Financial Planning and Management in Public Organizations by Alan Walter Steiss and Chukwuemeka O'C Nwagwu

CAPITAL BUDGETING AND DEBT ADMINISTRATION

Two fundamental government responsibilities stem from the broad objective to "promote the general health, safety, morals, and public welfare": (1) the regulation of the action of individuals to ensure that they will not be detrimental to the general public; and (2) the provision of public services and facilities for the mutual benefit of all or a majority of citizens. The imposition of regulations and controls in the public interest is as old as history itself. Of more recent origins, the provision of public facilities and services has become widely accepted as a basic responsibility of government in contemporary society. Segments of the public may complain when taxes are increased to provide new schools or to expand public welfare programs. It is generally acknowledged, however, that significant economies can be achieved by such government activities--economies that could not be derived if each citizen had to provide for these facilities and services on an individual basis.

A fundamental responsibility of local government officials is to preserve, maintain, and improve a community's stock of public buildings, roads, bridges, schools, parks, water and sewer service lines, and related capital equipment. The availability of public facilities can have a profound effect on the form and functioning of a community. Such facilities represent very large investments of public resources, usually exert their effects over period of many decades, and are not easy to modify once built. Regular maintenance of the existing infrastructure can avert crises and avoid prohibitive future replacement costs. Therefore, a systematic planning effort is vital in making decisions about the construction and financing of public facilities.

Capital Facilities Planning

The term capital facility refers to a project (1) involving a significant investment of financial resources of a non-recurring nature, (2) designed to provide new or expanded government capacity for the delivery of public services, (3) resulting in a fixed asset for the community, (4) which has a relatively long life (usually a minimum of 15 to 20 years). The extend time horizon and substantial commitment of resources requires that effective capital facilities planning involve planning, programming, financing, and debt administration.

The Planning Phase

Long-range planning of capital facilities has lagged significantly behind other development in the field. As governments began to assume greater responsibilities for the provision of public services and facilities, however, only the most evident needs were addressed, and these needs often were dealt with in somewhat haphazard fashion. As recently as 1910, state and local governments made no provision for the overall supervision and regulation of public expenditures through a comprehensive budgetary process. Municipal development during this period was characterized by the uncoordinated construction of public works. If any financial resources remained after the most obvious obligations were met, other projects might be initiated.

Long-range capital facilities planning provides a means of assuring that projects will be carried out in accordance with defensible system of priorities reflecting both public needs and the government's ability to pay. It promotes coordination among the various departments and agencies of government and thereby helps to circumvent overlapping or conflicting programs. It protects against undue influence by special interest groups, which may attempt to force the adoption of "pet projects" at the expense of more urgent or more meritorious improvements.

Action can be taken on bond issues or other revenue-producing measures before the need becomes so critical as to require emergency financing measures. Advanced planning extends the period of time available for the proper technical design of facilities and permits a continual, systematic appraisal of personnel and equipment needs, resulting in a number of economies. And finally, the planning may provide justification for the advance acquisition of properties needed for improvements, thereby taking advantage of lower market values.

The benefits of a systematic approach to planning capital facilities include the following: [1]

o Capital improvements can be synchronized with community objectives, anticipated needs resulting from growth, and financial capabilities.

o Careful planning of capital improvements helps local officials to make sound budgetary decisions, to avert costly mistakes, and to give evidence of sound financial planning which investors tend to view favorably, in turn, leading to lower borrowing costs.

o Capital facilities planning can be viewed as an essential element of a comprehensive growth management program since the locations and capacities of capital improvements help to shape and control future residential and economic growth in the community.

o Strong citizen participation in the capital facilities planning process can help build the political and social support necessary to achieve consensus on both the desirable projects--parks, schools, and community centers--and the less desirable projects that fall under the "not in my backyard" category--sewer treatment plants, landfills, and correctional facilities.

o Intergovernmental cooperation is encouraged by providing public officials of all governmental units an opportunity to plan the location, timing, and financing of improvements in the interest of the broader community.

o Capital facilities planning enables local officials to identify the most economical funding mechanisms, to avoid excess debt commitments, and to minimize unanticipated capital expenditures that could be detrimental to the overall financial well-being of the community.

