Strategic Fiscal Management - Avoiding the Next Fiscal Cliff: Do's and Don'ts

By Stan Finkelstein, Chair, Washington State Public Works Board

During the past five years, many counties and cities have struggled with shrinking resources, rising health care and energy costs and a citizenry clamoring for their governments to sustain and enhance services. The question often arises as to whether local officials could have initiated strategies prior to the start of the "great recession" that would have enabled them to better maintain revenues and expenditures and thereby the level and array of services. While no strategy is foolproof, especially given the inability to predict the magnitude and duration of economic downturns, the following "do's" and "don'ts" can help local officials temper the impact of those downturns. Key to any effective strategy is the willingness of local officials to avoid the intoxication of unsustainable revenue growth during periods of economic growth in order to set aside resources to meet needs during the down slope of the economic cycle.

While not an inexhaustible list, the following DO's are intended to provide guidance to local officials regarding how best to discharge their fiscal stewardship in a manner designed to maintain services during an economic cycle:

1. Understand the budget - Know the underlying assumptions regarding the key revenue sources; the factors that impact the revenue forecasts and the impacts of economic changes on those revenues. Also understand the expenditures; factors that may drive expenditures (e.g. crime rates and jail costs) and external factors that could impact expenditures, such as key cost drivers (e.g. inflation) legislative actions and court decisions.
2. Budget strategically - Recognize that the budget is based on a series of assumptions and forecasts normally agreed to 18 months prior to the conclusion of the year for which the budget is adopted. Revenue forecasts should be realistic, yet conservative. Anticipated expenditures should be budgeted on a "worst possible case", yet not excessive. The budget should identify mandatory and discretionary services and be designed to signal where reductions should occur if mid-year adjustments are necessary.
3. Monitor the budget throughout the year - Elected officials must be continually apprised of trends in revenues and spending and apprised as to when mid-year adjustments are required. In larger counties and cities a budget committee should be formed to work with fiscal staff to gain a comprehensive understanding of budget trends as they evolve. The entire governing authority should be provided with monthly budget reports by the jurisdictions chief administrative or fiscal officer.
4. Manage personnel costs - Traditionally, personnel costs account for upwards of 75% of total county or city expenditures. Jurisdictions should budget for accrued sick and vacation leave buyouts upon separation of employees and set aside reserves to accommodate those expenditures. Additionally, due to separations and delays in recruitment and filling of vacancies it may be appropriate to budget for a given vacancy rate below the fully staffed level.
5. Recurring capital expenditures should be integrated into the annual budget - Oftentimes when revenues are shrinking local officials tend to reduce capital maintenance and ongoing replacement expenditures in order to maintain services. The impact of that strategy is to ultimately result in increased deterioration of the jurisdiction's capital stock and greater capital costs. Vehicle and computer replacement, roadway resurfacing, and minor facility improvements are all ongoing expenditures and should be treated with co-equal importance to other ongoing responsibilities.
6. Recognize the interdependence between new capital facilities and future operating expenditures - Oftentimes new capital facilities; swimming pools, park and recreation facilities, new or expanded jails, etc., will impact future operating budgets. Before agreeing to invest in such facilities the county or city should undertake a comprehensive fiscal analysis to determine what the ongoing operating and maintenance costs will be and whether they can be absorbed.
7. Manage nonrecurring revenues and expenditures - Oftentimes local governments get into trouble by believing that revenues arising during periods of strong economic growth will continue indefinitely, only to find that when the economy stabilizes there arises a shortfall and new services cannot be sustained. A portion of those excess revenues should be set aside to cover reduced revenues during economic downturns and for nonrecurring capital expenditures. Similarly, unanticipated and emergent expenditures should be outside of the traditional operating budget and defrayed from reserves and other resources unless the jurisdiction is large enough to be able to annually predict such needs.
8. Budget ending cash balances and establish reserve accounts - Every county and city should budget between one and two months of beginning cash balances to provide for meeting expenditures prior to the receipt of the new fiscal year's revenues. In addition, reserves should be established to meet ongoing commitments, such as vacation and sick leave buyouts upon separation, and for smaller jurisdictions to accommodate sick and vacation leave accruals potentially necessitating overtime and temporary employees. In addition, it is encouraged that all jurisdictions fund a budget stabilization or "rainy day" fund that could be used to offset declining revenues during economic downturns. The latter could also be tapped to meet unanticipated or emergent needs.
9. Manage debt and borrow when beneficial - Most local officials lack the sophistication to understand when it may be desirable to incur "inside" (council-manic or commissioner authorized) debt and how to manage debt. Often county and city officials want to "save" for a major project rather than issue bonds due the fear of debt overwhelming their operating budget. The reality is that when the annual inflation in construction costs exceeds the cost of borrowing it is prudent to incur debt, especially when the debt is to be amortized by a guaranteed revenue stream such as road district tax levies or ongoing utility charges. This is especially true when borrowing from the Public Works Assistance Account or the state Clean Water or Safe Drinking Water Revolving Funds, all of which have inordinately low interest rates.
10. Develop a long term fiscal "vision" - The elected officials in every county and city, regardless of size should, in concert with their senior fiscal staff and administrators undertake a periodic fiscal retreat. Such a retreat should be used to review long term revenue and expenditure trends and to provide guidance in the long term strategic plan for the jurisdiction. A fiscal retreat can also be a source of fiscal training for newly elected officials as well as provide the means to determine the long term sustainability of existing and new service demands.

Strategic fiscal management requires not only the adoption of positive behaviors, it also encourages elected officials to implement fiscally prudent restraints; the DON'Ts. Following is a brief list of suggested restraints designed to enable counties and cities to avoid a fiscal cliff:

1. Don't encumber future budgets by excessive reliance on commissioner/councilmanic debt that is not secured by a guaranteed revenue stream - In many counties and cities there has been a tendency during good economic times to invest in capital improvements funded by ongoing general fund revenues only to find that when the economy returns to a normal growth rate that revenues decline and traditional services cannot be maintained.
2. Don't inflate revenue forecasts or underestimate expenditures simply to "balance" the budget - The budget is a prediction of the level of available resources and the costs of providing a market basket of services. Elected officials must accept the forecasts provided by their finance professionals and should never arbitrarily change those forecast simply to accommodate desires for enhanced or expanded services.
3. Don't defer necessary mid-year budget adjustments to accommodate political expediency - Frequently, when there is a revenue shortfall local officials are hesitant to reduce spending. The budget must be considered a "living" document that may need to be altered to respond to changing conditions. The sooner that budget cuts can be implemented the less dramatic the changes that may be required.
4. Don't make promises you can't keep - Frequently state and local officials tend to promise to their constituents enhanced and new services or tax cuts that cannot be implemented. This tendency raises expectations and when they fail to materialize they may cause hard feelings. Elected officials need to be realistic and periodically review the jurisdiction's spending priorities to determine whether the implementation of such promises is of a higher priority than current marginal expenditures.

For most local officials, fiscal management of a government is a difficult, if not impossible responsibility. The citizenry expects wise prudent management, certainty of service delivery, and reasonable and consistent levels of taxation. They are unaware of the impacts of changes in economic conditions on the available resources to their governments. It is incumbent on local officials to manage their responsibilities in such a manner as to try to provide a consistent level of services and to periodically step back and reevaluate what it is that the jurisdiction does provide and whether the array of and level of services is consistent with the priorities of the citizenry. The afore listed "Do's" and Don'ts" are not intended to be an exhaustive list but rather guidelines enabling local elected officials to better discharge their fiscal management responsibilities and gain an understanding of the complexities of public sector budgeting.