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INTERNATIONAL ASSOCIATION OF SCHOOLS AND
INSTITUTES OF ADMINISTRATION
ASSOCIATION INTERNATIONALE DES ECOLES ET
INSTITUTS D’ADMINISTRATION
GT-WG VI
Public Administration:
Challenges of Inequality and Exclusion
Miami (USA), 14-18 September 2003
L’Administration publique
Face aux défis de l’Inégalité et de l’Exclusion
Miami (Etats-Unis), 14-18 Septembre 2003
Fiscal Discipline as a Capacity Measure of
Financial Management by Sub national
Governments
Yilin HOU
Department of Public Administration and Policy
School of Public and International Affairs
University of Georgia
USA
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Author’s Biographical Note
Mr. Yilin Hou holds a master’s and a PhD degree in public
administration from the Maxwell School of Syracuse University, USA and
now teaches at the Rutgers University-Newark, USA. He worked through
the Government Performance Project (1998-2002) first as a research
associate and then as a faculty expert in financial management. His
research interests are public finance and budgeting, and strategic
management.
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Abstract
Public management literature has not adequately covered specific
capacity measures of financial management in subnational governments.
Using data from four national surveys of American state, metropolitan and
county governments conducted by the Government Performance Project
(GPP) at Syracuse University from 1998 to 2001, this paper attempts to
fill in the niche by developing a conceptual framework that builds toward
future subnational financial governance.
Fiscal discipline is defined as the capacity of a government to
maintain smooth financial operation and long-term fiscal health. It
branches
into
(1)
multi-year
perspective
on
budgeting
and
(2)
mechanisms to maintain fiscal health and stability over business cycles.
The measure is a scale ranging from low to high. The paper holds that
strong fiscal discipline builds up financial management capacity which
contributes to sound governance at subnational levels. The paper’s
purpose is to develop a capacity measure of governmental financial
management that can be applied cross-countries.
Key words
Fiscal
discipline;
financial
performance; subnational
government
management;
management
capacity;
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Fiscal Discipline as a Capacity Measure of Financial Management in
Subnational Governments
Raising revenue through taxation and then spending tax dollars for public
goods forms the very basis for the existence and functioning of all
governments. It is no exaggeration to say that no government can last
without public financial management. The significance of public financial
management, however, has so far been only ‘explicitly implied’ —in fact it
has long been taken for granted, for a review of public management
literature would show little published academic mention to it. i
Specific capacity measures of financial management in subnational
governments have in particular been an inadequately covered area in
public management research. Using data from four national surveys of
American state, metropolitan and county governments conducted by the
Government Performance Project (GPP) at Syracuse University from 1998
to 2002, this paper attempts to fill in this niche by developing a
conceptual framework that helps build towards future subnational financial
governance.
This paper defines fiscal discipline as the capacity of a government
to maintain smooth daily financial operation and long-term fiscal health.
Thus defined, fiscal discipline necessarily branches into (1) multi-year
perspective on budgeting and (2) mechanisms to maintain fiscal health
and stability over business cycles. Fiscal discipline covers a wider territory
than conventionally used; as a capacity measure it is an aggregate score
for areas covered, ranging from low, moderate, to strong and high. The
paper holds that strong to high degrees of fiscal discipline build up
financial management capacity which contributes to sound governance at
subnational levels, moderate fiscal discipline may not lead to high
management capacity, and that low fiscal discipline reflects low capacity.
Therefore, to build up its financial management capacity, a government
needs to start with strengthening its fiscal discipline.
Fiscal discipline is designed as a generic framework covering the core
areas of financial management that are essential components of any
financial management system. The paper’s purpose is to develop a
capacity measure of governmental financial management that can be
applied in not only developed but also developing/transitional countries
that adopt different political and economic systems.
The paper is organized as follows. Section one traces different
usages of the term ‘fiscal discipline’ and redefines it for this research. The
next section examines ‘fiscal discipline’ in the context of results from four
national surveys of state, metropolitan and county governments in the
United States under the framework defined in section one. The objective is
to testify whether this framework can capture the management capacity
of subnational governments. Section three refines the framework to a
more visible and specific capacity measure. The last section concludes
with limitations of this paper and suggestions for further research.
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1. Fiscal Discipline Defined
The term ‘fiscal discipline’ in public finance literature has been used
broadly without strict definition by academia as well as by professional
organizations like the Government Finance Officers Association (GFOA),
the National Association of State Budget Officers (NASBO) and the
National Council of State Legislatures (NCSL). Researchers found the term
so broad or vague that they did not care much about it. ii Practitioners,
however, found it a very convenient tool for general reference, so they
simply resort to it at their will. This might have been one of the reasons
why this concept has not drawn proper and adequate attention.
Academic usage of the term has so far been in three related meanings.
The first is by public finance theorist Richard Musgrave to mean mainly
deficit financing of current operations, i.e., a government should cover its
current expenditures only with current revenues. Deficits can bring current
benefits to residents and win political support for officials but add tax
burden on future tax payers. (Musgrave 1959; Musgrave and Musgrave
1989, 101) Inferences are: One, such deficit financing indicates low or
even absence of fiscal discipline; two, fiscal discipline involves not only
elected officials but also voters/tax payers, both of whom pay more
attention to immediately current needs than the future; three, it is up to
professional finance managers (elected or appointed) to correct this
erroneous inclination so as to maintain proper fiscal discipline.
The second usage, by John Mikesell, upholds Musgrave’s point against
deficit financing, ‘restraining expenditures to the limits of available
finance,’ and elaborates on fiscal discipline as part of the budgetary
control process, ‘insuring that enacted budgets are executed, and
preserving the legality of agency expenditures’ in intent and amount.
