Anessi-Pessina (2012 PAR) Budgeting and Rebudgeting in Local Governments-Siamese Twins

Eugenio Anessi-Pessina Catholic University, Milan, Italy Mariafrancesca Sicilia Bergamo University, Milan, Italy

Ileana Steccolini Bocconi University, Milan, Italy

Budgeting and Rebudgeting in Local Governments: Siamese Twins?

The literature on budgeting in the public sector has traditionally focused on the annual budgetary process. Much less attention has been paid to rebudgeting—that is, what governments do to revise and update their budgets during the fiscal year. Because of its potentially large impact on appropriations, rebudgeting seemingly deserves more attention than it has been granted so far. This article uses data from a sample of Italian municipalities to test hypotheses on the main drivers of budget revisions. According to the results, rebudgeting is strongly affected by the degree of incrementalism in the initial budgeting process, as well as by several internal and external determinants, such as political variables, organizational features, financial conditions, and the local socioeconomic environment.

I

stance and testing some hypotheses on the potential determinants of rebudgeting practices. To this end, we use data for Italian municipalities over five years (2003–7). The structure of the article is as follows: The next section reviews the relevant literature and develops the hypotheses. Then we offer a short background on Italian municipalities, their accounting systems, and their rebudgeting rules. The ensuing section specifies data and methods, followed by a presentation of the findings. The final section draws some conclusions and implications for practice and further research. Previous Studies and Hypothesis Formulation Compared with the initial budgeting process, budget execution and rebudgeting have received much less attention. The few existing studies on rebudgeting, moreover, have predominantly adopted an exploratory and descriptive stance (Dougherty, Klase, and Soo 2003; Forrester and Mullins 1992). They usually have investigated the importance and magnitude of budget revisions, the players who initiate the revision process or are otherwise involved, and the contingencies, events, and reasons that are more likely to cause it at the local and state levels.

n most public organizations, the main purpose of the budget is to authorize (i.e., to limit) spending by nature and/or purpose (Anessi-Pessina 2000; Caperchione 2000). Traditionally, the literature has focused on the annual budgetary process (Fenno 1966; Lu and Facer 2004; Rubin 1990, 2005; Wildavsky 1964), investigating such themes as the players involved, their roles, and the internal and external factors that influence budget characteristics. Approved budgets, however, often need to be revised during the fiscal year in order to incorporate changing priorities and face unexpected events (Caiden and Wildavsky 1974; Wildavsky 1988). Rebudgeting According to these studies, not only does rebudgetis thus allowed in most public organizations worlding significantly affect the original appropriations wide, although within different sets of constraints. (Hoskins 1983), but also it influences future budget Rebudgeting, moreover, has a potentially large impact cycles (Dougherty, Klase, and Soo 2003; Lauth 1988; on appropriations. So far, however, it has been the Lee and Plummer 2007). For example, the revisubject of remarkably little research. In addition, the sion of budgeted revenues during the fiscal year will few existing studies (Dougherty, affect future revenue forecasts Klase, and Soo 2003; Forrester (Bretschneider, Straussman, The purpose of this article is to and Mullins 1992) have preand Mullins 1988). In addition, enrich the existing literature by dominantly been exploratory governments have been shown adopting an explanatory stance and descriptive. to initially favor a conservative and testing some hypotheses on underestimation of revenues The purpose of this article is to hedge against the risk of the potential determinants of to enrich the existing literature revenue shortfall (Bretschneider rebudgeting practices. by adopting an explanatory and Schroeder 1985). This

Eugenio Anessi-Pessina is full professor of public and health care management at Catholic University in Milan, Italy. In addition, he is senior fellow at the Wharton School of the University of Pennsylvania (Department of Health Care Systems) and editor of Azienda Pubblica (a leading Italian-language public management journal). His research interests include public sector budgeting and accounting, health care management, and management control in government and health care organizations. E-mail: [email protected] Mariafrancesca Sicilia is assistant professor of public budgeting at Bergamo University and SDA Bocconi assistant professor of Public Management and Policy. Her research interests focus on public sector budgeting, accounting, and performance measurement. E-mail: [email protected] Ileana Steccolini is associate professor of public budgeting and performance measurement at Bocconi University in Milan, Italy, and director of the Public Management and Policy Department at SDA Bocconi School of Management. Her research interests include public budgeting, accounting and accountability, and performance measurement in the public sector. E-mail: [email protected]

Public Administration Review, Vol. 72, Iss. 6, pp. 875–884. © 2012 by The American Society for Public Administration. DOI: 10.111/j.1540-6210.2012.02590.x.

