1 &dh LA^...BUDGETING PRACTICES WORKGROUP MEETING Wednesday, September 11, 1996 1:00 p.m. - 3:30...

BUDGETING PRACTICES WORKGROUP MEETING Wednesday, September 11, 1996

1:00 p.m. - 3:30 p.m. Grimes State Ofice Building, Second Floor

Department of Education, State Board Room Des Moines, Iowa 503 Z 9

515-281-3436

I. Opening Comments Bill Vernon Gretchen Tegeler

- 11. Technology Budgeting Issues (cont'd)

- Review of Brainstorming Session Dave Meyers

- Technology Practices in the Private Sector Jim Youngblood, Director of Information Technology Services (formerly of

i7i. &dh Methodist Hospital)

Financial Group (ret.) 1 & LA^ . Bob Delaney, Principal' i!

III. Analysis of Improvements to the Annual Budgeting Cycle

- Review of Brainstorming Session

- Continuum of Options

Dave Meyers

Gretchen Tegeler

Iv. Workgroup Discussion

BUDGETING PRACTICES WORKGROUP MEETING Wednesday, September 25, 1996

1:00 p.m. - 5:OO p.m. Iowa Farm Bureau, Main Board Room, 2nd Floor

5400 University Avenue West Des Moines, Iowa 50265

5 15-225-5400

Opening Comments

Revenue Eitimating

Biennial Budgeting

- Pros and Cons - Discussion

Experiences of the “Top 5 States”

Discussion of Options

Bill Vernon Gretchen Tegeler

Charles H. Whiteman, Professor of Financial Economics, University of Iowa

Gretchen Tegeler

Gretchen Tegeler

All

Summary of the Significant Advantages and Disadvantages of Annual and Biennial Budgets

Biennial Budgeting:

PRO - * Allows more opportunity for more in-depth program review and analysis. * Imposes a longer range perspective in budget and fiscal planning. * Alleviates perpetual involvement in the budgeting process by administrative and fiscal

* Flexibility can be designed into the process, i.e., adjustments to appropriations can be staff, enabling more attention to planning and evaluation.

made as necessary during the second year.

CON - * Increased need for appropriation adjustments. * Spending and revenue forecasts are less reliable because they cover a longer period.

Annual Budgeting:

PRO - * Increased accuracy of revenue and expenditure estimates. * Fewer appropriation adjustments. * Allows the Governor to do a more fiequent review of agency programs and requires

state agencies to develop tighter administrative controls over the spending of public funds.

CON - * Less time to explore substantive issues and places restrictions on all other activities. * Requires continual involvement in the budgeting process by administrative and fiscal

* Results in a narrow viewpoint and encourages short-term fiscal decisions. * Less time for program review, planning and policy analysis.

staff.

7. The contention that biennial-budget states spend more money than annual- budget states.

1. The budgeting practices of the various states, including trends toward and away from biennial budgeting.

Annual budgeting is more common among the states than biennial budgeting; 30 states have annual budgets and 20 enact biennial budgets, most of them in the form of two annual budgets enacted at once (see table 1). Budgets are written for a specific fiscal year in almost every case. Because 13 of the states with biennial budgets have annual sessions in which they can and do revisit the budget, table 1 may overstate the extent of true biennial budgeting. The extent to which budgets are actually revised for the second year of a biennium varies from state to state and from time to time, largely depending on economic and fiscal conditions.

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.. TABLE 1. ANNUAL AND BIENNIAL BUDGETING STATES IN 1993

(Boldface indicates the 10 most populous states)

ANNUAL SESSION ANNUAL SESSION BIENNIAL SESSION ANNUAL BUDGET BIENNIAL BUDGET BIENNIAL BUDGET

(30 states) (13 states) (7 states)

Alabama Alaska Arizona

California Colorado Delaware Florida Georgia Idaho

Illinois Iowa

Kansas Louisiana

% Maryland Massachusetts

Michigan Mississippi

J Missouri New Jersey New Mexico ,~'l. New York Oklahoma

Penhsylvania Rhode Island

South Carolina South Dakota 0

Tennessee

% Z n t West Virginia

5

72a \

Connecticut* Arkansas* Hawaii* Kentucky* Indiana* Montana* Maine* Nevada*

Minnesota* North Dakota Nebraska* Oregon

New Hampshire* Texas* North Carolina*

Ohio*

Washington* Wisconsin* Wyoming

* Biennial budget states that enact two annual budgets at once. Other biennial budgets enact a consolidated two-year budget.

‘t

Survey Information on the “Top 5” 1) Utah 2) Virginia 3) Missouri 4) Minnesota 5 ) Maryland

Do they budget annually or biennially? How often does the legislature meet, i.e., every year or every other year?

Where on the “Continuum of Options do they fall?

What is the process that they use in making long term projections? How far in the fiture do they make their projections (this includes both revenue q d expenditures)?

How effective is their process of making long term financial projections at preventing bad budgeting practices? Would they recommend it for Iowa?

What process do they use in fbndig technology enhancements and improvements? Is there a separate finding stream?

What do they think are the budgeting practices that are most effective in making sure that the state’s fiture financial condition are considered in the annual or biennial decision making process?

Marvland only: Have they expanded their public revenue and expenditure projections out to four years? (Fiiancial World magazine stated that this would occur in FY 97).

Utah onlv: Explain the process that they use in assessing the long term fiscal impact of legislation (per Financial World magazine).

State of Connecticut

Advantages of Biennial Budgeting

+ Facilitates planning to the extent that a blueprint is established for the second year. + Provides a better picture of second year implications of spending decisions

Disadvantages of Biennial Budgeting

+ No real disadvantages other than some anticipated benefits have not yet been fully realized.

I Additional Comments and Information

+ Biennial budgeting was instituted, along with spending caps and the first state imposed income tax, in response to a fiscal crisis.

+ Biennial budgeting was promoted to the legislature as part of a package of fiscal reforms put in place to ensure that the new income tax would not become an unlimited supply of money for growth.

+ Biennial budgeting was also intended to provide time in the second year to do research and look to the future, as well as to address concerns with oversight responsibility and its long-term implications. Time savings have not been as great as anticipated. Tendency is .to not look closely at second year because they know it will be adjusted. Second year is almost as much work. Would recommend biennial budgeting because it promotes concept of looking at second year implications

-T----------- --1 v-------- --T-

State of Utah

Utah budgets annually and the legislature meets annually. Each session is 45 days long. Agencies are allowed to carry over finds into the next fiscal year. The amount of the carry over and how the finds will be used is determined by the legislature on an individual agency basis. Generally carry over funds are earmarked for technology, employee incentives andor training. TJlev considered biennial budgeting einht vears q p ~ but - 9 t make the change because of the uncertainty of revenue projections which go out longer Xan montns.

QLLIL.ccLI

Utah does not have a separate fhnding stream for technology enhancements and improvements. Agencies are allowed to carry over a portion of the prior year finding and they may be required to spend it on technology.

The Governor and the State Fiscal Director prepare an informal 5 year revenue projection. They do consult with key legislators, however there is not a joint estimate. They use the same base data and generally the Executive and Legislative Branch estimates are close enough that the informal process works for them. Because there is no official agreement, the process of projecting out five years has not necessarily prevented bad budgeting practices. Putting some teeth into the fiscal note process has been more effective. '3 tdl.1J.t dw

Utah's method of ensuring a long term budget perspective and preventing bad budgeting practices is unique to other states. A fiscal note which projects two y- * is r-uired for eveqLpr oszram bill passed by the legislature. - Fundmg is not provided for in the program bills. A separate Bill of Bills, which finds all program bills, is submitted at the end of the legislative session. The amount of available fbndmg for the Bill of Bills is determined at the beginning of the session. The Governor makes a recommendation and the legislature has the option of accepting or rejecting it. Generally the amount agreed to by the legislature is close to the Governor's recommendation. The process of isolating program expenditures and requiring a two year cost projection has been effective in reducing the potential for bad budgeting. They would recommend this process for Iowa.

' ~ ; 4 w c k A

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State of Virginia

Virginia budgets biennially and the legislature meets annually. The session is 60 days long in the first year of the biennium and 45 days in the second year. They feel that there are two significant advantages to the combination of biennial budgeting and annual sessions.

1. They have the opportunity to amend the 2nd year budgets ifpriorities, needs, or revenue estimates change. Some adjustments are needed in every biennium.

2. The process promotes better planning. If they fund a new program it generally sunsets at the end of the biennium. During this time the department has the opportunity to assess the success of the program. The Governor is required to provide data showing the success of the program ifa third year of funding is recommended.

The Governor and the State Finance Director determine the projected rate of revenue growth.^ They project 18 months into the future. The Governor's Revenue Advisory Committee, which consists of representatives fiom banking, the Federal Reserve Bank, key retailers and legislative leaders, provides direction to the Governor and the Finance Director. The projection is generally within 1% of the actual revenues. They also have the flexibility to adjust the estimates in the 2nd year of the biennium if necessary.

c

Virginia does not have earmarked funding for technology enhancements or improvements. They have established a higher education technology revolving fknd and have funded a K- 12 initiative but there are no fiands set aside for the technology needs of the rest of state government.

T--------------' --. -______T____I_------- -T-

c

State of Missouri

The State of Missouri prepares an annual operating budget and a biennial capital budget. The legislature meets each year.

Each year the state publishes a five year outlook for revenues and expenditures. The projections &e required by statute but were widely ignored until 1986. The methods used to develop the projections are relatively informal. The projections are not very detailed nor are they binding on the budget process.

Consensus revenue projections are derived from an informal process involving the legislative and executive branches. Expenditure projections are formulated by the budget agency with little collaboration with the legislative branch. The expenditure projections are presented by major areas with other and discretionary items lumped together. Estimates for the first year are well developed, and they have a good handle on the second year. Years three through five are estimated using an assumed inflation factor as well as known adjustments.

Missouri considers their method to be effective in contributing to good budgeting practices and adds that the consensus in revenue projections is of major benefit. Although the process is somewhat informal, it works for them, and they would recommend it for Iowa.

Missouri also believes that a key budgeting practice is to identify ongoing versus one-time revenue "blips", and to then match one-time revenues with one-time expenditures and ongoing revenues with ongoing expenditures. This practice promotes consideration of future financial condition in the decision making process.

An Information Office has recently been established and is working to develop a comprehensive plan for technology applications. Currently, the Data Processing Division reviews and '

prioritizes technology enhancement and improvement requests. State government acquisitions have no dedicated funding source and are normally included in the operating budget of the agency. The excess of revenue over projections has in the past been used to fund the acquisition of technology for schools and libraries in the state.

