Exceptional Proff 612
Introduction
Topics to be covered include:
· Bounded Rationality
· Lindblom’s Models
· Budgetary Incrementalism
· Comparison of Bounded Rationality and Incrementalism
· Primary Budget Actors and How They Interact
· Budgets Change
· A Bottom-Up Process
· The Niskanen Model
· Politics in Budgeting
· Five Key Concepts of Budgeting Reform
· Budget Politics and Policy Making
· Outside Influences on Budgeting
This week, we look at theories to explain how budget decision makers prepare budgets in various environments.
Bounded Rationality
HOW PEOPLE HANDLE THEIR DECISION-MAKING TASKS
Decision makers are rarely capable of processing all the information and inputs their budget environment produces, and conducting comprehensive reviews of every budget alternative is not possible. So the status quo forms the basis of the process, and this status quo is typically the last approved budget. This process of budget decision-making has been described as bounded rationality. In essence, this means that budget decision makers are limited in their capacity to process information.
-Herbert Simon, Economist
BOUNDED RATIONALITY
Generally speaking, the concept of bounded rationality explains how people handle their decision-making tasks by constructing simple models of reality and discovering the truth for themselves when faced with complexity and cognitive limitations. The American political scientist and economist Herbert Simon introduced this concept into behavioral economists in 1955. In Simon’s view, the human mind’s capacity for formulating and solving complex problems is very small compared with the size of the problems whose solution is required, and to simplify the choice process and bring it within powers of human computation, the goal of maximizing or optimizing should be replaced with that of satisfying. In other words, Simon advocated the idea of finding a course of action that is satisfactory but not necessarily optimal (Simon, 1955).
RESPONSES TO SITUATIONS
As an example, a person who is faced with a difficult decision will construct a simplified model of their more complicated situation based on their own past experiences and on how they view the stimuli of the present. Most responses to the situation are routine. Most people will use solutions that have worked for them in the past. Sometimes, a problem-solving process is necessary, or perhaps a limited search for alternatives along paths that are well worn and familiar. The first satisfactory solution is selected, and other alternatives are not assessed or considered.
REASONS FOR BOUNDED RATIONALITY IN BUDGETING PROCESS
· First, there is abundant empirical evidence that bounded rationality is important.
· Second, models of bounded rationality have proved themselves in a wide range of impressive work.
· Third, the standard justification for assuming unbounded rationality has so far been unconvincing.
· Finally, deliberation about an economic decision is a costly activity. Good economics requires that we entertain all costs (Conlisk, 1996, p. 669).
Lindblom’s Models
Charles Lindblom, Economist
Charles Lindblom expressed a similar idea. In 1959, Lindblom described and constructed two models of policymaking . The first, rational-comprehensive, is completely rational and fits the traditional concept of the rational economic man. This approach holds that policymakers begin addressing a particular policy issue by ranking values and objectives. They then move on to identifying and comprehensively analyzing all alternative solutions. Finally, they choose the most effective alternative in delivering the highest value to satisfy the stated objectives.
The rational-comprehensive model has several flaws. Defining values and objectives is difficult, and there are always trade-offs in public policy resulting from differences in opinion. Separating means from ends (policy recommendations from the objectives of those policies) is impossible. It is also impossible to aggregate the values and objectives of citizens, private organizations, legislators, appointed officials, and other members of the bureaucracy to determine exactly which preferences are most important. And identifying and analyzing every policy option is inefficient, if not impossible, for busy administrators (Lindblom, 1959).
Bounded rationality limits people in their ability to process new information, generate options, and anticipate consequences. Administrators face a highly complicated environment where multiple goals and multiple values are related to each other in unknown ways. The consequences of different courses of action cannot be reliably predicted.
Budgetary Incrementalism
Decision-making is made possible in an uncertain world only by simplifying the problem and making marginal adjustments in policies that have been successful in the past. Lindblom studied bounded rationality and determined that in most cases, changes in policy were incremental rather than completely rational. In other words, they were only marginally different from the status quo.
Therefore, budgetary incrementalism satisfies political and budgetary inputs while minimizing risk of failure or losses. This result is witnessed more at the higher levels of government (state and federal, for example) than at the lower levels of government (such as in county and municipal governments). Rapid political changes, high revenue growth, or significant budget deficits usually involve exceptions to budgetary incrementalism’s assumptions.
Lindblom developed incremental decision-making as a method of forming the best choices in the midst of uncertainty. The combination of a complex and unpredictable environment coupled with the limitations of human beings themselves, made sense for a decision maker to move away from problems (rather than toward solutions), make only small moves away from the problem, and be willing to reverse direction based on feedback from the environment (Jones, 1999).