Budgeting and Rebudgeting in Local Governments: Siamese Twins? 875

conservative underestimation, coupled with economic growth, can produce surpluses that are added to budgetary appropriations and may favor the parochial interests of legislators (Lauth 1988), thus creating a structural framework for rebudgeting.

processes, which are considered incremental when decision makers focus their attention on a relatively small number of alternatives as a method of simplifying decision making; and (3) consideration of both processes and outputs.

Along these lines, Dougherty, Klase, and Soo (2003) investigated the rebudgeting process in 15 West Virginia cities and found an “increasethen-decrease” pattern, with statistically significant mean differences between the original and the revised appropriations and between the revised appropriations and the actual outlays, but not between the original appropriations and the actual outlays. This pattern reflects a conscious strategy adopted by municipalities to ensure a buffer against unexpected events and to keep expenditures under their budgeted levels.

Less attention has been paid to the implications of incrementalism for budget execution and the need for rebudgeting. This is critical because focusing on initial budgeting leaves a large portion of the overall, yearlong budgeting process virtually unexplored. Our hypothesis is that an incremental approach to budgeting may not fully capture the organization’s needs and will consequently require more rebudgeting during the fiscal year. We thus expect a positive relationship between incremental budgeting on the one hand and rebudgeting on the other.

As to the players involved and their roles and motivations, Forrester and Mullins (1992) carried out a survey of 91 U.S. central cities. According to their results, rebudgeting is generally less visible than budgeting to the general public and is driven more by administrative than political bodies. It can be stimulated by managerial necessity, political concerns, or environmental pressures, and it affects the various government services and functions to different extents.

Hypothesis 2: Rebudgeting is affected by political variables. An important body of literature suggests that budgeting is affected by political variables. Because rebudgeting revises the budget to incorporate emerging priorities and needs, our hypothesis is that rebudgeting will also be affected by political variables.