State of Minnesota

The State of Minnesota prepares biennial operating budgets and biennial capital budgets in alternate years. The legislature meets each year.

Minnesota is by statute required to project revenues and expenditures for the current and succeeding two bienniums. Projections are developed by the Department of Finance, which is the budgeting agency of the executive branch, and are widely shared.

Revenue projections are based on information derived from a national economic model which is reviewed by the state's Council of Economic Advisors. The Council is composed of economists representing the private sector, state government, and academia. Minnesota has enacted legislation that requires the Governor to establish targets for revenue as a percentage of the total personal income of the State. These targets have been adopted by the legislature. This provides a mechanism to set an upper limit on spending for a long period which is of great benefit in planning.

Expenditure projections focus on eight to twelve major program areas with simple inflationary adjustment in the out years to the balance of spending areas. Historically, projections have varied about two percent for the first year and four percent for the second year. The variance for future years is not tracked because the projections are impacted by subsequent budgetary decisions and because the projections are really valued more for their capability to reflect trends. Minnesota is also using another budgeting tool which projects multi-year budgets in terms of percentage of the total budget to be spent in various program areas. These projections are useful in focusing debate on budget issues, starting with numbers that work under the established

* revenue limits.

The projections are very effective in providing the capability to track future year costs and they would recommend their method to Iowa. Although the out year projections are not binding, they provide an excellent tool for identifying emerging trends, which then allows planning and decision making to focus on these budget issues. It is also highly effective in highlighting and preventing bad budgetary practices such as the shifting of expenses to future years and the use of "one-time" money to fund ongoing projects or programs.

'

Requests for technology enhancements and improvements are submitted by state agencies to the Information Policy Office for review. The review considers the technology's ability to perform as intended and its compatibility with other technology, and results in a recommendation to approve or disapprove the request. Legislation is contemplated to require a prioritization of these requests. There is no dedicated funding source for technology acquisitions.

State of Maryland

The State of Maryland prepares an annual budget and the legislature meets each year.

Revenue and expenditure projections are prepared for five years. This practice has been in place for many years and the projections have been widely shared with all those who were interested. Beginning with FY97, the projections are now formally published in the budget document along with a discussion of assumptions and relevant explanations.

Revenue estimates are made by the Board of Revenue which is comprised of the Comptroller who is independently elected, the State Treasurer who is elected by the legislature, and the Secretary of the Budget who is appointed by the Governor. Five year revenue projections are required by statute. As the composition of the Board would suggest , there is a great deal of collaboration in making the revenue projections. The projections are not binding, however, the conventional wisdom is that the Governor ignores the projections at his own peril.

Expenditure projections for are made for five years as required by the previous year's budget bill, are prepared by the budget agency and are published in the budget document presented by the Governor. The projections are formulated by looking separately at the major components. Much of local aid expenditures are formula driven. Trend information and models are used to forecast state operations and entitlement program expenditures. The Transportation and Higher Education funds are budgeted separately.

Accurate forecasting is key in making sure that the hture financial condition is considered in the budget decision process. Maryland considers its budget and long-term' projection processes to be

* effective practices and believe they would be effective for Iowa.

Technology enhancement and improvement requests are reviewed by the Chief of Information Technology. The Chief sets standards for compatibility of systems, makes recommendations on the requests, and provides some prioritization of the requests for use for the budgetary process. A new fund was created last year to capture savings from technology improvements to be reinvested in technology.

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Table 0 Operating Expenditure Forecasts

Multi-Year Years Beyond Estimates Estimates Are Projected Expenditure Current Budget Orginated lnclude Operating Expenses

State Forecast Cycle* in Agencies Al l Programs Published

Alaska NP Arizona Arkansas California X X X NP

Alabama X 1 X X B

Co!orado B Connecticut Delaware Florida

X X

3 5

X X X

- PS NP 8'

Georgia X NP Hawaii X 4 X X B Idaho Illinois Indiana

X X

2 1

X X

B NP NP

Kentucky Louisiana Maine

X 3 X X X

PS B

+ Maryland X * 4 X NP Massachusetts X 2 B Michigan X 1 X X B Minnesota X 4 X X PS Mississippi X X B Missouri X 4 X R Montana Nebraska X 2 X PS Nevada New Hampshire X X

NP B

New Jersey X 2 X X NP New Mexico NP New York North Carolina North Dakota

X X

2 4

* X X

X X

NP NP B

Ohio X NP Oklahoma X 2 X NP ' Oregon X 2 PS Pennsylvania Rhode Island

X X

4 4

X X X

X B

South Carolina X B South Dakota X 3 NP Tennessee X X B Texas X X B Utah X 5 NP

)r, Virginia Washington West Virginia

X 4 X X

X X

B NP

Wisconsin Wyoming NP Puerto Rico NP . .

Codes: B....Published in the Budget NP .... Not Published

^Refers to the number of years beyond the current budget year or biennium for which estimates are made. Source: National Association of State Budget Officers, Budget Processes in the States, February 1995

PS .... Published Separately

Page 32

8

Characteristics of Multi-Year Financial Projections

Extent to Which Information is Shared

Statutory Requirement (Formal) or Voluntary (Informal)

Degree of Collaboration Between Executive and Legislative Branches

Extent to Which Information is Binding on Budget Process

Consideration of Future Financial Condition In Annual Budget Process: A Continuum of Options

No Informal Projections Independent > Formal, Consensus

Made & Informational & Binding 1 I

NA Not Widely Shared

NA Not S t atutody Required

NA Independent

NA Non-Binding (Informational)

States Iowa; Most States Missouri (3) Kentucky Florida Utah (i) Minnesota (4)

Virginia (2) Maryland (5)

LFB CAPITOL +++ LFB LUCAS m o o 2

_. TERRY E. BRANSTAD. GOVERNOR DEPARTMENT OF MANAGEMENT

GRETCHEN TEGELER. DiqEcToR

DATE:

Tdf ‘

FROM:

RE:

September 24, 1996

Meibers of the Budget Practices Work Group

Gretchen Tegeler, Director

. September 25 Meeting

As you how, at our last meeting Bill Vernon asked me to bring to the meethg on the 25th some specific options for consideration by the work group. I’ve done that, and have attached them for you to take a look at in advance of the meet@.

These options represent a concrete starting point for our discussion, If‘I haven’t already visited with you one on one, please feel free to give me a call if there are any other ideas that we’ve discussed that you think I’ve missed. We‘ll also have opportunity to add to them over the next several weeks.

Also, please recall that well be reviewing the concept of biennial budgeting tomorrow. A considerable amount of’research has been done on this topic, and brainstorming sessions have been held with legislative and executive branch staff Results of the research and brainstorming sessions were provided to you at our first meeting. It would be very helpful if you would review this information in advance of tomorrow’s meeting, and bring the materials With you for reference purposes.

Recall, we’ll be at the Farm Bureau. Lunch is available on site, at your own expense. A map was mailed to you earlier, but if you need another please give Dave Meyers a call at 281-8833.

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I

I

I

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I I

STATE CAPITOL BUILDING / D E S MOINES. IOWA 503 19 / 5 15-28 1-3322

09 /24 /96 .c

16:04 B 5 1 5 2 8 1 8451 LF’B CAPITOL +++ LF’B LUCAS @I 003

Budgeting Practices Work Group Options for Consideration

September 25,1996

Summary of Issues;

Over the past several years, state finances in Iowa have undergone a remarkable transforinstion. The condition of the general fund OI? the basis of genedy accepted accounting principles (GAAP) has improved fiom a negative $400 million in &cal year 1992 to over a S600 million positive balance in fiscal year 1996. At the close of the last fiscal year, reserve.fUnds held 10 percent of total available revenue, and an additional s i x percent of the general fbnd remained unspent.

This financial environment, while laudable, brings with it a whole new set of challenges. Among the most important challenges is determining how to sustain the state’s strong financial position into the hture. Current conditions, if viewed in a single year time horizon, cany with them the risk of making decisions that will not be sustainable into the fiture, Specifically;

For the first time in many years (since the state first began the process of building reserve finds), a surplus balance fi-om the prior year has become a beginning balance in the curient yezr. . B s carr;--ovqt balance is a one-time find% source, and cannot be used to sustain ongoing commitments of similar magnitude. Yet, its existence gives the appearance of significant fiscal capacity. Such a balance must be managed down carefully, requiring a multi-year perspective.

As hancial conditions have improved, a number of extraordinary commitments have been enacted that are phasing in over a multi-year time period. Examples include state funding for mental health (property tax relief), shifting the funding of the State Highway Patrol fiom the Road Use Tax Fund to the general hnd, and authorization for the construction of several new prisons. Because the full effect of these commitments is not apparent in a single-year time horizon, their future impact tends not to be taken into account in budget decision making. Yet, they have the potential for creating significant future difficulties if ignored.

A fhi l issue is directly associated with the annual budgeting cycle, A general find spending target is established for the single budget year. Over-emphasis on the spending targets can lead to machinations in the budget that understate the true level of spending. For. exampIe, items may be h d e d from reversions of the prior year, or an iterr; may be fbnded for just a small portion of the fiscal year. These items inevitably reappear in the second year in the form of “built-in” increases. Without a requirement to consider the second year of the budget, such practices are unchecked.

- +++ LFB LUCAS a 0 0 4 ' , 09/24/96 16 :05 B 5 1 5 281 8451 LFB CAPITOL -- ,7-- -.

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Optims for Consideration:

1. In addition to the budget year, the Governor could include a four-year financial projection of anticipated general fbnd revenues, expenditures and, annual operating surplus or deficit as a part of the budget materials transmitted to the General Assembly.

The projections would be informational (non-binding).

'Initially, there would not be a statutory requirement for undertaking such projections. However, the concept of a statutory requirement would be re- evduated' after two years of experience with the information (specifically, its accuracy and utility or impact).

Major assumptions, rationale for assumptions and data sources would be noted.

The projections would be developed, as much as possible, collaboratively with the Legislative Fiscal Bureau.

2. The Department of Management could request the University of Iowa Institute for Economic Research to provide five year economic and revenue projections, to support the Governor's projections. The Institute projections would be published as a part of the Governor's budget materials.

3 . When fiscal notes are prepared by the Legislative Fiscal Bureau, they could indude out-year impacts if the cost is projected to increase beyond the budget yeat. Fiscal notes could continue to be developed collaborativeIy with the executive branch.

4. Prior to the end of the session, the General Assembly could publish a list of all spending commitments that create an "automatic" increase during the subsequent year, with their dollar amounts, to include such items as:

4 The annualized amount of my partial year hnding;

The amount of any potentially ongoing spending item finded from a one-time spending source, including carry-over fimds;

The amount of any item ofspending for the fiscal year that is appropriated in a prior fiscal yeaq and

The amount of any item that in the subsequent year would not be eligible for fimding from its non general knd source, according to current or newly enacted definitions.