Governmental budgeting is extremely complex, and decision-makers rarely review full ranges of budget alternatives. They instead review the budget base, which includes marginal deviations from the current budget level. If budget actors agree on the expected base of their ongoing expenditure levels, budgetary stability can better be insured. Agency bureaucrats tend to advocate their own programs and have learned that requesting high increases in budgetary allowances can result in scrutiny from central budget offices and committees. Agency budget decision-makers, therefore, often request budgets that are reasonably mid-range. Central budget offices tend to closely review and cut the requests, and committees typically conform to these offices’ recommendations.
Comparison of Bounded Rationality and Incrementalism
· Bounded Rationality
· Incrementalism
Bounded rationality and incrementalism are not entirely incompatible, and do share several characteristics:
· Both hold that the ability of the human intelligence to collect, sort through, and process information is limited, and that this makes it essentially impossible for economically rational behavior to be attained.
· Both schools are also stimulated towards a search for alternatives by dissatisfaction with the status quo, and in both schools this search is limited to the familiar, with the status quo serving as an anchor for this search.
· The interrelation between ends and means and the search for alternatives that address the immediate problem adequately, if not perfectly or forever, are common to both schools.
· And both schools propose ways to overcome the cognitive shortcomings of individuals through collective means.
Primary Budget Actors and How They Interact
· Three Main Budget Actors
In the United States, there are three main budget actors: executive agencies, central budget offices, and legislatures. The interaction among these three budget actors has been relatively stable over the decades. At the local level, Mayors are usually responsible for balancing local budgets. At the state level, agencies work with Governors, central budget offices and State legislatures.
The Budget and Accounting Act of 1921 created the legal framework for proposing a federal budget that the President develops and submits to Congress. Approximately 18 months prior to the start of the fiscal year, executive agencies begin submitting their requests and justification materials to the Office of Management and Budget (OMB) for examination and review. After the President has made all final decisions concerning the budget, the OMB compiles the budget proposal.
Here is where the legislature takes its role. The President’s budget provides Congress with recommended spending levels for programs, projects, and activities. These recommendations are heeded (or disregarded) when appropriations and other budgetary legislation are passed. The funds that are allocated to executive agencies that request them are then distributed to programs, projects, and activities.
· Flexibility of Agencies’ Budgets
Agencies must be allowed a degree of flexibility during budget execution, and Congress has accordingly given them a limited amount of authority to make adjustments in their spending. An agency may reallocate funds from one project to another, or repurpose them for another use. The Impoundment Control Act (ICA) of 1974 allows the President to defer funds that have been allocated or propose that Congress rescind budget authority permanently. Certain executive budgetary procedures are triggered under limited, less common circumstances. For example, the OMB and executive agencies can shut down certain government operations if the appropriations they have been allocated have not been enacted by the start of the fiscal year.
· Budget Reforms
The U.S. Congress and the California Legislature were the models for legislative reforms in the 1960s and 1970s. Recommendations for reforms were made in five areas: space, sessions, structure, staff, and salaries (Ryu, 2014, p.130). In the decade following, legislative staffs grew substantially and became more professionalized, with salaries for those serving in state legislatures steadily increasing.
· Changes in Legislature's Members
From the 1950s to the 1990s, the tenures of members of legislatures have increased substantially, with more members serving longer and seeking more terms. Clearly, a higher proportion of legislators have committed themselves to political careers and have accumulated increased professional skills and capacity.
But since the 1990s, state Governors have gained more budget power and state legislatures have become less powerful in this respect. Fiscal stringency and performance-based budgeting systems became common among states in the 2000s.
Budget Punctuations
There have been occasions when there have been significant shifts in budgets due usually to a significant change in public policy. The observations of budget changes outside the normal range (larger than 30 percent, but generally 50 to 100 percent) have been characterized as budget punctuations . Scholars also attempted to explain why such dramatic budget changes happen in the first place.
To explain why processes characterized by stability and incrementalism occasionally depart from the norm, the punctuated-equilibrium theory was developed. Important governmental programs are sometimes altered dramatically, even if most of the time they continue as they did in the previous year. Most policy models have been designed to explain either stability or change, but not both as punctuated-equilibrium theory does. This theory, developed for the United States and its budgeting processes, has been applied to a number of advanced democracies.