Among political variables, the most obvious is the administration’s political orientation. The literature on political orientation sugThe purpose of our article is to go beyond the exploratory perspecgests that left-wing parties will be more likely to raise tax revenues, tive and to adopt an explanatory approach. Our starting point is while right-wing parties will prefer to cut that rebudgeting cannot be studied indepenexpenditures (see, e.g., Mulas-Granados 2003; dently of budgeting. Budget approval is the Our starting point is that Tavares 2004). To the extent that this is not outcome of a decision-making process, but rebudgeting cannot be studied incorporated into the initial budget, midyear it is also the starting point for a continuous independently of budgeting. adjustments that increase revenues should process of budget execution and revision. In thus occur more frequently under left-wing other words, budgeting can be viewed as a administrations, while midyear adjustments that decrease expendiyearlong process composed of initial budgeting and rebudgeting. tures should be more likely under right-wing ones. As a consequence, when looking at rebudgeting, a fruitful avenue may be to test the explanatory potential of those variables that have The description of an administration as being right- or left-wing, been identified as relevant by the literature on budgeting. This leads however, is extremely stylized, especially in the Italian political us to formulate five hypotheses, which are individually stated and context. In reality, majority coalitions can be highly fragmented, and explained here. this may have an impact on rebudgeting. According to the economic and fiscal reform literature (e.g., Alesina and Drazen 1991; Lora and Hypothesis 1: Rebudgeting is affected by the degree of increOlivera 2004; Mierau, Jong-A-Pin, and De Haan 2007), the timmentalism in the formulation of the initial budget. ing of reforms depends on the distributional effects that they produce. Rebudgeting can be likened to reforms in that it modifies the The concept of incrementalism has been interpreted in many distribution of both benefits and costs among stakeholders. Alesina different ways (Berry 1990), not necessarily involving budgetary and Drazen (1991) suggested that political fragmentation hinders choices. According to Lindblom (1959), incrementalism is a way of the adoption of reforms: political fragmentation could then also be simplifying decision making by reducing the number of alternatives expected to deter rebudgeting. At the same time, however, highly fragand their degree of innovativeness from policies presently in effect, mented majority coalitions may be unable to find a stable comproadopting a sequential consideration of alternatives, ignoring the full mise and end up demanding continuous budget revisions. The impact range of policy consequences, and increasing the dependency of of this variable on rebudgeting, therefore, cannot be signed a priori. ends on means. Wildavsky, on the contrary, defined incrementalism with specific reference to the budgeting process: a budget is incremental when “it is based on last year’s budget, with special attention Finally, the political budget cycle literature (e.g., Brender and Drazen 2005; Mink and De Haan 2006; Persson and Tabellini 2004; Shi given to a narrow range of increases or decreases” (1964, 15). and Svensson 2006; Tujula and Wolswijk 2007) proposes that budget choices are affected by electoral cycles. This is further reinforced by Following Wildavsky, the theory of incrementalism has dominated budgeting studies for the last 60 years. Boyne, Ashworth, and Powell the budget’s symbolic significance (Lu and Facer 2004), whereby budget choices are often adopted simply for their outward symbolism. (2001) identified three general uses of the term “incrementalism” Thus, it seems natural to extend the same presumption to rebudgetwhen applied to budgeting process research: (1) description of ing, to the extent that such choices are not directly incorporated budgetary outputs, which are considered incremental if differences into the initial budget. More specifically, the literature suggests that from the previous year(s) are small; (2) description of budgetary 876

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upcoming elections encourage greater deficits and discourage fiscal reforms, which, conversely, will often take place soon after the election. Therefore, the time elapsed since the last election can be expected to affect rebudgeting, with spending cuts and tax or fee hikes becoming gradually less likely as the next election approaches. In addition, unless elections are held toward the end of the fiscal year, the incoming administration must operate for several months within the budget approved by its predecessors. Therefore, a new mayor and/or majority coalition can be expected to make large changes to the initial budget. This is also consistent with Forrester and Mullins (1992), who found that rebudgeting is encouraged by changed priorities and the willingness to counteract previous decisions. Hypothesis 3: Rebudgeting is affected by organizational features. The impact of organizational features on budgeting has been investigated only to a small extent. However, these features can potentially play an important role (Greenwood, Hinings, and Ranson 1977; Forrester and Adams 1997; Lu and Facer 2004). On the one hand, budgeting is associated with organizational structure and mechanisms. On the other, it is part of the “intangible side” of organizations (Giroux el al. 1986), and it is shaped by the role of the various players and the configuration of powers, values, rules, and routines (Bretschneider, Straussman, and Mullins 1988; Greenwood, Hinings, and Ranson 1977). An organizational variable that can be expected to affect budgeting (and thus, supposedly, rebudgeting) is size. Bigger organizations tend to be more complex and difficult to manage because of the magnitude and variety of their activities. As a consequence, they must rely on rules, procedures, and “formal ways of doing things” that may make them slower to reach the consensus required to revise the budget. At the same time, however, larger and more complex governments are more likely to need midyear adjustments. The impact of size on rebudgeting, therefore, cannot be signed a priori. Another important set of organizational variables that can affect budgeting (and, supposedly, rebudgeting) is the power and influence of the actors involved. Among them, the Financial Comptroller Office (CFO) can be expected to exert a great influence, owing to its responsibility for controlling spending and for reducing uncertainty on the availability of resources for programs (Giroux, Mayper, and Daft 1986). Once again, however, the impact of this influence on rebudgeting cannot be signed a priori: powerful CFOs may stress ex ante programming (thus reducing the need for midyear adjustments) or, rather, prefer conservative budgeting (keeping initial appropriations low and hopefully increasing them during the fiscal year as revenues are actually achieved). Finally, each government will be characterized by its own values, beliefs, rules, and routines for budgeting and rebudgeting, which may encourage or discourage midyear adjustments. Hypothesis 4: Rebudgeting is affected by the municipality’s financial conditions. Another set of variables that may affect rebudgeting relates to the government’s financial position and the availability of slack resources