- I -

S. Using the above list, the General Assembly could publish a statement of estimated financial condition of the year following the budget year.

6 . The State could move towards biennial budgeting iri the following manner:

Budgets for smaller agencies with no histofL of supplemental finding &d relatively stable funding would be enacted on a biennial basis beginning in fiscal year 1998, which will be the First Session of the Seventy-Seventh General Assembly. Success would be monitored, with the eventud goal of all agencies being on a biennial basis by the fiscal year 2002.

An overall spending target could be established for the second yeat of the biennium.

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T h e University of Iowa

Date: Septemkr25,1996

To: Fisher Committee Workgroup on Budgetary Practices

From: Chuck Whiteman

Using the same procedures I have used in forecasting state tax revenues for the past nearly seven years, I have prepared a forecast this quarter for the two-fiscal-year period 1998-1999. This new forecast, together with the, the forecast I sent to the Revenue Estimat~ng Conference September 16, 1996, are displayed on the following page. As you can see, the degree of uncertainty for the 2 year forecast is not much bigger than that for the 1998 forecast alone. The reason for this is that revenues in two successive fiscal years are correlated; when this happens, the two-year forecast uncertainty can be much less than the sum of the two one-year uncertain@ measures.

college of Busines Adminisbati on W230B PBAB phone 319I335-0834 Inrtitute for Economic Research 10% C i , IA 52242-1000 FAX 3191335-1956 Bmail:emnin@ui~eduorvihhm@u iowaedu

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1

September mean 1997 growth: 6.0% Forecast standard deviation: 1.6%

mean 1998 growth: 6.3% standard deviation: 2.1%

September mean 1997 growth: 6.0% Two Year standard deviation: 1.6% Forecast

mn. 98-99 growth: 12.7% standard deviation: 2.3%

Asymmetric Loss Forecasts

Cost ratio = cost of shortage : cost of surplus

If the Cost Forecast Forecast

this (FY 1997) (FY 1998) ratio is this this

1 2 3 4 5 6 7 8 9

10

6.0 5.4 5.0 4.7 4.5 4.3 4.2 4.1 4.0 3.9

6.3 5.5 5.0 4.7 4.5 4.2 4.0 3.9 3.8 3.7


Cost ratio = cost of shortage : cost of surplus

If the Cost Forecast Forecast ratio is this this this (FY 1997) (FY 1998-1999)

1 2 3 4 5 6 7 8 9

10

6.0 5.4 5 .O 4.7 4.5 4.3 4.2 4.1 4.0 3.9

12.7 11.9 11.3 10.9 10.6 10.4 10.3 10.1 10.0 9.8

! Likely Growth in Iowa Tax Revenue 1997 -

0.25

0.20

2.

b

'8 0.15 .o

l OJO 0.0s

0 .oo 1.80 2.98 4.16 5.34 6.52 7.71 8.89 10.07

%Increase in Revenue

1.00 0.90

0.80

3 0.70

(r I 0.50 .&- 0.40

0.30

h 0.20

0.10 0.00

1.80 2.98 4.16 5.34 6.52 7.71 8.89 10.07 %Increase in Revenue

Mean: 6.0% Standard Deviation: 1.6%

Quadratic Loss Function Best Forecast = Mean of Predictive PDF

12

B lo - 8 $ 6 e

4

2

0 -4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0

Error in Forecurt (Negative = Shortage)

1998+1999 0.18 - 0.16 - -

0.14 -.


1.00 0.90

y 0.80 3 0.70

b i ::;: t :::: &- 0.40

0.10 0.00


Mean: 12.7% Standard Deviation: 23%

Asymmetric Lmear Loss Function

-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 Error in Forecast (Negative = Sortage)

i TheUniversityofIowa

phm 319L335-0834 FAX 3191335-1956

Date: September 16,1996

To: Revenue l%hahg conference: James Padsea, Dezmis Prouty, Gretchen Tegeler

From: Chuckwhiteman

The pages €tom The Iowa Economic Forecast Containing my fiscal year 1997 and 1998 revenue fo- follow. As you will see, the forecast fbr 1997 is higher than the one I produced in June. This is primarilydueto an i m p r o v e d d d for income in the state.

This quarter I have changed the way the general receipts forecast is made to reflect the capping of the racing and gaming reoeipfs coa$ibution to tk general fiuul. (Reapts in excess of $60 million now go for idhstmm projects, not to the g d fund.) Now, a forecast is made of total receipts net of racing andgaming, and then the $60 million racing and gaming maximum is added fbr the fiscal year. Thus all oftheuncertainty inb calculatons I amprovidmg canes fiom uncatam * tyin the non-racing and gaming portion of general reoeiptS; tbe $60 million contribution fiom racing and gaming is treated as known. Ifchanges aremade priortotheendofthe fiscal year tothe cap, they should betaken into account dollar for d o h in the general receipts forecast.

Iowa Revenue Outlook

Revenue estimate recommendation: The model predicts 6.0% growth in fiscal 1997 and 6.3% in 1998. In the past, Revenue Estimating Conference (REC) forecasts have often corresponded to those I would have chosen if shortfalls are viewed as about three times as costly as surpluses. Now, this suggests a 5.0% growth forecast for 1997 and 5.0% for 1998. To the extent possible, these forecasts account for the tax law changes implemented in the 1996 legislative session and for special circumstances which may have affected revenue collections so f i r this fiscal year.

Analysis: Fiscal year 1997 revenue growth net of racing and gaming receipts through August stands at 2.8%. This is moderate revenue growth given that revenue growth during the first two months of fiscal year 1996 was exceptional.

The forecast for fiscal 1997 is stronger than the one made by the Institute in June. This is primarily due to the stronger income outlook for the remainder of calendar year 1996 and for 1997. The forecast for fiscal year 1998 is slightly stronger than the one issued in June. Partly due to the uncertainty accompanying revisions to the income forecast, the uncertainty in the revenue forecast is unchanged fiom June.

The forecasts this quarter reflect adjustments to the “big four” (personal and corporate income taxes, the sales tax, and the use tax) for the number of processing days duxing the quarter (compared to last year), the timing of electronic b d s deposits of tax payments, and other processing details. (The adjustments are calculated by the Department of Revenue and Finance.)

The forecast also reflects legislative changes enacted for fjscal year 1997. The most important charge is the capping of the contribution of racing and gaming receipts to the general fund. Beginning with fiscal year 1997, only the Grst $60 million in racing and gaming receipts go to the general fund; the excess is earmarked for

current forecast, total receipts net of racing and gaming receipts are first predicted, and then the

I

infrastructure funding. Thus beginning with the

$60 million racing and gaming maximum is added to the result. (It is extremely unlikely that racing and gaming receipts will f d short of $60 million; the Department of Management predicts that racing and gaming revenues will exceed $95 million in fiscal 1997.)

The other important legislative change involves indexation of personal income tax rates. This accounts for about $5 million in revenue reductions for fiscal 1997. Other smaller changes to the tax code bring total reductions to receipts net of racing and gaming to $8.7 million.

Forecast details: The 1997 growth forecast represents growth over 1996, and the 1998 forecast represents growth over the 1997 forecast. The forecasts are:

September mean 1997 growth: 6.0% Forecast standard deviation: 1.6%

mean 1998 growth: 6.3% standard deviation: 2.1%

For comparison, the most recent forecast was:

June mean 1997 growth: 5.2% Forecast standard deviation: 1.6%

mean 1998 growth: 5.9% standard deviation: 2.1 %

The standard deviations reveal the uncertainty in the forecasts. Roughly speaking, the forecast plus and minus one standard deviation represents a U3 probability band; i.e., using the 1997 forecast, there is a 2/3 (subjective) probability that actual 1997 revenue growth will fall between 4.4% and 7.6%. The graphs in Figure 8 permit more precise calculations of this sort. The uncertainty in the forecast is of course quite large; it always is when forecasting a year or more into the future. To put this in perspective, year-- revenue growth at the end of April 1992 was 6.8%, but only 5.1% at the end of May-a 1.7% swing in a single month near the end of the fiscal year. The year ended at 5.9% growth-a 0.8% swing in the lust month of the fiscal year.

I believe that for planning purposes, the best forecasts are those which reflect the uncerta.inties that can be quantified (by the predictive distributions provided in Figure 8) together with the costs associated with incorrect forecasts. (How unhappy will we be in July 1997 if the fiscal year 1997 revenue growth forecast made in September 1996 is too low? Too high?) I have prepared diagrams which illustrate two kinds of "loss functions": one penalizes shortages and surpluses equally but at an increasing rate the larger the forecast error (the " w c Loss" function in Figure 8); the other penalizes shortages more than surpluses, though at a rate which grows linearly with increasing error (the "Asymmetric Linear Loss Function" in Figure 8). Using the quadratic loss function (which rewards pure forecasting accuracy), the best forecast is the mean of the predictive distribution: 6.0% growth for 1997,6.3% for 1998. The table below indicates forecasts that minimize the asymmetric loss for a variety of penalty weights for shortages relative to surpluses. For example, the official standing FY97 forecast of 2% (which does not take the tax law changes into account) is appropriate now if shortages are regarded as more than ten times as costly as surpluses.


Cost ratio = cost of shorrage : cost of surplus

Ifthe Cost ratio is this

1 2 3 4 5 6 7 8 9 10

Forecast this (FY 1997)

6.0 5.4 5.0 4.7 4.5 4.3 4.2 4.1 4.0 3.9

Forecast this (FY 1998)

6.3 5.5 5.0 4.7 4.5 4.2 4.0 3.9 3.8 3.7

0.2s

0.20

.@

.@ J 0.1s

1 0 . 1 0

0.05

0.00

1.00

0.90

$J 0.80

3 0.10

0.60

% 0.50 1::; 0.20

0.10

0.00

Like& Growth in Iawa Tax Revenue - 1997


1.89 3.08 4.24 5.41 6.58 7.76 8.93 10.10 %Inman in Revenue

Mean: 6.0% Standard Deviation: 1.6%

Quadratic Loss Function B a t F a m & = Mean dprodictivc PDF

4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 Emx in Faaurt (Negative - Sortage)

1998 - 0.18 - - 0.16 .-

0.05 2.40 4.03 5.57 7.11 8.65 10.20 11.74 Klncrurc in Revenue

1.00

0.90

3 0.80

3! 0.70

3 0.60

0.50

.e 0.40 p::: 0.10

0.00 0.M 2.49 4.03 5.57 7.11 8.65 10.20 11.74

%Incruse in Revenue

M6?lUl: 6.3y0 Standard Deviation: 2.1%

Asymmetric Linear Loss Function ovacstirmte cola3xu- cola

4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 Emx in Fortcast (Negative = Sholtagc)

,

Figure 8: Likely Growth in Iowa Tax Revenue

Revenue Forecasting Presentation to the Fisher Committee WGkgroup on

Budgeting Practices

Charles H. Whiteman Institute for Economic Research

College of Business Administration The University of Iowa

eptember 25,1996

.. 3

Iowa Revenue Growth

2 ' I

8 4 85 86 8 7 88 8 9 90 91 92 93

13

12

1 1

10 i - 9 f k 8

$ 6 0

5

4

- 0 7

L

I - revenue growth -I- income growth I

Revenue and Income

8m?