(Mikesell 1999, 44-45) Obviously, the ‘discipline’ here is intended for
elected as well as appointed officials to abide by the will of the people
expressed through their representatives, the legislators. That is, fiscal
discipline is exercised if government agencies execute the appropriations
bill faithfully by spending approved amounts of money on legislatively
intended items or purposes.
The third usage extends the coverage of fiscal discipline to legislators: The
legislature should act to ‘meet its own deadlines…on resolutions, budget
and appropriation bills.’ (Axelrod 1988, 146) iii Placing the words into their
context, several inferences can be made. To begin with, legislators are
also subject to the restraint of budgetary discipline though as
representatives of voters, they may try pork barreling for their districts.
Then, cooperation among legislators themselves and with the executive
branch is necessary to maintain smooth budgetary processes. If their
representation of the voters’ interests distorts the normal budgetary
procedure, fiscal discipline is discounted.
The interpretations of fiscal discipline from the above three aspects
are in fact complimentary. Together they form a more complete picture:
Fiscal discipline is meant for all players in governmental finance—
legislators, elected officials, civil servants, and citizens as well. If any one
group of these players goes astray, finance managers should uphold their
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professional standards (and ethics) to restore proper discipline. Besides,
fiscal discipline is applicable not only in the budgetary process to limit
current expenditures within currently available means and to guarantee
timely adoption of a reasonable budget to guide governmental operation
in the coming fiscal year, but also in the implementation of approved
budgets so that the fiscal discipline embedded in the budget document is
faithfully executed and line managers do not go against legislated intents.
The above interpretations, however, focus only on the current (upcoming)
fiscal year, which according to more recent research is far from enough.
For smooth financial operations, a multi-year perspective on budgeting is
necessary (Schick 2000), because any focus on the current year falls short
of planning which is an indispensable part of financial management that
has become a trend. It is difficult if not impossible to maintain annual
structural balance between current revenue and current expenditures
without resorting to multi-year financial planning. (Hou 2002a) In fact
multi-year budgeting has become an increasing trend even among
developing and transitional countries. (Boex, Martinet-Vazquez and McNab
2000) The multi-year perspective requires governments to conduct and do
well in two more areas: One is revenue and expenditure estimation for the
coming years; the other is to gauge the future fiscal impacts of all major
management
decisions,
because
all
decisions
carry
financial
consequences. (Brigham 1982, 3)
Furthermore, sound budgetary practices and well-planned budgets must
come with mechanisms devised to maintain fiscal health and stability in
cases of downturns of the economy and unexpected emergencies which
are natural occurrences out of the control of subnational governments. In
the more conventional economic wisdom, the stabilization function
belongs only to the national governments (Musgrave 1959; Oats 1972).
New theoretical exploration claims that subnational governments may play
a role in stabilizing government expenditures during recessions (Gramlich
1987) and recent research provides evidence that counter-cyclical fiscal
devices have been effective in this regard at the state level in the United
States (Hou 2001a and b). Such devices include general fund surpluses
and budget stabilization funds.
Fiscal health and stability is not complete without sound mechanisms for
debt management. Debts are necessary in infrastructure construction to
form an adequate flow of resources (current year revenues are not
enough) and to achieve inter-generational equity (the facilities benefit
future residents longer than current tax payers). But since current
residents enjoy full benefits from the facilities while paying only a fraction
of the costs for each year of their residence, they may demand more such
construction and their political representatives may simply follow the
voters’ will. Thus, mechanisms that restrict the amount, type, and
maturity of debts are necessary for long-term fiscal health and stability,
so that financial operation in the coming years will not be strained of
resources by too large a debt service burden.
Thus defined, fiscal discipline is a broader concept than used in the past.
It branches into (1) multi-year perspective on budgeting and (2)
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mechanisms to maintain fiscal health and stability over business cycles.
The two branches cover three stages of the governmental finance process:
(a) Medium- to long-term planning—revenue and expenditure estimation,
gauging fiscal impacts of major management decisions, and debt
management; (b) budget compilation and adoption—structural balance
between current revenues and current expenditures, and adoption of
budget prior to start of fiscal year; (c) budget execution/financial
operation—achieving structural balance, and maintaining built-in countercyclical devices.
--Insert Figure of Fiscal Discipline about here—
Such a concept of fiscal discipline grasps the core of governmental
financial operations. Applied well, it builds up financial management
capacity that leads to sound governance at subnational levels.
2. Fiscal Discipline in US State and Local Governments
To illustrate how the framework of fiscal discipline works in
subnational governments, let’s take as example the financial management
in US state and local governments. From 1997 to 2002 the Pew Charitable
Trusts (Philadelphia, USA) funded a nationwide comprehensive study of
the federal, state, metropolitan and county governments—the
Government Performance Project (GPP). The GPP surveyed selected
federal agencies, all 50 state governments, 35 metropolitan cities and 40
counties. The cities and counties sampled were the largest ones by
government revenue. They are distributed all over the country. (For a list,
see appendix 1.)
The GPP surveys focused on the management capacity of
governments instead of merely current performance because it is the
management capacity that counts for performance. The GPP survey
instrument was divided into five management areas: financial
management, capital management, human resources management,
information technology management, and managing for results. Data used
in the following analyses were taken from the financial management
section of the surveys, 1998 and 2000 for the 50 states, 1999 for the 35
metropolitans, and 2001 for the 40 counties.
2.1 Multi-Year Perspective on Budgeting
Timely Budget Adoption
Budgets are a financial plan and a guide for governments (Schick
1966). As such, adoption of budgets before the start of each fiscal year is
a necessary condition for smooth operation. However, the budgeting
process is highly politicized, involving multi-players and the coordination
(even bargaining and compromises) between the executive and legislative
branches. In this sense, whether a government can get its budget passed
in a timely fashion for the new fiscal year is an indication of its operating
environment.
