Budgeting. MIS Report, Volume 25, Number 8 (Washington, DC: International City/County Management Association, August 1993), p. 4. National Association of State Budget Officers, p. 27. Harry Hatry, Craig Gerhart, and Martha Marshall. Eleven Ways to Make Performance Measurement More Useful to Public Managers, Public Management, September 1994, pp. S15-S18. Strategic Budgeting in Texas: A New System for the 90s, p. 6. Interview with Barbara Newlin, Deputy Director, Evaluation and Management, Virginia Dept. of Planning and Budget, 1994. Kinney, p. 7. Alberta Treasury, Measuring Performance, A Reference Guide, p. 33 Performance Government at the City Level: An Interview with Tom Lewcock, The Long-Term View: A Journal of Informed Opinion, January 1994, p. 7.

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C. Philip Skardon, Texas Exploring Novel Budgeting Process Highlighting Values, Creating Excellence in Government, Winter 1996, No. 16, pp. 27-28. James E. Swiss, Public Management Systems: Monitoring and Managing Government Performance (Englewood Cliffs, NJ: Prentice Hall, 1991), p. 221. Charlie Bieleck, Minnesota Dept. of Finance, Presentation at the Managing for Results conference, Austin, Texas, November 1, 1995. US General Accounting Office, p. 5. NASBO, p. 27.

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