82

9J 99 8 i

ELB 8 p

3 ! 2 3 4 5 6 7 8 9

income growth (fy, %)

FY Revenue, CY Income

12 - 11 -

84

h

10- i - 9 - f

8 -

r

3 7 - $ 6 -

5 -

4 -

L

3- 1- -- 2 3 4 5 6 7 a 9 1 -

income growth (cy, X)

September Revenue Forecast FY97 General Receipts Increase vs. FY96

(Mean 6.0%, Std. Dev. 1.6%)

0.25

0.20

fj 0.15

[ 0.10

0.05

0.00

I0 1


September Revenue Forecast FY97 General Receipts Increase vs. FY96

(Mean 6.O%, Std. Dev. 1.6%)

1.00

0.90

0.80

3 0.70

i ::::: 0.40

L

t :::: 0.10

0.00 1.89 3.06 4.24 5.41 6.58 7.76 8.93 10.10

%lncrerie in Revenue

September Revenue Forecast N98General Receipts Increase vs. FY97

(Mean 6.3%, Std. Dev. 2.1%)

0.20

0.18

0.16

.@ 0.14 1 0.12 0

d ::::: 0.06 0.04

0.02

0.00 . . . . 0.95 2.49 4.03 5.57 7.11 8.65 10.20 11.74

%lacreare in Revenue

Decision-Theoretic Forecasts

Asymmetric Linear Loss Function Overestimate Cost 3X Underestimate Cost

12

10

-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 Error in Forecast (Negative = Shortage)

Revenue Forecast Accuracy Forecasts of Current Fiscal Year

Revenue Growth - Date - IER - REC - Actual 12/90 4.3% 6.10/. 4.7% 3/91 4.5% 5.6% 4.7%

12/91 6.7% 6.8% 5.9% 3/92 5.7% 6.0% 5.9%

12/92 11.5% 10.3 % 103%" 3/93 10.6% 10.3% 10.3%*

12/93 6.9% 5.0% 6.9% 3/94 7.0% 5.9% 6.9%

12/94 7.Oo/a 4.Oo/a 5.7% 3/95 55% 4.8% 5.7%

12/95 6.5% 4.9% 7.1% 3/96 6.0% 4.90/. 7.1%

* IIWMU liquor transfen

Revenue Forecast Record ‘90-’96

DEC MAR

DEC MAR

MSE

cw REC 0.7 2.4 0. 1.3

MAE

- cw REC 0.7 1.4 0.4 0.9

Reduction ’70% 81%

Reduction 50% 59% !

Characteristics of Multi-Year Financial Projections

Extent to Which Information is Shared

Statutory Requirement (Formal) or Voluntary (Informal)

Degree of Collaboration Between Executive and Legislative Branches

Extent to Which Information is Binding on Budget Process

Consideration of Future Financial Condition In Annual Budget Process: A Continuum of Options

No Informal Projections Independent > Formal, Consensus

Made & Informational & Binding

States t Iowa; Minnesota Kentucky Most States

. Florida

-

SUMMARY BUDGETING PRACTICES DISCUSSION

Executive Branch Staff

On September 5, 1996 a meeting was held with Executive Branch staff to discuss the departmental perspective on potential technology finding sources and identifjl alternatives for prioritizing technology needs. The following Executive Branch staff participated in the discussion:

Roger S tirler, Department of Education Lee Tack, Department of Education Dave Heuton, Department of Public Safety Steve Lindner, Department of Revenue and Finance Lorrie Tritch, Department of Human Services

Technology Funding: Should be a continual finding stream, not one-time revenues

Alternatives - A fund consisting of moneys fiom several sources such as

- federal finds - direct appropriation - reversions (50% currently retained by departments) - gambling revenues - lottery - cigarette tax (Nebraska is using a cigarette tax to fbnd the Year 2000

changes)

A revolving fund consisting of technology moneys currently in departmental budgets

- Could lead to an enterprise approach in the long teim - All finding sources should contribute to the hnd in a proportionate share - Negative fiscal impact on the departments initially - Long term benefits may outweigh short term pain

Issues - Would both agency specific and enterprise specific projects be included in this

Software maintenance - a coordinated approach could save money fbnding stream?

Prioritizing Technology Needs: Statewide Board - decision-making or consultative?

Provide coordinated approach to large purchases - use capitals methodology Would need enterprise buy-in to accept board decisions Provide consultation, advise and decision making outside of IT department Agency vs. statewide project fbnding - would they.address both? Benefits -

Take advantage of economies of scale Coordination of planning Settinghoordinating enterprise-wide direction and timeliness

Issues - Should the Board be the only source of decision rnakinghinding for enterprise

projects and the last resort for departmental specific initiatives? How would a centralized approach affect the grant writing process and use of

federal hnds? - Departments could consult with the Board preceding plan design - The Board could provide expertise and planning support in the early

Inventory - the Board could provide the impetus for the cataloging of current grant writing stages

resources (including Regents).

SUMMARY BUDGETING PRACTICES DISCUSSION

Legislative Branch Staff

also was asked to discuss what tradeoffs would perhaps lead to legislative support for the concept of biennial budgeting. The following Legislative staff participated in the discussion:

Randy Bauer, Senate Democratic Caucus Staff

Changes to Current Annual Cycle: Executive and Legislative Branch agreement on revenue estimates and assumptions for out years

.

- Agreement on long term expenditure estimates for large programs, i.e. Medicaid - DOM/Legislative Fiscal Bureau agreement on long term revenue

estimates rather than expand the Revenue Estimating Council Stabilize reserves without depleting the base

Significant legislative involvement early in any process that is driving changes in the

Could possibly agree to limited multi-year fbndmg in areas that have historically

Forward fbnding of some larger programs - currently forward fimd school aid vs. auto

More legislators as ex-officio members on BoarddCommissions

Use excess reserves for one-time or limited duration expenditures

system - ex. Budgeting for Results, Strategic Planning

maintained fairly constant hnding

pilot

Issues - Differences in Legislative and Executive Branch perspectives Need flexibility to react to changing needs or priorities - ex. federal fbnds

Tradeoffs in Biennial Budgeting: Transfer authority

- Shared responsibility? Is this constitutional? - Limits on Governor’s authority

Delivery of Governor’s budget recommendations and bills - submit earlier

Timely submission of departmental budget requests - put teeth in statute

Greater legislative involvement in long term strategic planning by departments Reauthorization of 2nd year

- may not be necessary if transfer authority is limited

Notes From Conversation With Hal Hovey, Editor of State BudEet & Tax News. September 4, 1996

Mr. Hovey has stated that "considering the impacts of spending and tax decisions over a longer period than one year" is one of the criteria of best budgeting that experts agree upon. I contacted Mr. Hovey to get his observations about what methods and practices do the best job of assuring this occurs. Following are notes from that conversation.

Mr. Hovey stated that when he was budget director in Illinois, he also did five year projections, and like ours, they were not public. He allowed it was difficult to create any interest or buy-in under those circumstances.

The most formalized process about which he is aware is in Florida. ,There, consensus estimating and projecting is done for both revenues and current services spending. (Consensus estimating means that both executive and legislative branches are bound by the estimates.) A fairly extensive planning effort is involved, whereby economics and demographics underlying the budget are projected down to the county level of detail. All parties are bound to use the same demographic assumptions about, for example, inmates, welfare caseload, Medicaid caseload, price indices, etc. The estimating is done by a group appointed by the Governor, Speaker of the House and President of the Senate. No outside party is involved.

More informal processes are used in other states. He referred me to Bob Bittenbinder, the director of the Pennsylvania budget office.

He said a different kind of mechanism exists in some states in the form of informal outside "watchdog" groups. Sometimes these groups do projections that have an influence on the budgeting process. Examples cited are Indiana (Fiscal Policy Institute), Minnesota (Citizens League and Business Roundtable).

More formalized outside "watchdog" groups also exist. New York City, for example, has an independent board that does 5-year projections with risk analysis and sensitivity testing. California used to have a Commision on State Finances to do projections, but dropped it because "the legislative and executive branches got tired of having a third party involved."

Some states have insitutionalized conservatism in their budgeting, for example, Oklahoma has a legal ceiling on revenue that can be used for budgeting, regardless of the actual revenue growth. North Carolina routinely underestimates revenue, then uses the surplus for one-time spending including infrastructure.

-

I

Notes From Conversation With Ron Snell, Finance Director, National Council on State Legislatures

September 10,1996

Mi. Snell was asked for his observations about state budget practices that are most effective in making sure the state's future financial condition is considered in the annual or biennial decision making process.

Mr. Snell responded that he sees a trend towards more and more Governors including information about long-term implications of their budgets in the materials presented to the legislature. He cited Rhode Island as an example. He said, "It doesn't have to be elaborate, as long as it effectively conveys the information." He noted that this type of information is, unfortunately, often ignored when times are prosperous.

North Carolina was cited as a legislative fiscal office that does a good job of projecting, but is less effective in the way the information is presented.

With the exception of Florida, he is unaware of states that undertake consensus forecasts of the entire budget. He sees this as primarily an executive branch function.

Mr. Snell has published many articles and papers on the subject of annual vs. biennial budgeting. He concludes there is no definitive evidence to show biennial budgeting has a positive impact on encouraging a longer-term view. However, he mentioned the City of Seattle as a place where biennial budgeting is credited with "turning their situation around," and notes it is widely supported by city administrators. He feels it does provide the opportunity for budget office staff and agency budget staff to do a better job of long- range planning and program evaluation.

Referrals include:

Rhode Island Public Expenditures Council

Ask for April 24, 1996 Report on FY 97 - 2001 Financial Projections 40 1-52 1-6320

California -- Elizabeth Hill (Legislative Fiscal Ofice) Internet access -- start with NCSL's web page (http:\\www.ncsl.org)

Minnesota Tax Research Division, Mnn. Dept. of Revenue ---I- 296-3425

A contact on the technology issue is NCSL's Rich Jones at 303-830-2200.