(Lu and Facer 2004). In this regard, governments that have accumulated larger surpluses in previous years should enjoy greater degrees of freedom during the initial budgeting process and thus require smaller midyear adjustments. The same should hold for governments (1) whose current revenues exceed current spending; (2) whose current revenues include a larger share of own taxes and fees as opposed to transfers from higher levels of government; (3) whose expenditures include a smaller share of rigid, nondiscretionary items such as personnel, interest, and loan repayment; and (4) that resort to borrowing to a lesser extent. A peculiarity of budgeting is that it occurs well before the preparation of the financial statement for the previous year. For municipalities, therefore, it is not unusual to experience the emergence of past-year surpluses or deficits halfway through the fiscal year. Obviously, the approximate size of the previous year’s surplus or deficit becomes common knowledge early in the new fiscal year, but it can be incorporated into the budget only when formalized through the preparation and approval of the previous year’s financial report. The emergence of past-year surpluses will generally stimulate rebudgeting in terms of higher capital spending (local governments usually have a list of relatively small capital projects awaiting a source of funding to be implemented), possibly higher current spending (although rules often exist that prevent or limit the use of surpluses to cover current spending), or lower capital revenues (as the newly discovered surplus can replace planned borrowing or asset sales as a way of funding investments) (see also Dougherty, Klase, and Soo 2003). Emerging past-year deficits, on the other hand, will have to be covered and, consequently, will induce budget adjustments in terms of increased revenues and/or reduced expenditures. Hypothesis 5: Rebudgeting is affected by the local socioeconomic environment. Finally, a large body of literature exists on the external factors that affect organizational behavior in the public sector. The demographic and cultural features of the community, for instance, can play a significant role (Brudney and Selden 1995; Forrester and Mullins 1992; Greenwood, Hinings, and Ranson 1977; Lu and Facer 2004). Bingham (1978) recalled that the socioeconomic characteristics of the community have been studied by many economists and political scientists as factors affecting decision making and city policies. In the Italian context, significant regional differences exist across a wide range of dimensions, including local government openness to public sector reforms (Putnam, Leonardi, and Nanetti 1993) and accounting innovations (Anessi-Pessina, Nasi, and Steccolini 2008). Local socioeconomic conditions can thus be expected to affect budgeting and rebudgeting practices. Budgeting and Rebudgeting in Italian Municipalities Italy has four levels of government: the central government, 20 regions, about 100 provinces, and approximately 8,100 municipalities. Each level has jurisdiction over several policy areas. With respect to municipalities, each has a mayor, a municipal executive board, a city council, and a professional bureaucracy. The executive structure of Italian local government is similar to the U.S. model of mayor-council government in that the mayor and city council are separate offices. Both the mayor and the city councilors Budgeting and Rebudgeting in Local Governments: Siamese Twins? 877