At the state level, budget adoption prior to start of fiscal year is not
a big problem. Eighty-eight percent of states (44) adopted budgets in time
for fiscal year 1999. The case with the big cities is similar—among the 83
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percent of the 35 cities (29) that responded to this question, 90 percent
(26) adopted the budget for fiscal year 2000 before start of the year. iv At
the county level, the rate of timely budget adoption (approval by the
Council before start of the county’s fiscal year) is lower than at the state
and city levels. From fiscal year 1997 to 2001, it was between 69 and 80
percent in a sample of thirty-five counties. v
It is difficult to offer an even remotely ‘educated’ guess as to the
attributes to the different timely adoption rates at the three levels.
Though local politics may be a factor that had contributed to late adoption
of the counties’ budgets, state politics is by no means any easier (many
scholars would claim it is much messier). If we speculate that multiintergovernmental revenues (from the federal and state governments) for
counties may complicate the process, the cities had faced the same
situation. A possible clue may be that local governments are subject to
legal restrictions imposed by states, vi as the case is with New Jersey
municipalities, vii but wouldn’t cities have encountered the same dilemma
if counties had? No doubt, this is an area that cries for further research.
But on the whole, relatively high rate of timely budget adoption is
common among high performing governments.
Budget Reflects Structural Balance Between Revenues and Expenditures
Balancing the annual budget is a very strong legal requirement at
the state and local levels. It is also of much significance in terms of fiscal
discipline. However, balancing the budget is easier said than done. With
such strong legal restrictions and high public scrutiny, many governments
still cannot hit this target. (Hou 2002a)
At the state level, a combined 72 percent (36 states) can balance,
out of which 38 percent (19) can balance their current revenue for current
expenditures, and 34 percent (17) balance their budget using carryforward balances from the last fiscal year, which is a normal practice,
especially for years of downturns.
For the three fiscal years from 1996 through 1998, the 35 cities on
average balanced their revenues against expenditures in both the general
fund and the total operating fund, with a small positive margin for the
former (average 1.57 percent and median 0.88 percent) and the margin is
a little bit larger for the total operating fund (average 2.39 percent and
median 1.81 percent).
The counties on the whole came out with larger general fund
surpluses than the cities. So balancing the budget is no problem for these
local governments. The counties’ fiscal discipline is shown in the fact that
when their general fund has a surplus, only 23 percent (8 counties) put
the surpluses back into the general fund for the next year; instead, 77
percent (27 counties) use the surpluses for capital expenditure, reducing
debt or unfunded pension liability or increasing their reserves. Though
also common at the state and city levels, such practices are much more
salient at the county level.
Among these practices, using part of the general fund (or general
fund surpluses) to partially fund capital investment that conventionally is
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done solely through debt financing is a relatively more recent revival of an
old tradition. viii This way of financing infrastructure is ‘against’ the widely
accepted theoretical principle of inter-generational equity, but it is a way
to reduce future debt burdens with current extra resources, with many
advantages—possibly higher credit rating from the financial market and
thereby lower interest costs on debt issues, higher confidence among the
residents and thus higher attractiveness to businesses and investors,
shorter cycle of construction thus earlier receipt of benefits from the
projects, to name just a few. During times of economic booms as the midand late 1990s in the United States, this is a technically wise and
politically courageous endeavor.
Revenue and Expenditure Estimation ix
Adopting budgets in time and maintaining structural balance both
need quality information—estimates—about the amount of revenues and
expenditures for the coming years. Accurate estimates do not come easily.
They are built by well trained, experienced professionals using advanced
computing equipment working on data collected from many aspects of the
society accumulated over time. It is a resource-intensive enterprise. Every
percentage point increase of the accuracy is achieved with millions of
investment. Expensive as it is, it is essential because it contributes
substantively to sound financial management.
Eighty-four percent of states (42) conduct future budget projections
that are equal to or longer than two years. And 84 percent (42) update
the estimates for the current year twice or more. Figures in Table 1 are
calculated by subtracting the actual from the estimated amount then
divided by the estimate. Positive ratios for revenue indicate actual
revenue is larger than estimates (underestimation of revenue); negative
ones mean the actual revenue is smaller than estimates. Negative ratios
for expenditure indicate an actual expenditure that is smaller than
estimated (overestimation of expenditure) and positive ones mean the
actual expenditure exceeds. Smaller absolute values indicate higher
accuracy (smaller error) rates.
From Table 1 ‘state estimation accuracy’ we can make the following
inferences. First, the four-year (fiscal years 1996 through 1999), 50-state
average accuracy for both revenue and expenditure of the general fund
and total operating fund is fairly high, all better than the five percent
benchmark. Second, most of average and median rates for revenue are
positive and those for expenditure are negative. These consistently
different accuracy rates for revenue and expenditure estimates pinpoint
the widely adopted practice of ‘fiscal conservatism’ or ‘protective’
estimates,
i.e.,
underestimating
revenues
and
overestimating
expenditures so that annual financial operations would end in positive
balances (surpluses).
Besides, the error rate of general fund revenue is higher than that of
total operating fund revenue, indicating that the conservatism in revenue
estimation is more clustered in general fund than total operating fund. On
the other hand, the error rate of general fund expenditure is smaller than
that of total operating expenditure, implying that the total expenditure
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had been more over-estimated. Finally, the absolute value of the average
in both revenue and expenditure estimates is consistently larger than that
of the median, meaning that revenue estimation is positively skewed and
expenditure estimation is negatively skewed. That is to say, some states
exercised extreme fiscal conservatism. x
--Insert Table 1 about here—
The 35 large cities are more accurate than the states with their
estimates: The error rates of revenue estimation range from 2.8 to 3.4
percent and the error rates of expenditure estimation flows only between
negative 0.2 percent and 1.4 percent. Both ranges are much smaller than
the five-percent benchmark. Such high accuracy leaves little room for
intended fiscal conservatism. The 2.8 to 3.4 percent of revenue estimates
may be by intention but not large in comparison with those of the states,
for that small margin is barely enough for working capital needs.