How Budgets Change
KEY FACTORS
SUBSYSTEM POLITICS VS. MACROPOLITICS
Collectively, government policymakers usually process information in a parallel way through subsystems, policy monopolies, iron triangles, and issue networks, and this leads to budgets changing only incrementally. But when issues move from subsystem politics to macropolitics , the Congress and President give their attention to one or a few high-profile items at a time. Under this lens, policies and programs can radically depart from the past, creating large budgetary changes.
ATTRIBUTES REVIEW
Policymakers tend to understand choices in terms of a circumscribed set of attributes, and tend to have considerable difficulties in making trade-offs among these attributes. For instance, a policy may promote economic growth but may also have a negative environmental impact. Only one of these competing values may be in the forefront of policymakers’ attention. If this attention were to dramatically shift for any reason, then the chosen policy might shift just as dramatically. In general terms, policymakers tend to stick with particular attributes used in structuring a choice until circumstances force them to re-evaluate these attributes (Jones, 1999).
BALANCED BUDGET CONSTRAINTS
Balanced budget constraints often prompt the federal government to respond with increased borrowing . That response is consistent with short-term economic stabilization, national security, and assisting those suffering loss, but an automatic default-to-debt response requires a routine means of restoring debt to planned levels. Otherwise, increases in public debt imply unplanned increases in future tax rates, reduced fiscal flexibility, lower income, and allocative inefficiency. In their article “Budgeting for Fiscal Uncertainty and Bias: A Federal Process Proposal,” Bhatti and Phaup propose a procedural offset to debt drift from shocks and planning bias (Bhatti & Phaup, 2015, pp. 89-105).
INTERNAL AND EXTERNAL FORCES
· INTERNAL Both internal and external forces have impacts on budgets, and the forces that might cause a change in the decision design may be external to the policymaker such as changing levels of public attention, striking and compelling new information, or turnover in the composition of the policymaking body (a change in the majority party that controls Congress, for example)
· EXTERNAL When changing external circumstances cause a change in budgets, the result is often a major change in choice and not a modest one.
Political institutions tend to make abrupt changes rather than smooth, moderate adjustments to changing circumstances, causing the agenda-based model of policymaking and the serial shift model of policymaking to produce a pattern of budget punctuations together. As attention shifts to new attributes, outcomes shift as well in a process that rarely goes smoothly. The usual forces of negative feedback and subsystem maintenance will occasionally be replaced by deviation-enhancing, positive feedback forces. As institutionally induced stability reasserts itself after the punctuation, the positive feedback leads to dramatic change.
This attention-driven, agenda-based budget model encompasses both change and stasis in budgeting. When changes occur, they should reflect the distributions found in earthquakes and other large interactive systems. The “earthquake” budget model anticipates many small changes, few moderate changes, and many large changes, and implies that punctuations should occur at all levels of policymaking and at all levels of the budget, not driven simply by external factors from the top down.
Both internal and external forces have impacts on budgets, and the forces that might cause a change in the decision design may be external to the policymaker such as changing levels of public attention, striking and compelling new information, or turnover in the composition of the policymaking body (a change in the majority party that controls Congress, for example).
A Bottom-up Process
The theory of punctuated-equilibrium is partially based on a “bottom-up” process. In this process, change may spill over into other, related subsystems or be affected by external factors. If punctuations did not occur at all levels of scale in the budget and during all time periods, the validity of this theory would be brought into question. However, budget decisions take place within political institutions, so inequality in the transmission of punctuations from one level to another can be expected. Both the President and Congress can transmit top-down budget changes throughout the executive branch when an issue affecting many agencies or programs reaches the national agenda. Top-down punctuations such as these can be transmitted more easily to departments, agencies, and bureaus than their bottom-up equivalents. Thus, fewer budget punctuations can be expected to occur at the top than at the bottom levels of governmental organization.
The President’s budget acts as a source of agency policy control—in particular, how the White House exercises control through OMB’s authority to prepare the budget, oversee agencies’ execution of the budget, and create and implement management initiatives through the budget process. Pasachoff’s article “The President's Budget as a Source of Agency Policy Control” identifies seven levers associated with OMB’s work on budget preparation, budget execution, and management and shows how these levers can control agency policymaking, and presents a reform agenda that maps out ways that the President, OMB, Congress, and civil society should respond to these accountability problems (Pasachoff, 2016, pp. 2182-2290).