are elected directly by the population. Elections are held every five years, usually between April and June. The mayor appoints the members of the municipal executive board, while the city council functions with legislative powers. In the last two decades, the powers of the executive have been greatly increased at the council’s expense. The electoral system, moreover, is designed to generally provide the mayor with a majority of seats in the city council. Majorities, however, are often composed of highly fragmented coalitions. Majority city councilors are technically free to withdraw their support and side with the opposition, which may force the mayor to call an early election. Early elections may also occur under other special circumstances, such as the mayor’s death, resignation, or removal for major criminal violations. In addition to the members of the municipal executive, the mayor can also choose to appoint a chief executive officer (or “city manager”) with general management responsibilities. The CFO, on the contrary, is a career civil servant and so are his or her subordinates. Municipalities are allowed to raise local taxes and charge fees for the services that they provide, but a significant percentage of their revenues is still accounted for by transfers from higher levels of government, especially in low-income areas of the country. For municipalities with populations above 15,000, between 2003 and 2007, own taxes, fees, and transfers averaged 54 percent, 26 percent, and 20 percent of current revenues, respectively. Current revenues, in turn, were 70 percent of total revenues, the other components being capital revenues (sales of noncurrent assets, capital transfers from other governments and private entities, totaling 19 percent) and borrowing (11 percent). These funds were used to cover current spending (65 percent), investments (27 percent), and debt repayment (8 percent). From an accounting viewpoint, municipalities still rely predominantly on cash and commitment-based budgetary accounting, although they are technically expected to also publish an accrualbased financial statement (Anessi-Pessina and Steccolini 2007). The budget, which is commitment based, must be approved by the council and is required to balance. Budgeted revenues can include borrowing, which, however, can only be used to cover capital

spending. Past-year surpluses may be added to budgeted revenues, while past-year deficits must be added to budgeted expenditures. The fiscal year coincides with the calendar year. Revenues are classified by nature, with “titles” as the most aggregate level. Expenditures are classified by nature and purpose, once again with “titles” as the most aggregate level. The list of titles is presented in table 1. Rebudgeting rules (table 2) require the budget to remain balanced. Therefore, increased budgeted expenditures for a given line item must be offset by (1) decreased budgeted expenditures for other line items, and/or (2) increased budgeted revenues. All revisions must generally be approved by the council no later than November 30, although exceptions do exist. Budget revisions occur throughout the year, but they are particularly frequent in two specific periods: in July, after the publication of the previous year’s financial statement, in order to revise the amount of surplus/deficit carried over from the previous year, and in November, just before the November 30 deadline, to make all of the remaining changes that are deemed necessary. Methods To test the hypotheses presented earlier, we used a panel data set of 657 Italian municipalities with populations consistently greater than 15,000 over a five-year period (2003–7). The data set was downloaded from the Department of the Interior’s Web site. For every year, the data set contains each municipality’s initial budget, revised budget, and year-end statement.1 For the initial budget and the year-end statement, the data set is very detailed, with expenditures broken down by both nature (e.g., personnel, supplies) and purpose (e.g., education, social services). For the revised budget, on the contrary, the data set provides only a very broad break-down of expenditures by title, that is, among current spending, capital spending, debt repayment, and clearing entries (table 1). As a consequence, rebudgeting was analyzed separately for current and capital spending. Debt repayment was disregarded because its rebudgeting is entirely dependent on external circumstances such as changing interest rates, and clearing entries were disregarded because of their purely technical nature. For each of the two titles, the dependent variable was defined as the percentage change between the revised and the initial budget.

Table 1 Titles for Italian Municipal Budgets Revenues

Expenditure

Surplus from previous year, if any Title 1—Tax revenues Title 2—Current transfers from other governments Title 3—Current nontax revenues Title 4—Disposal of fixed assets, capital transfers from other governments and private entities Title 5—Borrowing Title 6—Clearing entries (by definition identical to their expenditure counterparts)

Deficit from previous year, if any Title 1—Current expenditures Title 2—Capital expenditures Title 3—Loan repayments Title 4—Clearing entries (by definition identical to their revenue counterparts)

Note: Current revenues include Titles 1, 2, and 3.

Table 2 Rules for Rebudgeting in Italian Municipalities Types of Adjustments

Definition

Virement Use of new or larger than expected revenues Use of reserve funds

Funds are transferred between spending items; total budgeted expenditures remain unchanged Budgeted revenues are increased; budgeted expenditures can be increased by the same amount Funds are moved from the reserve fund item to other spending items; total budgeted expenditures remain unchanged

878

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Body Responsible for Approval