The positive sign on expenditure figures is more puzzling: It implies
that the cities spent more than they planned, but that is against intuition
and literature. xi Perhaps we can speculate that the cities are a little bit
‘conservative’ with revenue estimates but not with expenditure estimates.
Finally, unlike the states, the cities do not present much difference
between the estimates for their general fund and total operating fund.
--Insert Table 2 about here—
The percentage of counties that conduct and update their revenue
and expenditure estimates exceeds that for the states and cities. Ninetyfive percent (38) of the counties estimate at least for the coming year and
one year into the future, with nearly 90 percent (35) forecast two years
into the future. Besides, ninety percent update their estimates within the
fiscal year: Ten percent (4) update estimates semi-annually and 80
percent (32) update at least quarterly. Among this combined 90 percent,
half formally adopt the updated estimates.
The accuracy of county estimation of their revenues and
expenditures, however, displays features different from those of the
states. First, estimation accuracy of the general fund revenue is much
higher (error rate lower) than the states: the annual all-county averages
as well as the four-year all-county averages fall below 2 percent, in the
excellent range. This ‘excellent’ accuracy, however, is difficult to interpret
as to its causes. A detailed discussion is beyond the scope here. xii On the
other hand, the error rate of general fund expenditure estimation, both
annual and four-year averages, goes above the 5 percent benchmark. This
is not surprising considering the limited amount of expertise and resources
available at the county level for this purpose.
Second, when we take into account the practice of ‘fiscal
conservatism’ in estimation, it is clear that one, revenue estimation leaves
little room for this conservatism; and two, the off-the-mark accuracy of
expenditure estimation is on the negative side only, i.e., it is the major
means of the ‘protective’ device. Thus, the higher error rate is perhaps no
longer an ‘error’ any more. It is intended. Third, in both revenue and
expenditure estimation, the averages are lower than the median, i.e. the
distribution of the statistics is negatively skewed. For revenue, this
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indicates more cases of actual revenue lower than expected amounts; for
expenditure, however, more counties spend less than they plan, saving a
larger margin for unexpected incidents. Therefore, these county
governments rely on the differential of estimated and actual expenditures
to accumulate positive year-end surpluses as a fiscal ‘self-protective’
device. This is something not mentioned in previous literature.
--Insert Table 3 about here—
Gauging Future Fiscal Impact of Financial Decisions
All management decisions bring financial impacts. (Brigham 1982,
3) Assessing the major decisions and preparing for their possible financial
consequences is essential for higher estimation accuracy, smooth
budgeting procedures. It is also a necessary step towards a multi-year
perspective on budgeting. Like revenue and expenditure estimation, this is
also a manpower-intensive activity; unlike making financial estimation
that is done a few times a year, this is an on-going activity to track all
important management decisions. To smaller governments, the strain on
personnel might be too much.
Almost all states assess impacts of state legislations. The methods
used are mainly two: fiscal notes (90 percent, 45 states) and other
methods (30 percent, 13 states, overlapping). The length of assessment
extends to more than one year in 96 percent (48) of the states. The
percentage of states that assess impacts of federal legislations drops to 70
(35 states) only. Eighty-eight percent (44) assess out-year impacts on
pensions but only 54 percent (27) assess impacts on vacations (a
combined 50 percent [25 states] assess both pension and vacations). Of
these, about 80 percent are done on an annual basis, i.e., very few states
do it more than once a year.
The assessment rate lowers a lot at the local levels. Only 20 cities
out of the 35 (57 percent) have a formalized process for assessing the
impacts of all local legislations. xiii Of these cities, ten (29 percent)
formally assess all potential legislations of the city and seven assess
legislations when they are passed. At the county level, only about half
assess local legislations; the percentage is even lower that assess pension
and accrued vacation liabilities.
Summary of Findings
The rate of timely budget adoption is highest with the states, then
goes down to cities and is the lowest with counties. On maintaining the
structural balance between revenues and expenditures, however, counties
and cities do better than states. Counties allocate their surpluses for onetime expenditures and pay-as-you-go financing of capital investments.
On the whole, all surveyed governments achieved high accuracy
rate on revenue and expenditure estimation. I prefer to interpret their
high accuracy rates in terms of fiscal conservatism. For states, the
conservatism is more displayed in general fund on revenue estimates and
in total operating fund on expenditure estimates. Some states even go to
extremes along this ‘self-protective’ line. The 35 cities achieved higher
accuracy rates than states, leaving little room for fiscal conservatism
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which in relative terms is more obvious in revenue than expenditure
estimation. The counties’ accuracy rate on revenue estimation also
surpassed that of states. Their error rate on expenditure forecasts,
however, is higher. Such ‘errors’ are the location of the counties fiscal
conservatism.
Although almost all states assess the financial impacts of state
legislations, only 70 percent of them assess federal legislations. The rate
of assessing legislations drops to 60 percent for the cities and 50 percent
for the counties. This fact indicates that the surveyed governments still
have lot of work to do towards fully embracing the multi-year perspective
on budgeting.
2.2 Mechanisms for Fiscal Health and Stability
As defined in Section One, counter-cyclical fiscal devices are necessary
reserves to maintain service levels when revenue shortfall occurs and
good debt management policies can guard against disproportionate debt
burdens on future financial operations. Here we examine these two areas.