The Niskanen Model
· Bureaucracy and Representative Government
In 1971, the American economist William A. Niskanen wrote his most noted work, “Bureaucracy and Representative Government”. This book stressed the idea that much of governmental budget growth can be attributed to the budget-maximizing behavior of government bureaucrats. Since the manager of a bureau’s utility will typically increase as his bureau’s budget increases, that manager is likely to maximize that budget. Then, this bureau will have a great strategic advantage over elected legislative sponsors because it has a monopolistic power over available information regarding bureau programs and budgets. Niskanen also asserted that the agents of this bureaucracy will be aware of legislative sponsors’ willingness to pay for any output level, resulting in a surplus of bureau programs and social inefficiency. This approach is in stark contrast to incrementalism in which agency bureaucrats pad their agency budgets based on their political experience.
· Monopolistic Suppliers
Niskanen’s model assumes that executive bureaus are monopolistic suppliers of governmental programs and legislative sponsors are monopoly demanders for the programs. If legislative sponsors reveal more information with their demand for the programs, agency bureaucrats can take advantage of the information for maximizing their bureau budgets. A socially efficient level of bureau budgets will be obtained when legislative sponsors’ marginal benefit from bureau programs equals agency bureaucrats’ marginal cost of delivering the programs. But agency bureaucrats tend to take advantage of their superior information power over bureau programs and budgets. As a result, bureau budgets are likely to be larger than the budgets associated with the socially efficient level of service delivery.
· Why Budgets Expand
According to Niskanen, bureaucrats are not likely to reveal true production costs to legislative sponsors, and this explains why government budgets expand. The basic motive of bureau managers is based on rational deliberation of utility. However, rational computation does not necessarily result in maximizing efficiency. Instead, it is more likely to entail budget maximization.
· Criticism
Niskanen’s model has been the subject of numerous theoretical critiques. Firstly, budget maximization can be attributed to legislative sponsors’ preference for poorly managed bureaucracies, which may offer opportunities for their constituents. When consumer-voters take the time to shop around governments for the best services, their ability and influence can take control of budget-maximization of local bureaucrats. And when bureaucrats and legislative sponsors share information power, a surplus of bureau programs is less likely. When legislative sponsors concealed their true demand for bureau programs, bureaucrats are not as likely to maximize their bureau budgets. Numerous empirical findings on federal and state budget data have been conducted which indicate that budget maximization by agency bureaucrats is not as great as Niskanen has asserted.
Politics in Budgeting
GOALS AND OBJECTIVES
Politics and budgeting relate to each other in many ways, but most politics associated with public organizations have little room for an active role by the local public manager. With some specific exceptions, public managers generally avoid taking part in basic, partisan, and personal politics. They do, however, engage in policy and organizational politics that relate to their areas of responsibility. Budget politics is essentially a subdivision of policy politics that relates to the allocation of resources needed to carry out organizational policies. Budget decisions are made in the context of politics.
Government budgets on all levels of government outline the programs, goals and objectives that the government will achieve over a period of time and the revenues and expenditures that these programs will involve. Once this budget is approved by the budget actors involved and is passed by the legislature, it becomes a legal document. Federal budgets influence fiscal, social, administrative and economic policies and the impacts these policies make on the nation’s economy. But different disciplines take different perspectives on this subject. Politicians tend to view budgets as tools through which they can accomplish political objectives. Public administrators view them differently, as instruments by which public policy objectives are implemented. An accountant will center his or her view on accountability and on how much variation exists between the projected and the actual revenues and expenditures given in this budget. And an economist will view the budgetary process through the lens of budget alternatives and how public resources that are limited can most rationally be allocated to meet wants and needs that are unlimited.
BUDGETARY EFFECTS
Budgeting in the federal government occasionally implodes. The competing parties played repeated games of chicken in which they set short-term budget deadlines and established automatic procedures in hopes of outmaneuvering their opponents. They went to the brink of defaulting on the government's debt before they shut down the government completely. Meyers’s article “The Implosion of the Federal Budget Process: Triggers, Commissions, Cliffs, Sequesters, Debt Ceilings, and Shutdown” recounts the history of this implosion and discusses what might have caused it. Budgeting's decline was certainly driven by partisan conflict. Yet budgeting's decline was also due to a dumbing down of aspirations for the process. Ironically, budget hawks contributed substantially to this when they endorsed "action-forcing mechanisms" that they hoped would constitute "credible commitments" to adopt sustainable budgetary policies. Even if their aspirations were partially realized, their logic was flawed and the collateral damage was substantial (Meyers, 2014, pp. 1-23).
Official estimates of the budgetary effects of legislative proposals generally include anticipated behavioral responses except for those that would alter overall output or employment. In his paper "Dynamic Scoring: Why and How to Include Macroeconomic Effects in Budget Estimates for Legislative Proposals,” Douglas Elmendorf, former director of the Congressional Budget Office, concludes that such effects of legislative proposals should be included in budget estimates for major (but not minor) proposals and for proposals affecting federal spending as well as revenues (Elmendorf, 2015, pp.91-133).