Deadline

Council Council

Nov. 30 Nov. 30

Municipal Executive Board

Dec. 31

Following the hypotheses presented earlier, the independent variables were classified as internal and external, with the former including the degree of incrementalism in the initial budget formulation, as well as another three sets of variables reflecting the municipality’s political situation, organizational features, and financial conditions. The degree of incrementalism in the initial budget formulation was measured by the variable BUDGET_CHANGE, defined as the percentage change between the initial budget and the previous year’s actual expenditures. This is because an administration can incorporate its policies into the initial budget or pursue them through rebudgeting. The more a policy has been incorporated into the initial budget, the less it usually will need to be pursued through rebudgeting. The variable BUDGET_CHANGE, however, only captures the average budgeted increase (or decrease) from the previous year. To measure the degree of incrementalism in the initial budget formulation, it seems important to verify whether any such increase was uniformly applied to all items or, alternatively, whether different items were treated differently. As a consequence, the variables SPENDING_CATEGORY_CHANGES and SPENDING_ PURPOSE_CHANGES were introduced to reflect the variance of the percentage change between the initial budget and the previous year’s actual expenditures across different items, by nature and by purpose, respectively. These two variables, however, were included only in the analysis of current spending. For capital spending, they were excluded because of extensive variability in nature and purpose over time, especially in smaller municipalities, which tend to identify few capital projects per year. As to political variables, political orientation was defined as a dummy variable (POLITICAL_ORIENTATION) for the administration’s right- or left-wing orientation. Because Italy has traditionally been characterized by a very large number of political parties, however, coalition government is the norm, and the reference to right- or left-wing administrations becomes an oversimplification. To capture the administration’s political fragmentation, we introduced the variable POLITICAL_FRAGMENTATION, defined as the number of political parties in the majority coalition or, more specifically, the number of parties with at least one member serving on the municipal executive board. Finally, the electoral cycle was operationalized through a set of dummy variables (0_YRS_SINCE_ LAST_ELECTION, 1_YR_SINCE_LAST_ELECTION, 3_YRS_ SINCE_LAST_ELECTION, 4_YRS_SINCE_LAST_ELECTION) reflecting the number of years since the last local election, with year 4 as the maximum (as mentioned earlier, elections are scheduled every five years, although early elections may be called under particular circumstances) and middle-of-the-cycle year 2 as the baseline. For organizational features, the municipality’s total spending on staff (STAFF) was used as a proxy for size and complexity. This was supplemented by two more specific variables. CFO_OFFICE_SIZE is the municipality’s spending on its Financial Comptroller Office, scaled by the municipality’s population. The purpose of this variable was to verify whether a larger (and supposedly more powerful) Financial Comptroller Office reduces the need for rebudgeting (e.g., because it can devote more resources to planning) or rather increases it (e.g., because it can induce politicians to be more conservative in the initial budget formulation and to increase authorized spending

through rebudgeting only when expected revenues are actually recognized). REBUDGETING_ON_OTHER_TITLE is the percentage change between the revised and the initial budget for the title not used as the dependent variable (i.e., capital spending when the dependent variable is rebudgeting for current spending, and vice versa). As mentioned earlier, governments will be characterized by different values, beliefs, rules, and routines for budgeting and rebudgeting, which may encourage or discourage midyear adjustments. The specific assumption behind the variable REBUDGETING_ ON_OTHER_TITLE is that municipalities may be characterized by a certain inclination or aversion to rebudgeting that cuts across different types of expenditures. The last set of internal variables was intended to reflect the municipality’s financial conditions and presence of slack resources. All of these variables were scaled by current revenues to control for the municipality’s size. ACCUMULATED_SURPLUS is the municipality’s accumulated surplus from previous years; CURRENT_ SURPLUS is the budgeted excess of current revenues over current expenditures; FINANCIAL_AUTONOMY is the municipality’s degree of financial autonomy, measured by the share of current revenues accounted for by own taxes and fees (as opposed to transfers from higher levels of government); EXPENDITURE_RIGIDITY is the municipality’s degree of expenditure rigidity, measured by the share of current revenues needed to cover personnel and interest expenditures; and NET_BORROWING is budgeted borrowing, net of budgeted debt repayment. The additional variable REVISION_ OF_PAST_SURPLUS was introduced so as to control for the midyear emergence of past-year net surpluses or deficits, which clearly can be expected to encourage rebudgeting. As for the external variables, LOCAL_GDP reflects provincial per capita gross domestic product (GDP) (GDP data are not available at the municipal level, and provinces are the equivalent of counties) and was selected to capture the community’s overall economic conditions; SOUTH is a dummy variable for whether the municipality is located in northern or southern Italy and was expected to serve as a more general proxy for the cultural, social, political, and economic configuration of the municipality’s environment (e.g., Anessi-Pessina and Steccolini 2007; Anessi-Pessina et al. 2008; Nasi and Steccolini 2008; Putnam, Leonardi, and Nanetti 1993). Table 3 lists all of the variables with their specific definitions and data sources. The data were analyzed using both a between-effects and a fixed-effects model. The between-effects model assumes that the unobserved variables differ over time but are constant across cases for the same time period. Conceptually, this is the same as taking the mean of each variable for each case across time and running a regression on the collapsed data set. It consequently required the exclusion of the dummies reflecting the electoral cycle: because elections are usually held every five years, the five-year average of each dummy was nearly identical across all municipalities. The fixedeffects model, on the other hand, controls for omitted variables that differ between cases but are constant over time. It consequently required the exclusion of the variables that are time-invariant (SOUTH) or changing very slowly over time (STAFF). Fixed effects were chosen over random effects on the basis of the Hausman test (Wooldridge 2009). Further tests were performed for Budgeting and Rebudgeting in Local Governments: Siamese Twins? 879