Capital facilities planning should be built upon a continuous assessment of client/community preferences, an identification of goals and objectives, demographic estimates and economic forecasts, and projections of development expectations. Data on future community needs must be sufficiently reliable to justify decisions that involve relatively large, long-term commitments of financial resources. The following elements should be included in this planning framework:

(1) External factors--such as demographic shifts, changes in economic activities, social trends, scientific and technological change, emerging land use patterns, and so forth--that may influence the service programs of the community or organization.

(2) Total service demands. Assumptions, standards, and criteria used to quantify and project facility and service needs must be clearly identified and tested against available trend analyses.

(3) Service delivery responsibilities. Present and future roles of various levels of government, as well as private enterprise, in the provision of facilities and services must be examined. Such an evaluation may include recommendations regarding the elimination of overlapping responsibilities through coordination or realignment.

Forecasting Community Growth and Change

The demand for public improvements is a function of growth. This emphasis on meeting growth demands does not imply a "self-fulfilling prophecy," however. In situations of service crisis, local governments may be panicked into uneconomical investments and over development. Comprehensive capital facilities planning can help avert these crises, thereby contributing to more realistic and rational patterns of growth.

To anticipate the types of improvements required, the population to be served should be delineated to the fullest extent possible. An aging population, for example, will require specialized health facilities and housing. Young adults just starting families, on the other hand, will require schools, day-care centers, and recreational facilities. Income levels, household size, and other demographic and economic characteristics also provide vital information as to facility needs and service expectations.

*Application of Reed-Merrell tables on the probability of dying to actual mortality data.

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Demographic projections are often based on an age-cohort survival model, which analyzes the population by narrow age categories (cohorts) according to vital statistics on births, deaths, and net migration patterns (inflows or outflows of population). Further breakdowns can also be made by race, sex, income, and so forth. It is important to understand the current demographic composition of the community in order to identify any unique characteristics that may influence future population structure. For example, the transient student population of a college town is influenced by factors other than typical demographic elements and cannot be "aged" in the cohort structure with the resident population.

Five-year age-cohorts are "stepped up" through each iteration (see Exhibit 1), and the results of this "aging" of cohorts are then modified by adjustments for births, deaths, and net migration. The basic mathematics of the age-cohort survival model are fairly simple. Making good assumptions about migration is not easy, however, and for this reason, many projections turn out to be inaccurate or unrealistic in terms of actual demographic data.

Mistakes in projecting population can be quite costly. The baby boom, for example, which began in the late 1940's and lasted until the early 1960's, produced huge increases in public school enrollments. In the 1960's and early 1970's, many localities assumed the trend would con-tinue into the foreseeable future, and made substantial investments in new school buildings. In fact, however, enrollments peaked a few years into the 1970's and then started downward. Today, many school districts, which have experienced significantly declining enrollments, are still paying off the bonds on underutilized school buildings .

Economic Forecasts and Projections

Economic forecasts are an important factor in the preparation of demographic projections, since assumptions concerning population growth or decline are based in part on economic activities. A locality exper-iencing rapid industrial growth, for example, will likely experience a wave of worker in-migration. The age and socio-economic characteristics of these new groups must be forecast to ensure adequate provision of basic public facilities and related services.

Economic projections and forecasts, in turn, must be translated into public improvement needs. The attraction of young workers and their families to an area experiencing industrial growth will likely result in increased demands on the educational system. If the municipality is not responsive to these demands, the momentum of economic activities will be adversely affected.

Future economic conditions also determine the financial capacity of a community to pay for capital improvements. Economic indicators--including data on employment, cost of living, disposable income, building activity, and bank deposits--can be used to analyze trends and to suggest the future revenue capacity of the community.

Economic base studies, widely applied in capital facilities planning, divide the local economy into two broad categories:

(1) Basic or export industries--those industries producing goods and services (and capital) for distribution to markets outside a defined local economic area; and

(2) Nonbasic or service industries--those producing goods and services that are consumed within the local economic area.

A distinction is made between economic activities that bring new money into the community (basic industries) and those that simply result in the recirculation of money (service industries). An underlying assumption of this approach is that expansion of basic activities usually results in growth of service activities and thus, growth in the total economy. Forecasts of economic growth are based on multipliers that relate local activities to exports.

Employment growth generally fosters population growth because job opportunities attract new residents. But the process works the other way too. Population growth creates employment in retailing, wholesaling, personal services, and related activities. In fact, the relationship goes still further because pools of labor and capital built up to serve a local population, in time, may foster the growth of manufacturing and other activities which are not directly related to servicing the local population.