Notes From Conversation With Brian Roherty, Executive Director of the National Association of State Budget Officers

September 10,1996

I asked Brian for his observations about state budget practices that are most effective in making sure the state's fbture financial condition is considered in the annual or biennial decision making process.

Brian responded that the trend seems to be towards the establishment of groups of "outside experts" whose forecasts the Governor and legislature agree to use in the budgeting process.

c

For example, in Minnesota there is such a group, consisting of folks from the major corporations, who have responsibilities for forecasting within their companies. For example, 3-M, Cargill, IDS, Nonvest, Gereral Mills and the Federal Reserve Board are among the members. The forecasts are for a four year period. They are economic forecasts primarily, which are then expected to be used consistently as inputs for projections of revenues and expenditures.

Brian feels that deferring to a group of folks outside government enables the focus to be on the policy rather than the numbers.

IOWA

Description

In Iowa, the legislative and executive branch are bound to consensus estimates for revenue only, and for a one-year period. Members of the Revenue Estimating Conference are the Director of the Legislative Fiscal Bureau, the Governor’s designee (Director of the Department of Management) and a third public member.

Longer-term (current year plus four) forecasts of overall financial condition (revenues and expenditures)are undertaken by the executive branch. This is not a statutory requirement, and the information is not widely shared. It is used as guidance for development of the Governor’s budget.

Longer-term forecasts are also undertaken by the legislative branch on an “as requested” basis. Typically, these forecasts contain some sensitivity testing, i.e. varying results are shown based on a range of assumptions about revenue estimates in the out years. Again, this information is not widely shared.

Effectiveness

The executive branch forecasts have been effective in providing guidance to the Governor about what commitments can be sustained over the long term. However, the projections are not widely shared, and assumptions can be disputed by others. Therefore, they are of limited usehlness in the legislative process. Because a range of revenue estimates isused in legislative ro-iections, it is possible to choose the assumption that e n & J a t k b i o n - . - - .

- desired. ir--p- \

- 1

Description

Minnesota is by statute regnired to pject revenues and expenditures for the CuITQLt and succeeding two biembms- Projections are developed by tht Department of Finance, which is the budgeting agency of the executive bmcb. Revenut pjcCtions arc based m iaformation derived from a national eamomic model which is revimd by the state" Corned of Economic Advisors. Thc cormcil is composed of economists rep-- the private sector, state government, and academia I k p e n b projectio~~~ focus on eight to twefve major program anas with simple inA;ttionftrv a d . . d m the out years to the baIance of spending axeas. Historically, projections have varied about two percent f ir the first year and hr percent fbr the second year. The variance for fidme yean is not trackxd because the pjections are impacted by mbsqxnt bdgebry decisions and bemuse the projections are redly v d d more for their

r

Capbiii tp reflect trends.

This budget process is vay effrctzve in grovillinp the capability to fmck fixture year costs. Mbugh the out yur projections are not binding, they provide an excfuent tool fix ibtiQhg emerging hen&, which then allows plaaaing and decision m k k g to focus on these budget issues. It is aIso highiy effkctive in highlighthg and prwenting bad budgetary practices such as the sbift.ing of expenses to fiamr: years and the ase of "om-time" money to fnnd ongoing projects ormlPfJ=-

The hGnneso@ Depaxtment of Finance employs economists on s&f€ and utikes a m x n k of computer models to project rcvenucs. It may be possl'ble for Iowato ~pksnent a model such as this without a significant increase in staff or resources. -

KENTUCKY

Description

The State of Kentucky has developed a fiscal management initiative to ensure the long- term financial integrity of the state’s budget. The initiative is intended to enhance the coordination among multi-year revenue forecasting, financial projections, and budget preparation. Previously, the state forecasted revenues for a two year period but the process was informal, non-bindmg, and not statutorily required. Additionally, there was no major effort to make financial projections out past the immediate biennial budgeting period. Under the latest reforms, however, the state is statutorily required to forecast revenues for the immediate biennial budgeting period and both the executive and legislative branches are bound by this revenue estimate. Also, a special group, the Long Term Policy Research Center, was established to forecast financial projections into the “out years”, usually for a four year period but sometimes as far out as ten years. This group is comprised of twenty-one members with ten members fiom the executive branch and 11 members fiom the legislative branch. The financial projections are not specifically detailed out by program but are lumped together according to fbnctional area, i.e., Human Services, Justice, etc. The projections are not binding and are used solely for informational purposes and to provide a picture of what state expenditures would look like in the fbture given certain assumptions.

Effectiveness

Because the implementation of these initiatives occurred within the last year it is too early to adequately assess the impact that they may have on the long tern budgeting process.

Applicabilitv to Iowa

Iowa already has consensus revenue estimating though it is for one year. While they were unable to provide specifics, Kentucky indicated that their process required a significant commitment of staff time and resources. The Long Term Poiicy Research Center uses stafffiom the central budget office and several other agen&es of state government as well as private sector persons who provide services under contract. It is expected that there would be a significant cost to implement a process of this scale in Iowa.

F I S C A L M A N A G E M E N T

I N I T I A T I V E

.......................................................................... '

; .. i

P R O G R A M M I S S I O N

The objective of Governor Pad E. Patton's fiscal management initiative is to ensure the long-term financial integrity of Kentucky. The initiative will enhance the coordination among multiyear revenue forecasting, the budget preparation, and the maintenance of an adequate budget reserve trust fund.

A B O U T T H E P R O G R A M

Immediately upon taking office, Governor Patton directed the office for policy and management, the commonwealth's budget agency, to rake the lead in developing a coordinated revenue forecasting, multiyear budgeting, and comprehensive debt management process. The objective is to ensure a srmcrurally balanced budget for the next two bienniums.

Governor Patton used these principles in developing the budget that he introduced to the Kentucky General Assembly in January 1996. This integrated fiscal management program provides the legislature, the Governor's cabinet, and the public with an enhanced long-term under- standing of the commonwealth's fiscal condition. The infbrmation will serve as a nfkence point to d u a r e new fiscal policy initiatives relative to revenue, continuing expenditures, and long-term debt.

The rationale and impetus for this initiative were twelve major budget cutbacks in fourteen fiscal years during the 1980s and 1990s. These cutbacks occurred in part because of economic flucwtions, but they also resulted from tax and expenditure policy changes that were made without consideration of their long-term ramifications. Over time these cut- ba& created structural imbalances that caused concern among credit- rating agencies, disrupted program implementation, and created sub- stantial budget planning problems for both state agencies and state universities.

I

Y

\ STATEOF

_. TERRY E BRANSTAD. GOVERNOR DEPARTMENT O F MANAGEMENT

GRETCHEN TEGELER. DIRECTOR

DATE: Oc%ober 7,1996

TO: Members of the Fisher Commission Budget Practices Workgroup

FROM: Gretchen Tegeler Iowa Department of Management

RE: Information for the October 8th Meeting

Attached please find information for tomorrow’s Budget Practices Workgroup meeting. In addition to a copy of the meeting agenda and a copy of the minutes from the previous meeting on September 25th, you have received copies of two draft documents. The first document is a report that relates to part one of our mission statement dealing with those budgeting practices that promote a multi-year perspective in decision making. The second document provides options for consideration that relate to part two of our mission statement concerning technology funding and decision making. Please take the opportunity to review both of these documents prior to tomorrow’s meeting. Thank you.

_-

If you have any questions or comments please call Dave Meyers at 5 15-281-8833.

STATE CAPITOL BUILDING 1 DES MOINES. IOWA 503 19 / 5 15-28 1-3322

BUDGETING PRACTICES WORKGROUP MEETING Tuesday, October 8, 1996

1:00 p.m. - 5:OO p.m. Iowa Farm Bureau, Main Board Room, 2nd Floor

5400 University Avenue West Des Moines, Iowa 50265

5 15-225-5400

Opening Comments

Technology Issues

Discussion of Draft Report

Final Recommendations

Instructions to Staff

Closing Remarks


Gretchen Tegeler

All

All


BUDGETING PRACTICES WORKGROUP MEETING September 25, 1996

Minutes of the Meeting

Workgroup Members Present: Bill Vernon, Co-Chair; Gretchen Tegeler, Co-Chair; Gerald Bair; Don Byers; Bill McCabe; Steve Odem; Joan Poe; Doug True; Bev Wharton; Ed Wiederstein

Others Present: Glen Dickinson; Dave Fardal; Mike Goedert; Dave Meyers; Patricia Schroeder; Brian Thilges; Charles Whiteman; Doug Wulf

Co-Chairperson Bill Vernon called to order the fourth meeting of the Budgeting Practices Workgroup at 1:00 P.M. on September 25, 1996. The meeting was held in the Main Board Room of the Iowa Farm Bureau in West Des Moines.

Co-Chairperson Gretchen Tegeler opened the Budgeting Practices Workgroup meeting with a brief overview of the meeting agenda and what she hoped the Workgroup could accomplish during the meeting.

Ms. Tegeler introduced Dr. Charles Whiteman, Director, Institute for Economic Research at the University of Iowa. She explained that Dr. Whiteman's presentation would focus on the process and methodology of developing revenue estimates and the impacts of extending them further into the future. _-

Dr. Whiteman gave the Workgroup an overview of how his estimate is determined. H e stated that there are hundreds of economic variables factored into his model and that no individual variable can be used as an accurate guide to predict revenue growth. Dr. Whiteman's model also accounts for the uncertainties of variables including cyclical changes in variables and timing issues related to calendar and fiscal year data. He also pointed out that data used in forecasts is sometimes revised, and in some cases, changed after the fact.

Dr. Whiteman discussed the issues surrounding long range economic forecasts. He stated it is not difficult to produce accurate revenue forecasts into the future, but warned the Workgroup that the longer the outlook, the greater the possibility for inaccuracy in the estimate. Using the 1997 estimate as a starting point to predict 1998 and 1999, Dr. Whiteman predicts little change for this period. He believes existing revenue trends will continue due to a lack of uncertainty in the economic factors. Typically, long range forecasts tend to be more conservative than current year forecasts due to the uncertainty of the data. Mr. Vernon asked what assumptions were used regarding interest rates. Dr. Whiteman stated that he cannot forecast interest rate changes so they are not an important factor in his model. He noted that other states use similar forecasting techniques, but he stressed that. all forecasts are unique due to the differences in variables and the interpretation of the results.