Table 3 Variables* and Data Sources Variable

Measure

Source of Data

Internal variables

Degree of incrementalism in the initial budgeting process Budget change: extent to which initial budgeted amounts differ from the previous year’s actual amounts (BUDGET_CHANGE) Budget changes by purpose and nature of spending (SPENDING_ PURPOSE_CHANGES; SPENDING_CATEGORY_CHANGES)

(Initial budgeted amount, Title j, year t)/(Actual legal commitments, Title j, year t –1 ) – 1, j = current or capital expenditures, t = 2003–7 Variance of budget change by destination and by nature of spending

Department of the Interior, 2002–7

Department of the Interior, 2003–7

Years since the last election (t_YRS_SINCE_LAST_ ELECTION)

Dummy for left (1) or right (0) wing Number of parties with at least one member serving on the Municipal Executive Board Number of years elapsed since the last local election

Organizational features Size (STAFF) Relative size of Financial Comptroller Office (CFO_OFFICE_SIZE) Rebudgeting for the title not used as the dependent variable (REBUDGETING_ON_OTHER_TITLE)

Personnel expenditures Per capita spending on Financial Comptroller Office Revised budget/Initial budget for current (capital) spending when capital (current) spending is the dependent variable – 1

Department of the Interior, 2003–7

Accumulated surplus or deficit from previous year/Total current revenues (Budgeted current revenues – Budgeted current expenditures – Budgeted loan repayments)/Budgeted current revenues (Tax revenues + Fee revenues)/Total current revenues (Personnel + Interest expenditures)/Total current revenues (Budgeted borrowing – Budgeted debt repayment) / Budgeted current revenues (Past-year surplus or deficit included in the revised budget – Past-year surplus or deficit included in the initial budget)/Revised budgeted current revenues

Department of the Interior, 2002–7

Provincial per capita GDP Dummy for north (0) or south (1)

National Statistical Institute (Istat), 2003–7

Political variables Political orientation (POLITICAL_ORIENTATION) Political fragmentation (POLITICAL_FRAGMENTATION)

Financial conditions Accumulated surplus/deficit (ACCUMULATED_SURPLUS) Current surplus/deficit (CURRENT_SURPLUS) Financial autonomy (FINANCIAL_AUTONOMY) Expenditure rigidity (EXPENDITURE_RIGIDITY) Net borrowing (NET_BORROWING) Revision of past-year surplus/deficit included in the budget (REVISION_OF_PAST_SURPLUS) External variables Local socioeconomic conditions Local economic conditions (LOCAL_GDP) Geographic area (SOUTH)