Maintaining fiscal stability used to be taken as a federal function that
subnational governments have no to play with (Musgrave 1959; Oats
1972). Theorists have forwarded contrasting propositions. Edward
Gramlich for example believes that state and even local governments may
have a role to play. (1987) Afterwards, researchers have come up with
empirical evidence at the state and large city levels (Pollock and
Suyderhood 1986; Sobel and Holcombe 1996; Wolkoff 1987; Wagner
1999). More recently, Hou (2002a) has provided evidence that
subnational counter-cyclical fiscal policy exists and was effective at the
state level in the past 20 years. Besides, debt management and
investment management are vital areas for fiscal health at both state and
local levels.
Counter-Cyclical Fiscal Devices
Though governments can have quite a few counter-cyclical fiscal
devices in times of need, the two major ones are general fund surpluses
and the budget stabilization fund. The former has historically been of such
use while the latter became widespread only since the 1980s.
Budget Stabilization Fund (BSF) xiv
By the end of 1999, ninety percent of states (45) had had a
legislation enabling a budget stabilization fund. The percentage might be
higher if we consider the facts that Alabama was considering one, pending
on legislative action and Illinois’s legislature had passed one, pending on
governor’s signature. xv
The percentage is much lower at the city and county levels. Only 17
cities (49 percent) report having a budget stabilization fund. Among the
40 counties, the percentage is a mere 40 percent (16) and among these,
only six (15 percent) are legally required BSFs, i.e., with enabling
legislations, with another eight (20 percent) having a general fund balance
requirement.
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What has caused the delay of BSF legislation at the city and county
levels is beyond our knowledge with currently available data. It is a mere
guess that perhaps the local governments are going through a similar
exploration process as states did before the 1980s. The current recession
may become a trigger for governments of large cities and counties to
adopt the BSF, as the case with the states.
The states seem to have a fairly high BSF balance. Take fiscal year
1999 for example, the average BSF balance against general fund
expenditure is 4.84 percent (median 3.26 percent). About 54 percent of
states maintained a BSF balance ranging from 4 to 9 percent; another 18
percent of states had balances between 2 and 4 percent. xvi The cities
maintain a much lower BSF balance: The balance of about 20 percent of
cities was below 2 percent of general fund expenditure, 20 percent
between 2 and 6 percent, none had a balance between 6 and 10 percent.
The counties’ BSF balances do not form a comparison due to its small
sample.
General Fund Surplus (GFS)
General fund surplus is here defined as the unreserved undesignated
balance of the general fund at the end of fiscal year. xvii This surplus can
be used to cover any unexpected expenses and as working capital. A
review of the GFS of the state, city and county governments reveals
different patterns at these levels. The following table provides summary
statistics of GFS as a percent of general fund expenditure. xviii
--Insert Table 4 about here—
An examination of the summary statistics reveals that for both the
annual and three-year average of the average and median GFS, the states
rank the lowest, the cities higher than the states, and the counties the
highest. For the minimum and maximum balances (marked as ‘low’ and
‘high’ in the table, respectively), the states are again the lowest, the cities
higher than the states, and the counties the highest. This order goes in
exact contrast to the adoption of the budget stabilization fund at the three
levels.
From the above data, a preliminary conclusion seems to be that the
states rely mostly on BSF as a counter-cyclical fiscal device for selfprotection against revenue downfalls. The counties depend almost solely
on general fund surplus as a fiscal reserve for protection. The cities
present the middle case—with fairly wide adoption of the budget
stabilization fund, they maintain some BSF and also a relatively large
amount of general fund surplus as reserves.
The question then is: Why do the states and counties consult to
different devices? A probable reason, when we take into account the
politics of spending, is that at the state level, legislators often employ pork
barreling to favor their electorates, thus forming the spending pressure
that goes against fiscal reserves during good years. On the other hand,
tax payers tend, since the late 1970s’ tax revolt movement, to restrict the
taxing power of state governments, which is in a sense far away from
their direct provider of vital services, thus forming the political pressure
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that fights against taxation for refunds during booms. The cities again
present the middle case.
The following table presents the distribution of general fund surplus
in various ranges, from deficit to over 20 percent of general fund
expenditure. This distribution makes clearer the difference between the
three levels of government:
--Insert Table 5 about here—
The first striking difference is the percentage in general fund
deficits: 22 percent of states in contrast to six percent of cities and merely
three percent of counties. In contrast, only four percent of states and six
percent of cities but 21 percent of counties fall in the category of very
large surpluses (over 20 percent). The cities stand out in the middle
ranges: They make up a higher percentage in the 5-10 percent and 10-20
percent ranges than the states or the counties.
How should we interpret these results? Obviously, there is not just
one perfect policy that fits all levels of government. Different devices
better serve different levels. Thus, in assessing the performance of the
state, city and county governments, we must apply appropriate measures.
2.3 Lessons from the American Case
The example from American state and local governments illustrates the
actual use of fiscal discipline in several aspects. First, fiscal discipline as
defined in this paper is easily traceable in the daily operation of
subnational governments, with its branched areas covering the core of
financial management. Second, though the concept of fiscal discipline
applies well to all subnational levels, each level of government, with a
different management environment from other levels, may deserve
different assessment standards in some of the areas.
3. Fiscal Discipline as a Capacity Measure
Fiscal discipline as defined in this paper and illustrated in the previous
section serves well as a measure of financial management capacity in
subnational governments. Take for example the 40 American counties
from the GPP survey, in which we first calculate a score for each of the
areas covered under this term, then sum up the area scores for a fiscal
discipline score (Table 6, Column 2). There exists a high correlation
between the fiscal discipline score and the total calculated score of
financial management (0.93), because fiscal discipline really covers the
core of financial operations. The correlation between the fiscal discipline
score and the final grade of financial management remains high (0.70).