Mr. Vernon questioned why the Revenue Estimating Conference (REC) did not agree with Dr. Whiteman's revenue estimates. Ms. Tegeler pointed out that Dr. Whiteman uses aggregate tax data for his model. The REC on the other hand, uses specific tax receipt data from 20 different taxes; they also factor into their calculations the differing tax collection and tax processing periods. She also reminded the Workgroup that the REC's three members use differing forecasting methods, and must reach a consensus decision. Ms. Tegeler added that Financial World gave Iowa an "Am grade in the Financial Management category which is the category that evaluates the state's revenue forecasts, Finally she noted that there are downsides when revenue estimates are calculated both too high and too low since budget decisions are being made using the forecasting data.

Following a short break, Mr. Vernon refocused the Workgroup on the issue of biennial budgeting. Ms. Tegeler walked the Workgroup through the information provided at previous meetings, and reviewed a handout summarizing the pros and cons of annual and biennial budgeting. She reviewed a handout prepared on Connecticut's experience with their recent change from annual to biennial budgeting. They have generally been pleased with the change, however the time savings in the second year was not as great as anticipated. Ms. Tegeler pointed out that the first year of the biennium would require additional staff time, but the second year would allow more time for other issues such as in-depth program review and analysis.

The Workgroup began a general discussion of the pros and cons of biennial budgeting for Iowa. An issue was raised regarding what expectations the legislature has for biennial budgeting. Ms. Tegeler noted that biennial budgets create a perceived shift in the balance -- of power between the executive and legislative branches. She suggested that a modified biennial budgeting approach might be acceptable to the legislature. By allowing selected agencies to submit t w o year budgets the legislature could evaluate the process and study the off-year activities of the agencies. The legislature could see the results and make further decisions on biennial budgeting. Ms. Tegeler added that two of the top five ranked states do two year budgets.

Ms. Tegeler walked the Workgroup through a review of Financial World's Top 5 best managed states. The primary similarity among these states is their ability to do long-range financial projections, ranging from four to five years into the future.

Ms. Tegeler gave the Workgroup an overview of some preliminary recommendations which was followed by a group discussion. The Workgroup gave broad support to the concept of multi-year revenue estimating and wider dissemination of the information gathered. Ms. Tegeler indicated her desire to maintain the current method the REC uses to predict revenues, and to supplement this data by publishing long-range financial projections supplied by an independent source.

Mr. Vernon brought up the issue of revenue estimation's impact on collective bargaining agreements and whether or not the Workgroup should consider this in their recommendations. Ms. Tegeler suggested, and Mr. Vernon agreed, that due to the complexity of this issue, it would be best to add it to the portion of the final Fisher Commission report entitled "Other Recommendations."

Ms. Tegeler concluded the meeting by asking the Workgroup members to focus their attention on developing final budgeting recommendations. The next meeting will include further discussions on technology budgeting with a proposal on technology budgeting recommendations. A draft of the Workgroup's final report will also be ready for further review. The next meeting is scheduled for Tuesday, October 8th, from 1 :00 to 5:OO P.M. at the Iowa Farm Bureau, Main Board Room in West Des Moines.

I i ’ . i I

I

I

BUDGET PRACTICES WORK GROUP REPORT PART 1: PROMOTING A MULTI-YEAR PERSPECTIVE

Mission

To review, analyze and make recommendations about budgeting practices, including biennial budgeting, that will promote a multi-year perspective in decision making.

I I Summarv of Msior Issues

I

Over the past several years, state finances in Iowa have undergone a remarkable transformation. The condition of the general fbnd on the basis of generally accepted accounting principles (GAAP) has improved from a negative $400 million in fiscal year 1992 to over a $600 million positive balance in fiscal year 1996. At the close of the last fiscal year, reserve funds held 10 percent of the total available revenue, and an additional six percent of the general fund remained unspent.

This financial environment, while significantly improved, brings with it a whole new set of challenges. Among the most important challenges is determining how to sustain the state’s strong financial position into the future. Current conditions, if viewed in isolation (that is, within a single year time horizon), carry with them the risk of making decisions that will not be sustainable into the future. Specifically:

For the first time in many years (since the state began the process of building reserve funds), a surplus balance from the prior year has become a beginning balance in the current year. This carry-over balance is a one-time funding source, and cannot be used to sustain ongoing commitments of similar magnitude. Yet, its existence gives the appearance of significant fiscal capacity. Such a balance must be managed down carefully, requiring a multi-year perspective.

As financial conditions have improved, a number of extraordinary commitments have been enacted that are phasing in over a multi-year time period. Examples include state fbnding for mental health (property tax relief), shifting the finding of the State Highway Patrol from the Road Use Tax Fund to the general fund, and authorization for the construction of several new prisons. Because the full effect of these commitments is not apparent in a single-year horizon, their future impact tends not to be taken into account in budget decision making. Yet, they have the potential for creating significant future difficulties if ignored.

A final issue is directly associated with the annual budgeting cycle. A general fund spending target is established for the single budget year. Over-emphasis on the spending targets can lead to machinations in the budget that understate the true level of spending. For example, items may be funded from reversions of the prior year, or an item may be funded for just a small portion of the fiscal year. These items inevitably reappear in the second year in the form of “built-in” increases. Without a requirement to consider the second year of the budget, such practices go unchecked.

1 I

ISSUE 1: CONSIDERING THE FUTURE

I

Exnlanation of Issue

The condition of the general fund on the basis of generally accepted accounting principles has improved from a negative $400 million balance in fiscal year 1992 to over a $600 million positive balance in fiscal year 1996. While remarkable in itself, this “$1 Billion Turn Around” is only one of the major accomplishments that the State has achieved. Others include:

Implementing major tax reductions; 0

0

Budgeting consistent with generally accepted accounting principles (GAAI?); Creating and maintaining full reserve funds (10%);

Maintaining a significant general fund balance; and Creating the Rebuild Iowa Infrastructure Fund.

While these changes have greatly improved the financial condition of the State, they also carry a risk that decision making which is too focused on a single year will result in an over-commitment of resources, thereby jeopardizing the state’s strong financial condition in the future.

Specifically, for the first time in many years a surplus balance from the prior fiscal year has

source and cannot be used to sustain ongoing commitments of a similar magnitude. This balance must be managed down very carefully and to do so requires a multi-year perspective. The illustration below demonstrates what occurs when a prior year balance is not carefully managed:

become a beginning balance in the current year. This carry-over balance is a one time hnding .-

Revenue Prior Year Balance

What Happens When A Prior Year Balance Is Committed To Ongoing Expenditure?

(Example, $ in Millions)

Year 1 Year 2

4,000 4,200 (5% growth) 3 00 0

Total Available Revenue 4,300 4,200

Spending (473 00) (4,500) (4% growth)

Ending Balance (Deficit) 0 (300)

The presence of a significant number of multi-year budget commitments also creates a risk if decision making is limited to a single budget year. In fiscal year 1998 (the upcoming budget

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year), multi-year fhnding commitments (commitments made in past years that are being phased in) total $247 million. These commitments include such items as K-12 allowable growth, school technology, new prisons, and mental health property tax relief Because the full effect of these commitments is not apparent in a single-year time horizon, the potential that these commitments will create significant future financial difficulties is often ignored. There is a need therefore to have multi-year information available as part of the decision-making process. The illustration below demonstrates what occurs when fbture commitments are not considered in current year decision-making :

What Happens When Future Commitments Are Not Considered In Current Year Decision Making?

(Example, $ in Millions)

- Year 1 Year 2

Revenue 4,000 4,200 (5% growth)

Spending (4,000) (4, 150) (4% growth) Phasing in Prior Year Commitments (250)

Ending Balance (Deficit)

Current Status

Currently in Iowa there is no cohesive mechanism to inform decision-makers of the financial ramifications of long term budget decisions which have already been made or are being considered. No single source documentation is published which lists those financial commitments with multi-year impacts. While long term financial projections are prepared and may be used by both the Executive and the Legislative branches in making critical budget decisions, these projections are not routinely shared nor made public and therefore are not effective in shaping pending budget decisions that have an impact on the State’s fhture financial condition.

An important component of the budgeting process that is critical to the development and use of long term financial projections is the ability to make use of long range economic forecasts. In order to effectively make multi-year budget projections a solid basis must first exist and long range economic forecasts can provide that basis. Iowa currently relies on the University of Iowa Institute for Economic Research to provide economic and revenue forecasts for a two-fiscal-year period (current budget year plus one fhture year). These forecasts are reviewed quarterly by the Iowa Economic Forecasting Council. The Council’s review, along with the forecasting information, is provided to the Revenue Estimating Conference (REC) as background information

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for the REC to use in developing the state’s official revenue estimate. This information is an invaluable resource that provides critical information, baseline data, and assumptions. The track record of Professor Whiteman’s revenue estimating over the past six years has been very good. In the aggregate over this time period, the mean actual error has been less than one percent.

A review of state budgeting practices surrounding the use of long term financial projections has uncovered a wide variance among the states as to how these projections are developed and used. For some states, Iowa included, the projections are done informally and are not widely shared. They are not statutorily required, they are not binding on the budgeting process and there is very

In Iowa, as in most states, the legislature prepares fiscal notes to project the fiscal impact of proposed legislation. These notes play an important role in providing expenditure projections on legislative proposals. Fiscal notes are not required by statute. They are, however, required by joint rules of the House and Senate, if joint rules have been agreed upon. During legislative sessions when there are no joint rules, the Legislative Fiscal Bureau follows tradition and prepares fiscal notes for all legislation with a projected fiscal impact of $50,000 or more. Each fiscal note contains a two year projection of costs if there is an increase or decrease in the second year.

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Research Summarv

National experts agree that long range financial projections are a critical component of sound financial management. Mr. Hal Hovey, editor of the national publication State Budget and Tax News, states that “considering the impacts of spending and tax decisions over a longer period than one year” is a practice that experts agree is one of the key criteria of successhl budgeting practices. Mi-. Ron Snell, Finance Director of the National Council on State Legislatures, states that he sees a trend around the country toward more and more Governors including information about the long term implications of their budgets in the materials presented to the legislature. The information, he suggests, doesn’t have to be elaborate as long as it effectively conveys the information. This finding was also confirmed by Ms. Kathleen Quail, Director, Public Finance Ratings, with the Standard and Poors Corporation, a financial rating agency. Also, Brian Roherty, Executive Director of the National Association of State Budget Officers, states that long range economic forecasts done by “outside experts” can effectively be used as inputs for the projection of state revenues and expenditures.

--

In 1995, Financial World magazine conducted a study that ranked the financial stability of each of the states. In that study Iowa ranked sixth, only behind Utah, Virginia, Missouri, Minnesota, and Maryland. One common practice that the “top five” states use that Iowa does not is the projection of expenditures into the “out years” or those years that are beyond the current budget cycle. Four of the “top five” states make expenditure projections for four years and one state, Utah, makes projections for five years. Currently, Iowa makes projections for only one year

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beyond the budget cycle. Research conducted on those states that do long range projections suggests that the projections do assist in keeping the state’s fbture financial condition in perspective. (See Attachment B.)