Five Key Concepts of Budgeting Reform
REFORMISM
Reformism posits that budgetary decisions should be based on efficiency and not politics. The actions and the decisions of the politicians and lobbyists are mostly influenced by political considerations. These might not be rational, and they typically are less efficient. This creates a constant conflict between bureaucrats and politicians.
INCREMENTALISM
Where incrementalism is concerned, budgetary decisions are made based on bargaining with budget stakeholders. Existing policies and practices are adjusted, but only to a minor degree. The incrementalist views public budget as a negotiation tool for compensation and to reach consensus among political actors.
INTEREST GROUP DETERMINIST
The interest group determinist concurs that interest groups significantly influence the outcome of a government budget. Interest groups are powerful stakeholders in government budgeting and policy development, and wealthier interest groups have the means to hire strong lobbyists and public sector consultants who can influence the legislature and executive branch, skewing the budgetary process in their own favor.
BUDGETARY PROCESS
The budgetary process is the focal point of budget politics. The three main policy actors compete for control of the budgetary power to influence the process for their own desired results and political gains.
POLICYMAKING
The fifth view of the politics of budgeting involves policymaking . The role of the budget is debated to develop and advocate public policy. Competing stakeholders hold policy debates in order to sort out differences as the budget is being debated (Rubin, 1990).
Budget Politics and Policy Making
· Stakeholders
As discussed earlier, stakeholders in the budget process, including those who make decisions concerning policy formulation, program selection, resource allocation and spending, borrowing, balancing, budget implementation, and performance review must interact. They also must compromise. The executive branch sets the tone and the direction of the budget by highlighting which policy priorities and objectives will be achieved in the next fiscal year. Based on these instructions, government agencies and departments prepare their own budgets in consultation with the OMB’s budget officers, and these completed budgets are consolidated and submitted to the legislature for approval.
· Stakeholder Input
Stakeholder input the process may include institutions, businesses, individuals, bureaucrats, interest groups and the general public. If they have concerns about budgets, they testify at legislative hearings and town hall meetings, which allows for openness, transparency, and public accountability in the budgetary process. The budget is amended as necessary over the course of the fiscal year, and audits and evaluations are conducted to measure performance. Feedback is provided so that anomalies can be observed and heeded.
· Negotiations throughout Budget Process
Negotiations and interactions among the political actors and stakeholders are found throughout the process. Elected and appointed public officials, public administrators, civil servants, interest groups, and the general public are all involved. At the planning stage of the budget cycle, private sector stakeholders lobby the executive branch in an effort to influence budget priorities, programs, and agendas. The legislature and the executive branches bargain and compromise on which direction the budget should take during the appropriations phase. The process and system of creating a government budget is more political than technical, and public administrators and managers must understand the political dynamics of government budgeting.
Outside Influences on Budgeting
Outsiders often attempt to influence public managers and policymakers concerning budgetary decisions (also known as lobbying). Typical outside supporters include clientele, employees, suppliers and service providers. Regulatory agencies such as Occupational Safety & Health Administration (OSHA) and the Environmental Protection Agency (EPA) may also figure into the process.
A well-placed lobbyist can be invaluable to lobbying interests. In 2013, more than twelve thousand registered lobbyists spent over three billion dollars in efforts to influence policymaking on the federal level. On the state level, similar efforts have been made by lobbyists as well. While the efforts of lobbyists are substantial, how or whether these efforts pay off in terms of influence over legislative outcomes has not been fully understood.
Conclusion
Reflection:
· Which model is the better choice for budgetary decisions, bounded rationality or budgetary incrementalism? Is either ideal?
· Do the interactions between budget actors make the process more convoluted and less efficient? How might it be improved?
· Should politics play a lesser role in budgeting, or is the role it plays acceptable?
The theory of bounded rationality suggests that budget decision makers are limited in their capacity to process information. Another model, budgetary incrementalism, satisfies political and budgetary inputs while minimizing risk of failure or losses. Bounded rationality and incrementalism are not entirely incompatible, and do share several characteristics. In the United States, there are three main budget actors—executive agencies, central budget offices, and legislatures—and each must interact with the others in order to remain stable and maintain a predictable process. The observations of budget changes outside the normal range have been characterized as budget punctuations.
To learn more about the federal budget process and its different facets, read Center on Budget and Policy Priorities’ article “ Policy Basics: Introduction to the Federal Budget ” and the Brookings Institute's articles on “ Reimagining the Federal Budget Process. ”