The final grade for financial management differs from the calculated score
in that the latter takes data only from the survey response and published
documents, i.e. source of hard data, whereas the final grade considers
factors from sources other than hard data are considered. xix Surprisingly,
even the correlation between fiscal discipline and the final overall grade
(of all five sections) is considerable (0.59). What this tells us is that fiscal
discipline is not only a good capacity measure of financial management
but potentially an indicator of the overall management capacity.
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--Insert Tables 6 and 7 about here—
As shown in Section 2, for each of the specific management areas covered
under the concept of fiscal discipline, assessment standards may vary for
different levels of government. A typical example is the accuracy of
revenue and expenditure estimates: Governments at a higher level like
the states in the US have more resources and expertise in financial
management and therefore can achieve higher estimation accuracy. City
and county governments, on the other hand, do not have as much
expertise on forecasting nor as much resources to invest into estimation
activities. Therefore, the results of assessment would be distorted if the
same accuracy rate is taken as the benchmark. xx
Besides, different tools may better fit different levels. The counter-cyclical
devices are an example. While the budget stabilization fund has been the
choice of most US state governments, more of the city and county
governments in the GPP surveys prefer general fund surpluses. In this
case, overemphasizing the importance of the budget stabilization fund and
discounting general fund surpluses would downgrade the capacity of the
city and county governments.
Therefore, in using fiscal discipline as a capacity measure to assess
the management capacity and actual performance of subnational
governments, weights should and can be adjusted for different levels of
government and for specific management areas. As long as the
adjustments are systematically applied, the assessment results should be
consistent and fair. Take again the example of the US counties. Had
another set of weights been used in calculating the aggregate score of
fiscal discipline, the results would have been consistent in relation to the
total score. (See Table 6)
Thus, scores from management areas sum to a final measure of fiscal
discipline (Column 2 of Table 6) that is a scale ranging from 0 to a high
number, which can be characterized into classes of low, moderate, strong
and high (or more classes as necessary and fit). The dividing lines
between every two neighboring classes vary from case to case, depending
on the sample size. This paper holds that strong to high fiscal discipline
builds up financial management capacity which contributes to sound
governance at subnational levels. Moderate fiscal discipline is barely
adequatem while low or poor fiscal discipline reflects poor management
capacity. Thus, any government needs to first improve its fiscal discipline
if it wants to improve its financial management capacity. In this sense,
fiscal discipline is an essential component of good governance.
Since fiscal discipline as defined here covers the core areas of
financial management, its variation from country to country should not be
very large despite the differences in the political system adopted in
countries around the world. In this sense, fiscal discipline is a good
candidate as a capacity measure of governmental financial management
that can be applied worldwide.
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4. Concluding Remarks
The purpose of this paper is to fill in a niche in public management
literature by developing a capacity measure of governmental financial
management by subnational governments. The measure chosen is fiscal
discipline that is based on the conventional usages of the term but
broadened to cover the core areas of financial management—not only
timely adoption of budget, structural balance between current revenue
and current expenditures, but also accurate estimation of revenue and
expenditure, gauging fiscal impacts of major management decisions, as
well as mechanisms to maintain long-term fiscal health and stability. An
aggregate score of fiscal discipline can be obtained by adding together
scores for all areas covered under this concept according to a set of
weights.
Data from four national surveys by the Government Performance Project
of state, metropolitan and county governments in the United States
illustrate that fiscal discipline thus defined cover the major areas, and that
a high correlation exists between the aggregate score of fiscal discipline
and the total score of financial management, the final grade for financial
management that considers more of broad management issues, and even
the average final overall grade of all five subsystems of governmental
management.
This concept and usage of fiscal discipline is intended to be a capacity
measure that can be applied to different countries; however, what this
paper has done is only one step. Application of the measure into other