One of the questions associated with a state’s ability to support longer-range budget projections is the existence of good forecast information. Charles H. Whiteman of the Institute for Economic Research, showed that projecting out an additional year (beyond the two that he currently projects) would not significantly increase the degree of uncertainty associated with his forecast. Beyond that, the longer-term forecast would tend to converge to a historical average.

With respect to the practice of preparing fiscal notes, the research showed that legislatures around the country routinely prepare fiscal notes to provide expenditure projections on legislative proposals. These fiscal notes detail the projected financial impact of proposed legislation. While this practice is common, the number of years included in the projection and the extent to which this information is shared varies widely from state to state. The state of Utah, for example, which was ranked first in the nation in financial management in 1995 by Financial World magazine, requires a two year projection on every fiscal note prepared. This fiscal note information is widely shared during the decision-making process and has been effective in estimating the collective “out year” impact of legislative proposals.

.- Recommendations

In order to increase the extent to which the state’s fbture financial condition is considered during the budgeting and appropriations process, and to minimize the risk associated with a single-year focus, the following steps are recommended:

1. In addition to the budget year, the Governor should include a four year financial projection of anticipated general fund revenues, expenditures, and annual operating surplus or deficit as part of the budget materials transmitted to the General Assembly.

0 The projections should be for informational purposes only and should not be binding on the budgeting process.

0 The projections should include major assumptions used in developing the projections, the rationale for the assumptions, and all background and data supporting the assumptions.

To the extent possible, the projections should be developed collaboratively with the Legislative Fiscal Bureau.

There should not be a statutory requirement to include the projections, however, the concept of a statutory requirement should be re-evaluated after two years. This would allow time to study and review the accuracy, utility, and impact of the projections prior to implementing any statutory change.

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2. The Department of Management should request the University of Iowa Institute for Economic Research to provide five year economic and revenue projections. These projections should be published as part of the Governor’s budget materials that are presented to the General Assembly.

3. Legislative fiscal notes should continue to be developed collaboratively with the Executive Branch. However, when fiscal notes are prepared by the Legislative Fiscal Bureau, they should include out-year impacts ifthe cost of a legislative proposal is projected to increase or decrease compared with the initial budget year.

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ISSUE2: ACCURATELY STATING THE PRESENT

Exdanation of h u e

A high level of emphasis on the general fund spending target for the budget year in question, and the lack of a requirement to look at the second year of the budget, fosters budgeting practices that understate the true level of spending and create built-in increases for the subsequent year. This emphasis on the short term, rather than the long term, results in the temptation to shift obligations to subsequent fiscal years or to other, one-time sources of funding. Both of these practices represent unsound budgeting practices and therefore jeopardize Iowa’s future financial stability.

._

Current Status

Iowa currently has no requirement to report how current budget decisions will affect years beyond the fiscal year for which budget decisions are being made. In an effort to stay within spending targets, this frequently leads to “off budget” spending practices that are contrary to sound financial management. For example, during the last legislative session the following off budget spending practices occurred:

1. Shifting ongoing general fund spending to other one-time funding sources.

0 Human Services technology ($1 million) 0 Human Services staff($790,0000)

2. Funding items in the wrong fiscal year, i.e., fiscal year 1996 supplemental appropriations for fiscal year 1997 spending.

0 Housing Councils ($1 million)

3. Deliberately underfunding items (planning supplementals).

Human Services provider reimbursements ($6.4 million)

4. Creating future built-in increases (automatic pilot spending).

0 DOT indirect costs ($7.1 million) 0 Funding newly hired judges for one month of the fiscal year

The second year financial implication of budget decisions such as those identified above are not required to be disclosed in Iowa. Therefore, the full future impact of financial commitments are not known at the time budget decisions are made.

Research Summarv

Research conducted by experts involved in governmental policies and finances has revealed that many states are concerned about practices that conceal the true level of spending and create built- in increases in the future. Financial World magazine noted in their article, “State of the States 1995”, that several states’are attempting to avoid or eliminate the use of “quick fix” budgeting practices that do not accurately reflect the true level of spending. Claudia Hutton, Communications Director for the New York State budget office, explained the problem very clearly by stating, “When you rely on nonrecurring revenues, you just mask your problems and exacerbate them. _-

Recommendations

1. Three days prior to the end of the statutory end of the legislative session, and again at the actual close of the session, the General Assembly should publish an itemized list of all spending commitments, including the dollar amount for each of those commitments, that create an “automatic” increase during the subsequent year. This should include such items as:

The annualized amount of any partial year funding.

The amount of any potentially ongoing spending item fhded fiom a onetime spending source, including carry-over funds.

0 The amount of any item of spending for the fiscal year that is appropriated in a prior fiscal year.

0 The amount of any item that in the subsequent year would not be eligible for f’bnding fiom its non general fund source, according to current or newly enacted dehitions.

2. The General Assembly should publish a statement of the estimated financial condition of the year following the budget year, incorporating the list of spending commitments referred to above.

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ISSUE 3: BIENNIAL BUDGETING

Exdanation of Issue

One budgeting practice that offers the potential for enhancing the consideration of fiture financial condition in the budgeting process is the concept of biennial budgeting. An annual budget requires that a new budget be prepared for each fiscal year. A biennial budget, however, covers a two year period and requires that a new budget be prepared every other year. While there are various advantages and disadvantages for each type of budgeting process, there is general agreement that, because more time is available in the off-year, biennial budgeting provides more of an opportunity for long term planning, program review and evaluation.

Current Status

Currently, the State of Iowa has an annual legislative session and budgets on an annual basis. Section 8.22, Code of Iowa, requires the Governor to recommend annual budgets for Executive Branch agencies. State agencies are required, by the Department of Management, to submit budget requests which reflect two fiscal years. The Governor submits two-year budget recommendations to the legislature. This two year budget submission requirement encourages state agencies to consider the long term implications of their request. The legislature, however, appropriates finds for only one fiscal year.

_ _

Research Summarv

According to the National Conference for State Legislatures (NCSL), thirty states have annual legislative sessions and enact annual budgets. Seven states have biennial legislative sessions and enact biennial budgets and thirteen states have annual legislative sessions and enact biennial budgets. (See Attachment C.)

There has been an extensive amount of research conducted surrounding the advantages and disadvantages of annual and biennial budgeting. Listed below is a summary of the signiticant advantages and disadvantages of each

Biennial Budgeting

Advantages:

Allows more opportunity for greater in-depth program review and analysis; Imposes a longer range perspective in budget and fiscal planning;

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0 Alleviates perpetual involvement in the budgeting process by administrative and fiscal enabling more attention to be directed toward planning and evaluation; and

0 Flexibility can be designed into the process, i.e., adjustments to appropriations can be made as necessary during the second year.

Disadvantages:

0 Increased need for mid-term appropriation adjustments; and Spending and revenue forecasts are less reliable because they cover a longer period.

Annual Budgeting

Advantages:

Increased accuracy of revenue and expenditure estimates; Fewer mid-tery appropriation adjustments; and

0 Allows the Governor and the legislature to do a more fiequent review of agency expenditures and requires state agencies to develop tighter administrative controls over the spending of public fbnds.

Disadvantages: _-

0 Less time for program review, planning, and policy analysis; 0 Less time to explore substantive issues and places restrictions on all other activities;

Requires continual involvement in the budgeting process by administrative and fiscal StaBC?, and Results in a narrow viewpoint and encourages short-term fiscal decisions,

Two states have recently changed the way that they budget. Nebraska and Connecticut changed to biennial budgeting because their former system of annual budgeting did not allow enough time to review expenditures in depth. Leaders in the Texas legislature contend that the biennial budget cycle was essential to their reforms. It provided time for the development of long range plans, performance measures, and benchmarks, and for the negotiating among legislators, executive branch officials, and agency staffthat the process required.

Some states, Arizona and Kansas for example, have implemented a modified biennial budgeting approach. Beginning with the 1995 session, the Arizona legislature made biennial appropriations for 88 state agencies and continued to make annual appropriations for only the 14 largest agencies. Those 14 agencies receive more than 95 percent of total appropriations. This reform removed a large number of very small budgets fkom annual reconsideration. The time in the off year is used for program performance evaluation. Agencies are required to develop strategic plans and evaluation criteria and submit them to the legislature. The legislature reviews the strategic plans and conducts a series of program authorization reviews intended to link budgets to

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performance. Arizona’s modified biennial budgeting approach is designed to allow for these improvements while not forsaking the advantages of annual legislative review of the budgets of major state agencies. Kansas also is experimenting with this combination of biennial and annual budgeting on a limited basis.

States that budget biennially routinely establish spending targets for the second year of the biennium. Minnesota, for example, develops expenditure projections that focus on eight to twelve major program areas with simple inflationary adjustments in the out years to the balance of spending areas. Although the out year projections are not binding, they act as spending targets and provide an excellent tool for i d e n w g emerging trends. This then allows planning and decision making to focus on these budget issues. It is also provides a framework in which to view the state’s financial condition in the second year.

Recommendations

Biennial budgeting appears to offer the potential to address many of the budgeting practice issues identified by the work group. In order to test the concept within Iowa, the State should move towards biennial budgeting in the following incremental manner:

0 Budgets for smaller agencies with no history of supplemental finding, relatively stable

on a biennial basis beginning in fiscal year 1998, which will be the First Session of the Seventy-Seventh General Assembly. Success would be monitored, with the eventual goal of all agencies being on a biennial basis by the fiscal year 2002.

fhdmg, and which are most advanced in Budgeting For Results (BFR), should be enacted _-

0 Capital budgeting should be moved to a biennial basis.

0 An overall spending target should be established for the second year of the biennium.

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I ' A t t a c h m n t B

Operating Expenditure Forecasts

I Multi-Year Years Beyond Estimates Estimates Are Projected

I Operating fxpenses

i Expenditure Current Budget Orginated Include

State Forecast Cvcle* in Agencies A// Programs Published Alabama X 1 X ' X B I

Arizona I Arkansas

NP

~ California X X ' X NP I Colorado 6

Connecticut Delaware I Florida

X X

3 5

X X X

PS NP 6' I Ceonria X NP

Hawaii X 4 X X 6 Idaho X 2 X B

I Illinois X 1 X NP 1 Indiana NP I

I Kansas X 3 X B

I

1 Iowa X 1 X X B

I Kentucky

i Louisiana I k i n e X 3 X

X X PS B I * Marvland X' 4 X NP

I Massachusetts X 2 B I Michigan X 1 X X B

Mississippi X X B Missour i X 4 X B Montana Nebraska X 2 X PS Nevada NP New Hampshire X X B

I

' a Minnesota X 4 X X PS

_-

New lersev X 2 X X NP New Mexico NP New York North Carolina North Dakota

X X

2 4

X

, x X X

NP NP B

Ohio X NP Oklahoma X 2 X NP Oregon X 2 PS Pennsylvania X 4 X X X Rhode Island X 4 X B South Carolina X B South Dakota X 3 NP Tennessee X X B Texas X X B

8 Utah X 5 NP Vermont

Washington X X NP West Virginia ' Wisconsin

+ Virginia X 4 X X B

Puerto Rico Nr

Codes: B....Published in the Budget NP .... Not Published

*Refers to the number of years beyond the current budget year or biennium for which estimates are made.

