SOLUTIONS : Washington

Reality-Based Budgeting: How to permanently resolve state budget gaps

According to the National Conference of State Legislatures (NCSL), state lawmakers have closed combined budget gaps (the difference between planned spending and forecasted revenue) of $145.9 billion in their fiscal year 2010 budgets (on top of gaps faced in 2008 and 2009). At least 42 states are facing major budget issues.

CNN Money reported on January 15 that state tax collections in the first three quarters of 2009 posted their steepest decline in at least 46 years. Federal stimulus funds provided by the American Recovery and Reinvestment Act (ARRA) supported state budgets in 2009 and 2010, but these will be drying up by 2011. Nine states are reporting that they won't return even to their 2007 revenue level until at least 2014.

All of these factors point to a problem that is getting worse, not better. If legislators don't act immediately and decisively, they will be facing an even greater crisis in the near future.

It will be tempting for many legislators to try to address the issue in the usual ways with the usual so-called "solutions": across-the-board cuts; raids on money in non-general fund accounts; delayed funding of legislation; partial contributions to pension funds; reliance on federal stimulus dollars; and accounting gimmicks, such as delaying payments until the next fiscal year, changing earning assumptions on pensions so less is invested, etc. These actions may put a temporary "patch" on state budget gaps, but when federal funds run out in a year or two, states that didn't act to permanently solve the problems will face what many governors and legislators are calling "structural deficits." These occur when spending exceeds revenue over a prolonged period.

The best time for legislators to deal with (and put an end to) overspending is now. This requires fundamental reforms to state governments and budget systems. It means tough decisions that impact powerful special interests in popular spending areas like K-12 public schools, higher education, Medicaid, or state employee salaries and benefits (including pensions).

The alternative, if legislators are not willing to do the necessary hard work, is to raise taxes. But government spending in many states is already at higher levels than taxpayers can sustain. The blame for this largely belongs to public officials who have forgotten that governments exist to serve citizens, not the other way around.

Problem: Conventional Budgeting
Budgets drive all policy, which is why debating, writing and approving a state budget is the primary task legislators must accomplish. Governors and state agencies cannot spend even one dollar without legislative approval.Conventional Budgeting

Many state legislators start the budget process by focusing almost entirely on "inputs" (i.e., how much needs to be put in to sustain current programs and expenses). They take existing programs, adjust costs for inflation, add caseload increases, splice in a few new initiatives, and call this their baseline budget. This could also be called a "cost-plus" or "iceberg" model, where decades worth of spending and programs remain unseen and unexamined under the surface while the debate rages year after year over the small part that sticks up above the surface. In this model, the cost, effectiveness and demand for existing programs is rarely considered.

The problems get worse when typical budget debates focus on program intentions, not results, and when most of the attention is focused on who spends the money, not who benefits.

Legislators who use this conventional budget approach become "enablers" for agencies and programs that likely have outdated or fundamentally flawed designs, and that may even be providing services or spending resources in direct conflict with lawmakers' policy views.

When legislators discover their conventional baseline budget is higher than estimated revenue forecasts, they often focus exclusively on how to fill the budget gaps. Discussion turns toward program cuts, tax increases and accounting gimmicks, until spending lines up with expected revenue.

Addressing long-term disparities in spending and revenue with accounting gimmicks and one-time money sources is a recipe for disaster. Quick fixes may postpone pain for a time, but they don't resolve the deeper, structural problems. And, eventually, there are no more left to try. Which leaves two options: tax more or spend less.

Today, most state economies are too weak to sustain tax increases. Raising taxes now may very well result in even less revenue due to the negative impact on the economy.

This leaves reductions in spending, but typical across-the-board program cuts ignore important considerations like efficiency and effectiveness and can ham-handedly hurt the most vulnerable citizens.

Conventional budgeting never truly considers how to maximize every tax dollar spent. It doesn't analyze the efficiency, effectiveness and necessity of existing state programs and spending. It rarely asks how a service can be improved or purchased differently. It virtually guarantees overspending.

Legislators may be able to get away with this in good economic times, but it is unsustainable in the long-term. Which is where they find themselves today. Legislators who procrastinate on hard decisions now are only inviting harder decisions in the future. Tough measures now will become tougher measures later.

Legislators can choose: They can continue to use broken conventional budgeting systems as long as possible, which will result in increasing budget gaps and increasingly desperate scrambling for short-term "solutions." Or they can stop deceiving themselves and taxpayers, get a grip on the depth of the problem they face, and do today what will someday be an urgent and unavoidable necessity: restructure their state spending.

It's not really much of a choice. Albert Einstein defined insanity as "doing the same thing over and over again and expecting different results."

Solution: Priority and Reality-Based Budgeting
The Evergreen Freedom Foundation recommends that state legislators take action this year to resolve their serious financial crises by changing their budget focus from inputs to outcomes. In other words, they should junk the old conventional model and start designing budgets from the ground up based on priorities and performance.