countries is to be done and further details in application are to be
explored.
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www.iiasiisa.be
Table 1: Accuracy of State Estimates of Revenues and Expenditures
(Federal funds included)
1996
4.20%
1.14%
1997
3.83%
2.77%
1998
1999
4.75%
3.07%
3.41%
1.60%
-8.10% -7.62% 12.61% 12.39%
65.63% 67.68% 64.95% 65.67%
4-yr
Avg
50
states
3.59%
2.49%
11.03%
65.70%
1.75%
1.90%
11.43%
29.46%
-2.03%
-1.35%
23.02%
14.50%
3.35%
1.02%
15.73%
77.64%
-1.27%
-0.97%
28.38%
26.30%
1.64%
0.97%
12.91%
41.73%
-1.33%
-0.47%
29.14%
13.42%
2.79%
0.83%
10.20%
47.23%
-1.67%
-1.17%
27.25%
16.62%
-4.12% -2.63% -3.56% -4.33%
-2.05% -1.58% -2.61% -1.64%
41.89% 43.27% 43.90% 40.80%
Low
High
26.40% 29.31% 32.70% 15.58%
Revenue estimation accuracy = (actual revenue - estimated
revenue)/estimated revenue
Expenditure estimation accuracy = (actual expenditure - estimated
expenditure)/estimated expenditure
-3.60%
-2.20%
42.23%
24.22%
Item
General fund
Revenue
Fiscal Year
Average
Median
Low
High
Total
operating
fund revenue
Average
Median
General fund
expenditure
Low
High
Average
Median
Low
High
Total
operating
fund exp’dture
Average
Median
3.94%
1.04%
12.77%
80.24%
-2.09%
-1.52%
28.61%
15.35%
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Table 2: Accuracy of City Estimates of Revenue and Expenditure
(Federal and state funds included)
-1.48%
7.20%
1998
1999
2.63%
3.77%
2.81%
5.98%
38.79% -7.19%
19.41% 9.33%
4 yr
Avg
35
cities
2.87%
3.13%
12.83%
12.82%
Average 3.33%
1.97%
5.07%
3.34%
Median
2.71%
Low
10.87%
High
20.20%
Average 0.54%
Median
0.38%
Low
13.99%
High
14.61%
3.05%
3.33%
3.97%
20.25% 12.18% 14.84%
12.27% 25.79% 18.65%
0.24%
0.17%
0.77%
0.02%
-0.09% -1.00%
-3.65%
5.86%
-5.93%
6.24%
Average 1.89%
Median
2.07%
Low
20.43%
High
23.49%
2.31%
0.56%
1.96%
-0.83%
0.73%
1.85%
12.81% 30.12%
25.81% 15.76%
Category
General Fund
Revenue
Total
Operating
Fund
Revenue
General Fund
Expenditure
Total
Operating
Fund
Expenditure
1996
Average 2.75%
Median
2.15%
1997
2.32%
1.57%
Low
High
-3.87%
15.35%
-7.14%
23.12%
2.99%
3.26%
14.53%
19.23%
0.43%
-0.17%
-5.98% -7.38%
11.85% 9.64%
1.33%
1.30%
17.62%
22.05%
Able 3: Accuracy of County Estimates of Revenue and
Expenditure
(Federal and state funds included)
1996
1997
1998
1999
-0.65%
0.39%
0.22%
1.35%
0.46%
1.63%
1.13%
1.71%
Revenue
Low
28.46% 26.26% 26.78% 12.09%
High
11.17%
9.64%
9.44% 11.97%
General
Average -6.52% -7.78% -7.22% -6.76%
Fund
Median
-4.62% -6.93% -4.96% -5.19%
Expenditure Low
32.61% 31.71% 31.50% 24.24%
High
6.07%
7.04% 16.35%
3.48%
1. Data taken from county Comprehensive Annual
Notes: Financial Reports.
2. Accuracy = (actual expenditure – estimated
exp)/estimated expenditure
General
Fund
Average
Median
4-Yr
Avg
0.33%
1.23%
23.40%
10.55%
-7.07%
-5.42%
30.02%
8.23%
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Table 4: General Fund Surplus as a Percent of General
Fund Expenditure
96-98
1996
1997
1998
Avg
States
Average
2.33%
2.57%
4.23%
3.04%
(50)
Median
2.61%
2.64%
3.58%
2.94%
Low 55.74% 56.55% 69.58% -60.62%
High 25.10% 23.85% 26.52%
25.15%
Cities
Average
7.00%
6.81%
8.28%
7.36%
(35)
Median
5.19%
4.84%
7.12%
5.72%
Low 11.03% -8.17%
0.00%
-6.40%
High 28.87% 28.16% 29.27%
28.77%
Counties Average 10.82% 11.56% 13.41%
11.93%
(39)
Median
5.89%
6.78%
8.08%
6.92%
Low -1.23%
0.00% -5.35%
-2.19%
High 48.19% 55.02% 49.74%
50.98%
1. Data are taken from Comprehensive Annual
Notes: Financial Reports of these governments.
2. Figures are actual amounts at the end of each
fiscal year.
3. Positive figures represent general fund surplus
and negative ones denote general fund deficit.
Table 5: Distribution of 1996-1998 Average General Fund
Surpluses
States (50)
Cities (35)
Counties (39)
Number Percent Number Percent Number Percent
Deficit
11
22%
2
6%
1
3%
0 -- 2%
10
20%
8
23%
7
18%
2 -- 5%
10
20%
5
14%
8
21%
5 -- 7%
2
4%
4
11%
5
13%
7 -10%
6
12%
6
17%
3
8%
10 -15%
4
8%
6
17%
5
13%
15 -20%
5
10%
2
6%
2
5%
> 20 %
2
4%
2
6%
8
21%
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Table 6: Fiscal Discipline Score for GPP County Assessment
(2001)
Fiscal
Calculated
Final
Final
Discipline
FM
Full 56
Full 100
FM
Overall
Alameda
28.74
57.94
7
7
Allegheny
29.54
51.98
5
4
Anne Arundel
33.01
51.69
7
6
Baltimore
41.88
73.43
11
10
Broward
38.07
67.00
10
8
Clark
41.12
70.03
10
7
Contra Costa
34.41
64.47
8
8
Cook
13.51
23.64
8
7
Cuyahoga
35.36
69.35
9
6
Dallas
32.75
67.20
10
9
Erie
14.24
30.66
8
7
Fairfax
48.37
80.61
11
11
Franklin
36.27
66.12
9
9
Fulton
38.40
67.51
8
6
Hamilton
38.16
73.98
9
9
Harris
36.62
59.01
8
7
Hennepin
41.68
75.28
10
9
Hillsborough
43.25
74.57
9
6
King
34.56
66.10
8
6
Los Angeles
32.25
65.82
8
6
Maricopa
45.56
76.73
11
11
Mecklenburg
30.46
53.85
8
9
Miami-Dade
26.74
60.47
8
7
Milwaukee
29.26
59.40
7
8
Monroe
34.52
60.11
6
6
Montgomery
48.20
78.64
10
9
Nassau
13.30
26.23
1
3
Oakland
35.90
62.54
9
9
Orange
35.98
68.08
9
9
Palm Beach
28.76
62.45
9
7
Prince Georges
41.40
73.14
10
8
Riverside
29.66
54.36
8
7
Sacremento
33.38
58.23
8
7
San
Bernandino
24.83
35.34
6
5
San Diego
40.25
70.85
11
10
Santa Clara
32.27
65.54
9
7
Shelby
39.89
66.45
9
9
Suffolk
29.21
47.26
8
5
Wayne
38.57
70.12
8
8
Westchester
37.41
61.36
9
7
1. The score for fiscal discipline is the sum of the scores for items
defined in this paper, totaling 56.