PS .... Published Separately * "Top 5 S t a t e "

Excerpted fram The National Association of Stalk Budget Officers, Budset Processes i n in the States, February 1995

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Attachment C

TABLE 1. ANNUAL, AND BIENNIAL BUDGETING STATES IN 1993 (Boldface indicates the 10 most populous states)

ANNUAL SESSION ANNUAL, SESSION BIENNIAL SESSION ANNUAL BUDGET BIENNIAL BUDGET BIENNIAL BUDGET

(30 states) (13 states) (7 states)

Alabama Connecticut* Arkansas* Alaska Hawaii* Kentucky* Anzona Indiana* Montana*

California Maine* Nevada* Colorado Delaware F I O r i d a Georgia Idaho

Illinois Iowa

KanSaS Louisiana Maryland

Massachusetts Michigan

Mississippi Missouri

New Jersey New Mexico New York Oklahoma

Penns yivania Rhode Island

South Carolina South Dakota

Tennessee Utah

Vermont West Virginia

Minnesota* Nebraska*

New Hampshire* North Carolina*

Ohio* Virginia*

Washington* Wisconsin* Wyoming

North Dakota Oregon Texas*

_-

* Biennia1 budget states that enact two annual budgets at once. Other biennial budgets enact a consoiidated two-year budget.

Esrcerpted f r m "Annual and Biennial Budgeting: The Exper ience of State Governments , by Fonald K. Snell, Fiscal Program Director, National Conference of State Legislatures, August, 1996

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Budget Practices Work Group Options for Consideration - Part 2 (Information Technology)

October 8,1996

Summary of Issues

In 1991, the Governor's Committee on Government Spending Reform (the Fisher Commission) included a task force on information technology (IT), which made a number of recommendations to strengthen the use of technology as a cost containment and service improvement tool in state government.

The key recommendations from this task force have now been implemented, including the development of an "enterprise-wide" (across all agencies) idormation technology plan, and more recently, the administrative consolidation of the state's three data processing centers and other related enterprise IT activities. With an enterprise plan and the restructuring of information technology services in place, the State is now effectively positioned to move into the fbture with the view that information technology is a key asset in state government, rather than a back-room "utility" function. This view reflects the growing recognition of the importance of IT in advancing the overall mission of state government.

While many of the planning and organizational changes have been made to position IT as an asset in state government, funding and budgetary issues have yet to be resolved. Among the issues:

.-

1. There is a lack of an enterprise (statewide, cross-agency) perspective with respect to IT budgeting, both in the executive branch and in the legislative branch of state government. This lack of enterprise perspective can have several consequences:

Priorities are not established from an enterprise point of view. Success or failure of fbnding requests may have more to do with which appropriations sub-committee is involved (and the ease or difficulty with which it is able to meet its budget "target"), rather than return on investment or contribution to statewide priorities.

0 Decisions made independentiy may result in a lack of compatibility or inter- operability with other information technology systems.

0 Opportunities for multi-agency collaborative efforts such as an integrated workforce development information system are more difficult to execute, since "ownership1' is fragmented and no process exists to effectively advance these multi-agency initiatives.

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2. Information technology does not effectively compete in the appropriations process. There are a number of reasons for this:

0 Sometimes a decision may be cast as "computers versus clients," (for example, child care assistance versus PC software upgrades) rather than being understood as a part of the cost of delivering the service.

Internal administrative systems such as financial accounting, budgeting and purchasing are highly dependent on information technology, yet because they are lodged with administrative agencies, they are most subject to "cutting government" initiatives. This occurs despite their wide-ranging impact on all agencies and services.

IT lacks a constituency. Practically speaking, through the political process, the presence or lack of a constituency can have a major impact on budgetary outcomes.

A comparison of state government (a highly information-intensive industry) with Fortune 500 companies of similar size ($4.5 billion - $6.7 billion net revenues) shows that total spending for information technology in state government is about 1.3 percent of annual revenues, whereas in these comparably-sized private sector companies, the percentage averages 2.1 percent. Some of this difference may be attributable to the factors described above.

_-

Current Status

In the executive branch of state government, all IT budget requests are independently developed by each agency. The new IT agency currently has no role in the development or review process. The review by budget office staff does not occur from an enterprise standpoint; it is agency-by-agency. Requests are often presented separately from programmatic requests, so the evaluation may to some degree involve a komputers versus clients" choice. Typically, information is neither requested nor provided concerning return on investment. A review to ensure compatibility with predominant technology architecture does not occur. Few collaborative projects are requested. For fiscal year 1998, about $33 million in new hnding requests have been made for IT projects.

In the legislative branch, most IT hnding recommendations are considered by individual appropriation (budget) sub-committees on an agency-by-agency basis. For example, the Human Services appropriations sub-committee would consider the Governork recommendations for the Department of Human Service's (DHS) IT requests along with all other DHS budget recommendations. There are two information technology-related standing (non-budget) committees that have recently been formed. They are the Technology Committee in the House, and the Communications and Information Policy Committee in the Senate. While standing committees traditionally have no budgetary role,

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these committees have nevertheless been involved in the appropriations process for the Iowa Communications Network (ICN) and could potentially have a role in the fbture with the new IT entity.

Research Summary

Information technology organization and hnding in state government is a work in progress all across the nation. There is no "model" of management and budgeting, nor any obvious continuum of options. The work group members, however, were able to add valuable perspective about how the private sector has approached these issues,

Brian Roherty, Executive Director of the National Association of State Budget Officers (NASBO) was asked for a reference on which state is "most advanced" in terms of how it undertakes budgeting for information technology, compatible with the "IT as an asset" philosophy adopted in Iowa. Mr. Roherty suggested Maine as the best example.

Beginning in fiscal year 1997 (this year), Maine established a coordinated effort to plan, budget and acquire information technology for state agencies. This change in the process was tied to an overhaul of the state's Department of Information Services which now coordinates agency IT planning and acquisition.

Maine's effort began with the Governor setting aside $5 million for information technology acquisition from savings generated by executive branch agencies. (The equivalent amount in Iowa, based on the overall size of the state budget, would be about $12 million.) In order to qualify to receive these funds, state agencies were requested to develop a strategic technology plan. The plans were submitted to the Department of Information Services, which in turn screened them and forwarded them to the Information Technology Plan Review Team. The IT Plan Review Team composition represented a cross-agency commitment of people with IT expertise. The IT Plan Review Team's role was to review all plans and the corresponding budget requests and make final decisions as to which projects received funding and how much was spent.

Other states with a centralized IT review function in the executive branch include Arizona and Indiana. Both have created standardized formats that bring to bear in the decision making process information about return on investment, how the projects support agency business plans, whether opportunities to collaborate with other agencies have been explored, whether statewide standards of compatibility are met, and how well the projects meet statewide priorities. In Arizona, a centralized IT agency performs this fbnction. In Indiana, the review function is carried out by the budget office in collaboration with a Data Processing Oversight Commission.

Private sector members of the work group and several presenters indicated that in their companies, a corporate-wide perspective is accomplished in IT funding by involving key

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managers in a group decision making process. This way, individual agencies are forced to consider their requests within the context of contribution to overall corporate goals.

Recommendations

In order to foster more of an enterprise-wide perspective in IT decision making and to enhance the ability of IT to compete effectively in the appropriations process, the following steps are advanced for consideration by the work group:

1. The role of the new Information Technology Services organization in the budgeting process should be enhanced. The role should vary depending on the extent to which the request is agency-specific or multi-agency:

A "checklist" approach should be used for agency-specific requests, to assure that enterprise-wide standards (for connectivity or inter-operability) are being followed, and that opportunities for joint development with other agencies have been explored. It is important to keep agency-specific projects with the agency budget request, based on the principle that information technology supports the implementation of a business plan and is NOT a separate function. As much as possible, agencies should incorporate IT into programmatic requests rather than isolating them as separate requests.

A prioritization and sometimes advocacy responsibility is appropriate for large multi-agency projects or projects with multi-agency impact. The assembly and presentation of information for these projects is cumbersome, but could be enhanced through the involvement of the IT agency. For example, quantieing the benefits (time savings) of a new financial accounting system would require a coordinated effort involving all state agencies. Similarly, the Year 2000 programnling changes that will be necessary to maintain the operation of state government is a large-scale (potentially $30 million) project that must be undertaken in a coordinated fashion. Because these multi-agency projects are typically high dollar, they are unlikely to all be funded in a given year. Therefore, a prioritization method is critical.

In order to fulfill these responsibilities, the IT agency should be empowered to make necessary information requests from other state agencies.

2. The review and prioritization by the IT organization of large, multi-agency requests should occur in conjunction with an IT Review Team made up of key cabinet level directors and the budget director. The process should be a consultative one, similar to what has been found to be effective in the experience of private sector members of the work group.

3. While agency-specific IT budget recommendations should still proceed through their respective appropriations sub-committees, the General Assembly should consider the creation of a joint appropriations sub-committee for information technology dedicated specifically to the IT agency itself and to larger-scale projects that either involve or affect multiple agencies. These projects will typically result in appropriations to multiple agencies, but the decision making would be occurring in a centralized fashion. The decision making would be informed by the analysis and prioritization done by the Review Team.

4. The Governor and General Assembly should consider the establishment of a dedicated fknding source for the large-scale, multi-agency IT projects. Currently, at the end of each.fisca1 year, 50 percent of their annual operating savings are retained by agencies to carry forward for use in meeting technology or training needs. Similar to the Maine approach, one idea would be to dedicate the other 50 percent of operating savings to an enterprise-wide "Technology Fund." Such an approach would have generated about $3 million this year. Other options should be explored in addition to operating savings.

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1 &dh LA^...BUDGETING PRACTICES WORKGROUP MEETING Wednesday, September 11, 1996 1:00 p.m. - 3:30...

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