These are simple concepts. Priorities are determined by well-defined core functions: What is government responsible for achieving? Performance is the measure of how efficiently and effectively those priorities are delivered (i.e., return on investment). No legislator should get away with advocating tax increases without first being able to clearly articulate the state's priorities and show how the state is achieving the best possible results at the best possible price. This is, very simply, the job they were hired by their fellow citizens to do.

How it Works
Priority and reality-based budgeting views all of state government -- all of its agencies and functions -- as a single enterprise. New proposals are evaluated in the context of all that state government is responsible for doing, and the strategies for achieving the best results are developed with an eye on all of the state's resources. Agencies and services are not sealed in fortified towers where they siphon large portions of state revenue with few questions asked; they are all under one tent where they can be constantly evaluated to ensure they are delivering the highest priorities as efficiently and effectively as possible. Nothing is sacrosanct.

Reality-based budgeting assumes the rules can change and barriers can move if that is necessary to maximize results for citizens. It prompts governors and legislators to ask four key questions at the start of each legislative session:

1. What must the state accomplish?Reality Based Budgeting Flowchart
2. How will the state measure its progress and success?
3. How much money does the state have available to spend?
4. What is the most efficient and effective way to deliver essential services within available funds?

Question #1: What must the state accomplish?
The first step in responsible budgeting is to determine the state's core functions: the essential services it must deliver to citizens, in priority order. We suggest developing a meaningful list of no more than ten core government functions.

Accomplishing this will require time and courage. The process will undoubtedly spark debate between both parties in the legislature, and perhaps all three branches of government. Many public officials who publicly embrace the idea of developing budgets around a model of more carefully prioritized spending, may also vigorously oppose or undermine the model in day-to-day operations. Determination is necessary to make priority-based budgeting a reality.

Once the core functions are determined, they should serve as a litmus test for the hundreds of agencies, boards, commissions, programs and services currently being funded, as well as all future proposals. Agencies should be asked to submit their budgets based on delivering one or more of the state's identified core functions. If an agency or program is not advancing one of these functions, it should be abolished.

Question #2: How will the state measure progress and success?
After identifying the state's core functions, legislatures must determine what it looks like to accomplish those core functions. In other words, it must define specific and measurable results to be achieved, as well as benchmarks to measure progress toward those results.

The legislature should begin by requiring each agency to have a mission statement supported by specific goals and objectives that are directly linked to one or more of the state's core functions.

o Agency mission statements should be brief but precise descriptions of the agency's reason for existing -- its unique purpose and functions. What is the organization? What does it do? Why? And for whom?
o Agency goals should answer the question: "What do we need to achieve to accomplish our mission?" They should be macro-level, issue-oriented statements of the outcomes the agency will achieve. These define the overall expectations and intentions of the agency.
o Agency objectives break goals down into smaller, more specific pieces. They describe measurable tasks and results the agency is expected to achieve within a given time period.

Once the state and agencies have defined what it looks like to successfully achieve government's core functions, legislators must determine how to measure progress toward those outcomes. Performance indicators are a key tool to make accountability possible by allowing legislators and agencies to answer the question: "Are we making progress toward our goals?"

Agencies should have at least one performance measure (defined outcome) for each major activity they do, and immediate and intermediate measures are preferable (though not always necessary). If there isn't a definable outcome, the activity should be eliminated. A good performance measure:
o Shows whether or not the activity is achieving its purpose and contributing to statewide results.
o Is reliable, accurate and verifiable.
o Is understandable and relevant to citizens and stakeholders who may have little or no knowledge of agency operations.
o Is stated in positive terms (i.e., desired results).
o Is connected to challenging but achievable targets.
o Can be obtained at reasonable cost an effort.

The importance of a careful review of both the core functions of government and the outcome-based measures of success cannot be overstated. Once these are in place, agencies and programs can be prioritized based on how effectively they will help meet the state's goals.

Question #3: How much money does the state have available to spend?
This is a superbly sensible question to answer before the legislative session even begins, but it is rarely asked even when the budget session begins. In many states, standing committees meet and pass legislation with little or no relevant spending framework. By asking the question up front, lawmakers would understand their spending limitations in advance, which would enhance the importance of standing committee hearings.

States should not spend or plan to spend more than the forecasted revenue for the next budget period. We recommend forming a non-partisan revenue forecast council to provide a bottom line before budget discussion begins. And we recommend legislators designate two percent of the forecasted revenue for a reserve fund, allow this fund to grow to five percent, and then return anything in excess of that five percent to taxpayers.

Question #4: What is the most efficient and effective way to deliver essential services within available funds?
Legislators must decide whether or not the core functions they've agreed upon can be accomplished within forecasted revenue. The first three questions in the reality-based budgeting framework deal with developing meaningful and measurable goals. This question is about making sure essential services are delivered as efficiently and effectively as possible without compromising on cost and quality. When legislators have determined that a service or program is a core function of government, they can decided what level of government should provide it, and how competition can be used to control costs and enhance quality.