2. Calculated financial management score is the total score of each
county out of 100.
3. The final financial management score and the final overall score are
converted from the published grades, ranging from A down to F. A is
equal to 12 and F is 1.
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Table 7: Correlation Between Fiscal
Discipline and
Maxwell FM
Final FM
Final Overall
0.93
0.70
0.59
Appendix
A. List of the 35 metropolitans covered in the GPP 1999 City Survey
Anchorage
Atlanta
Austin
Baltimore
Boston
Buffalo
Chicago
Cleveland
Columbus
Dallas
Denver
Detroit
Honolulu
Houston
Indianapolis
Jacksonville
Kansas City
Long Beach
Los Angeles
Memphis
Milwaukee
Minneapolis
Nashville
New Orleans
New York City
Philadelphia
Phoenix
Richmond
San Antonio
San Diego
San Francisco
San Jose
Seattle
Virginia Beach
Washington
B. List of the 40 counties covered in the GPP 2001 County Survey
Alameda, CA
Allegheny, PA
Anne Arundel, MD
Erie, NY
Fairfax, VA
Franklin, OH
Maricopa, AZ
Mecklenburg, NC
Miami-Dade, FL
Baltimore, MD
Broward, FL
Clark, NV
Contra Costa, CA
Cook, IL
Cuyahoga, OH
Dallas, TX
Fulton, GA
Hamilton, OH
Harris, TX
Hennepin, MN
Hillsborough, FL
King, WA
Los Angeles, CA
Milwaukee, WI
Monroe, NY
Montgomery, AL
Nassau, NY
Oakland, MI
Orange, CA
Palm Beach, FL
Prince George's,
MD
Riverside, CA
Sacramento, CA
San Bernardino,
CA
San Diego, CA
Santa Clara, CA
Shelby, TN
Suffolk, NY
Wayne, MI
Westchester, NY
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Figure: FISCAL DISCIPLINE
PLANNING
BUDGETING
OPERATING
Revenue &
Expenditure
Estimation
Timely
Adoption of
Budgets
Adopting
Counter
Cyclical Fiscal
Devices
Gauging Fiscal
Impacts of
Mgmt Decisions
Structural
Balance—
current
revenue &
expenditure
Maintaining
Structural
Balance
Debt
Management
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Endnotes
i
Recently, Hou (2002b) elaborates on the significance of financial management in government management
systems in terms of prominence of the finance management office, education and qualifications of finance
managers, public oversight and professional standards on government financial operations, employment of new
technology in financial management, the learning inclination, and recent focus on planning and control in
governmental finance.
ii
I have found very little literature that elaborates on this concept.
iii
The context of the comment by Axelrod is in regard to the United State Congress’s delay in coming up with
budget resolutions in the early 1980s.
iv
I would be cautious about this percentage because the 35 cities are not a complete set of any category and then
only 90 percent of the 35 responded to this question.
v
Five counties did not provide response to this question. The timely adoption rates for these five years are 69%
for 1997, 71% for 1998, 77% for 1999, 80% for 2000, and 74% for 2001 respectively.
vi
In the American federal system, local governments are creatures of state governments. This is the ‘Dillon’s
Rule.’
vii
The author’s first-hand data from the New Jersey Initiative project (Maxwell School, 2001-2002) is that many
municipalities in New Jersey cannot have their budgets adopted before the start of their fiscal year because of
some unique stipulations in the New Jersey local finance law. For details, see the financial management chapter
drafted by the same author in the NJI report (2002).
viii
In the 1950s, near 50 percent of capital financing was from state and local own-source current
revenues. This source shrank steadily over the decades. (Peterson and McLoughlin 1991, 266)
ix
In the GPP financial management survey, the term ‘ estimation’ refers to predictions for the coming fiscal
year, and ‘ forecasts’ for futures years. The word ‘ projection’ is used more generally. Since even the forecasts
are but a few years into the immediate future, this paper uses the three terms interchangeably for convenience of
narration.
x
The true story would have been much more sophisticated than just fiscal conservatism because financial
managers are more oriented towards higher accuracy to raise their professional reputation; elected officials may
face political pressure from large surpluses. Reasons for such high ‘ error rates’ deserve separate treatment.
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xi
Whether this is, at least partly, due to the urban nature of the cities in contrast to the states and counties is
beyond what the author can offer a reasonable interpretation with the current amount of information, but it is an
open clue for further investigation.
xii
Obviously the methods used for estimation at the county level are not as advanced as those adopted at the state
level and the qualifications of county staff are not as good as the state level either; and we have data to support
this claim. On the other hand, revenue sources at the two levels are different, which may add some punch to this
difference in accuracy. Another important factor is the 50 states are a complete set while the 40 counties we have
examined form merely a small subset of the counties, lacking representativeness. The author will elaborate on
the accuracy attributes in a separate paper.
xiii
Only 21 cities provided useable response to this question, making the percentages distorted. But we may
argue that most likely those that did not provide clear responses did not have a formalized procedure for the
assessment.
xiv
Budget stabilization fund is popularly called ‘rainy day fund.’
xv
Having a BSF legislation is not equal to having a real budget stabilization fund. For example, a state may have
no BSF balance at all for some (even many) years; some states may have merely a with-the-fiscal year device
that is strictly speaking not a BSF.
xvi
Alaska as an extreme outlier keeps a very large BSF.
xvii
For rationale of this definition, see Hou 2002, Chapter 3.
xviii
Expenditure figures are in conformity with the generally accepted accounting principles (GAAP).
xix
These are mainly interviews by participating journalists from the Governing magazine with county officials,
residents, consultants and so on.
xx
The ‘ distortion’ would be consistent in extent for all assessed governments.