The Local Infrastructure

Land use studies are a part of planning for capital facilities. It is not possible, for example, to plan for sewer construction without having definite ideas about what areas of the community need to provided with sewers. Land use studies also are important for identifying land suitable for various types of capital facilities and for estimating the cost of such public improvements--the cost of sewers, roads, and other facilities can be greatly influenced by topography, subsoil conditions, and the like.

The results of the land use studies must be consistent with the economic and population forecasts. If a land use study does not indicate enough developable area to accommodate projected population and employment increases, for example, the planner should think seriously about scaling down those projections.

Financial Planning and Fiscal Policy

The demand for services and facilities increases and changes as a function of growth and the social and economic characteristics of the community. However, local revenues have tended to increase at a slower rate, creating an ever widening fiscal gap for many localities. In economic terms, the revenue sources available to local governments are relatively inelastic; that is, they are not very responsive to changes in the overall economy. The inelasticity of local revenues is attributable, in part, to the tax structure which forces local governments to rely heavily on local property taxes, which have proven to be relatively unresponsive in meeting increasing demands for public services and facilities.

Other taxes have also not been very productive at the local level. Unilateral taxation of income, sales, or business by local governments often results in a shrinkage of the local tax base. That is, if one municipality introduces such taxes, economic activities tend to locate beyond the taxing jurisdiction (for example, major shopping facilities located just outside the taxing jurisdiction of cities) unless adjoining political jurisdictions coordinate their tax policies such that no one jurisdiction has locational advantages that can be exploited by economic elements.

Government services tend to be labor intensive and not readily amenable to the substitution of capital for labor. Thus, while there have been massive increases in productivity in manufacturing, transportation, and agriculture, increases in public sector productivity have been much less significant. Hence, the cost of public services have risen compared to many other goods and services.

Thus, it is not difficult to understand the fiscal bind in which many municipalities find themselves. Taxpayers demand good schools, adequate police and fire protection, and other public services. At the same time, however, they stoutly resist any increases in local taxes to pay for these services.

Most intergovernmental aid is from the state rather than the federal government. Much of the state funds received by local governments, how-ever, is really "pass-through" money. As federal transfers to the states diminish, state generosity to local governments is very likely to decline. For all of the above reasons, careful estimating of revenues and planning of expenditures is important.

Revenue and Expenditure Analyses

A sound revenue policy must be predicated on the basis of a thorough assessment of public service and capital facilities needs. Estimates should include an analysis of the revenues to be collected if existing fiscal policies are maintained. New revenue sources or shifts in yields from current sources under alternative policies should also be analyzed.

Sources of revenue should be disaggregated into appropriate categories and projected over a number of years. Demographic and economic forecasts are important in estimating the size of the tax base in the future. The impact of inflation must also be considered in estimating the magnitude of revenue sources such as sales and property taxes. The availability of intergovernmental aid also must be estimated. Consider-able uncertainty is involved in such analyses, and the likelihood of any municipality accurately projecting its revenues over the next decade is quite small. Nevertheless, there is no good alternative to the use of such projections.

Expenditure data should also be separated into major categories. Historical fiscal data assist in determining appropriate multipliers for each expenditure category. For example, a profile of historical data might be used to project the cost per pupil of primary school education. Population projections for the community provide enrollment estimates in future years. This yields a first approximation of the real costs. The projected costs might then be adjusted for projected inflation to yield the actual dollar costs. Note that one uncertainty (projected cost per pupil) is being multiplied by a second uncertainty (number of pupils) and then by a third uncertainty (changes in the value of the dollar). Therefore, the results of such analyses are necessarily only very rough approximations.

Capital Costs and Debt Burden

The annual cost of any improvement program is determined by the planning, scheduling, and methods of financing, together with the projected operating costs. To be most effective, the programming of capital improvements should undertake to level off annual costs and to avoid erratic fluctuations. Annual costs, when measured against tax resources and available subsidies, determine the tax burden generated by the capital improvements program. The overall debt burden is determined by the total capital costs, together with the schedule and financing methods When the tax or debt burden becomes too great for public resources, it may be necessary to reduce the level of improvements scheduled until their costs fit to these resources.

Standards of service must also have a degree of "built-in" flexibility; to be meaningful, they must represent actual performance or benefits. As new operational techniques are introduced or as new demands arise, it is important that such standards be flexible enough to permit adjustments to meet changing conditions.

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