To make this process functional, agencies must have mission statements, goals and objectives. These must be categorized as high, medium or low priority depending on how effectively they accomplish the state's core functions, and they must be held accountable to well-defined performance measures. The agency's budget request should reflect these priorities and measures.

Once agencies have submitted a budget, legislative policy committees should carefully review all agency priorities and budget requests under their jurisdiction to determine whether or not they comply with the core functions of government that have been adopted.

This is when legislators can and should begin to debate the "make or buy" issue. As lawmakers review agency goals and confirm they are core functions, they should consider whether government must actually deliver the services that accomplish those goals, or whether government's duty is simply to ensure the goals are accomplished. It may make the most sense to contract services to private organizations and companies that have already developed the best practices to deliver them as efficiently and effectively as possible.

As legislators follow this process, a government "buy list" is created, focusing the discussion and debate away from "cuts" and onto "outcomes to be purchased." Essentially, reality-based budgeting changes the budget submission rules. Agency budgets become less about requesting funding, and more about offering to deliver specific results for a specific price. These offers can be evaluated and measured against what is most important to citizens (core functions), and legislators can then buy (fund) with available dollars the products and services that are most desired.

Example: Washington State
In 2003, Washington state successfully used priority-based budgeting to close a $2.8 billion deficit without raising taxes. Our state's economy was recognized by both political parties as too weak to withstand a tax hike. So legislators and the governor joined efforts to prioritize services within available revenue. They asked the question: What are the most important things we can buy with our limited funds?

Washington's core functions are as follows:
1. Improve student achievement in elementary, middle and high schools.
2. Improve the value of postsecondary learning.
3. Improve the health of Washingtonians.
4. Improve the security of Washington's vulnerable children and adults.
5. Improve economic vitality of businesses and individuals.
6. Improve statewide mobility of people, goods, and services.
7. Improve the safety of people and property.
8. Improve the quality of Washington's natural resources.
9. Improve the cultural and recreational opportunities throughout the state.
10. Strengthen government's ability to achieve results efficiently and effectively.

(Readers may or may not like these core functions. That's fine. These are simply an example from one state. More details can be found at

Using these core functions as a guide, Washington legislators then considered revenue from all sources (not just the general fund) and assumed that no spending commitments or proposals were sacrosanct. They then chose which services to purchase and add to the budget in order to accomplish the state's core functions, and they prioritized activities within those functions.

Reductions in spending were not haphazard or routine; they were driven by what legislators had determined were the highest and lowest priorities. Agencies were directed by the governor to provide more details on the specific services they delivered, such as who would benefit, how much the services cost, and what they would achieve. Agencies were required to categorize all of their activities as high, medium or low priority, with at least one third of the activities in the low priority category. This enabled the governor's budget staff to create a priority list comprised of activities across all agencies, and then propose a budget to the legislature that funded the activities that contributed most to the state's overall goals.

The good results born of this process surprised nearly everyone, even those who initially thought it was just another public relations gimmick. Its success scared agency directors, unions, many lobbyists, and lots of lazy legislators who suddenly realized they had to pay attention and say "no" to special interests who couldn't prove high value for each dollar spent. And the state resolved a $2.8 billion dollar deficit without raising taxes.

Unfortunately, Washington's subsequent legislators and governor have not applied this process since, and we now face yet another yawning budget gap.


Priority and reality-based budgeting serves citizens well by ensuring government delivers essential services as efficiently and effectively as possible. It maximizes the value of each hard-earned tax dollar, which is an important responsibility of legislators. It protects vulnerable programs from election-year rhetoric. It provides a logical place for legislators in cash-strapped states (i.e., most of them) to begin meaningful debate and restructure spending.

Once a budget is written, we recommend legislators adopt and implement legislation developed by the American Legislative Exchange Council (ALEC) calling for the final budget proposal to be posted on a website for 72 hours before a vote is taken. After a budget is signed and adopted, we urge legislators to develop a transparency website where citizens can see how and where dollars are being spent.

Moving to reality-based budgeting is not a partisan issue. The Democrat Leadership Council has for years been lobbying its members to embrace outcome-based budgeting:
That citizens want value for their money is no mystery. We all want as much value as we can get from each dollar we spend-including what we spend on government. The price and value of government are up against the price and value of housing, food, clothing, health care, and countless other goods and services that meet people's needs. The price of government is limited, therefore, by the value that citizens want-and get-from government, compared with the value they want and get elsewhere. Government can compete-and stay relevant-only by delivering more value per dollar. But the only way to accomplish this is to reinvent the way we do the public's business. Our public institutions must learn to work harder, but more important, they must learn to work smarter. - DLC May 7 Blue Print Magazine.

Legislators should view the current economic crisis and resulting budget gaps as an opportunity to reform their state budget process from an input system to an outcome and reality-based system. More information and guidance is available from the Stewardship Program (


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