* Some variables were transformed to better approximate a normal distribution (log for P_GDP and reciprocal of square root for STAFF).

heteroscedasticity (modified Wald test), serial correlation (LagramMultiplier test), and cross-sectional dependence (Pasaran test). For both current and capital spending, these tests did not reject the absence of serial correlation and cross-sectional dependence, but rather confirmed the presence of heteroscedasticity. This was taken into account by using robust standard error estimates. Another issue was multicollinearity, which stemmed to a large extent from the strong negative correlation between SOUTH on the one hand and LOCAL_GDP and FINANCIAL_AUTONOMY on the other. The issue was consequently solved by dropping SOUTH from all specifications. Results From a descriptive viewpoint (table 4), rebudgeting is generally used to increase spending appropriations. The average increase was 4.4 percent for current spending and 16.4 percent for capital spending. Table 5 shows that, over the period 2003–7, 92.1 percent of municipalities adjusted current spending upward, while the remaining 7.9 percent adjusted it downward. For most municipalities (63.5 percent), the revision did not exceed ±5 percent of the initial amount. For capital spending, upward revisions occurred in 81.4 percent of the municipalities, with the other 18.6 performing downward revisions. The size of capital spending revisions was Table 4 Percentage Change between Revised and Initial Budget Title Title 1—Current expenditures Title 2—Capital expenditures

880

Mean

Std. Dev.

4.4% 16.4%

4.7% 37.8%

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much greater than for current spending. Upward revisions within 5 percent of initial appropriations occurred only in 23 percent of municipalities, while 29.2 percent of municipalities increased their initial appropriations by more than 20 percent. Similarly, downward revisions within 5 percent of initial appropriations occurred only in 6.4 percent of municipalities, while 6.9 percent of municipalities reduced their initial appropriations by more than 20 percent. From an explanatory viewpoint, tables 6 and 7 report the regression coefficients and the significance thresholds for the between-effects and the fixed-effects models, respectively. Hypothesis 1—that rebudgeting is affected by the degree of incrementalism in the formulation of the initial budget—is generally supported, in that BUDGET_CHANGE is negative and strongly significant (p < .01) across all specifications. This is consistent with rebudgeting being a complement to the initial budget formulation and playing a smoothing role that increases the incremental nature of the yearlong budgeting process. The more a policy has been incorporated into the initial budget, the less it needs to be pursued through rebudgeting. In fact, rebudgeting can be a way to repeal some policies that the administration introduced in the initial budget and, consequently, to realign the budget to the previous year’s situation. Contrary to expectations, however, the variable SPENDING_CATEGORY_CHANGES is never significant, while the variable SPENDING_PURPOSE_CHANGES is insignificant in the fixed-effects model and significant but positive in the betweeneffects model. In other words, governments that formulate the

Table 5 Distribution of Municipalities by Sign and Magnitude of Percentage Change between Revised and Initial Budget, 2003–7 2003

2004

2005

2006

2007

Average, 2003–7

Current Capital Current Capital Current Capital Current Capital Current Capital Current Capital Spending Spending Spending Spending Spending Spending Spending Spending Spending Spending Spending Spending Upward revisions

0%–5% 5%–10% 10%–15% 15%–20% > 20%

Downward revisions

0%–5% 5%–10% 10%–15% 15%–20% > 20%

55.9% 28.2% 6.0% 2.9% 1.1%

22.4% 14.8% 11.7% 5.6% 33.0%

59.5% 23.5% 4.9% 2.1% 0.8%

24.6% 12.5% 10.8% 6.4% 30.5%

55.2% 28.0% 7.4% 2.2% 1.3%

21.5% 12.1% 8.1% 7.6% 31.6%

94.2%

87.4%

90.7%

84.8%

94.0%

4.7% 0.7% 0.2% 0.2% 0.0%

4.6% 1.6% 0.7% 1.6% 4.0%

7.2% 1.1% 0.4% 0.0% 0.6%

3.0% 2.5% 1.9% 1.7% 6.1%

4.7% 0.4% 0.4% 0.0% 0.5%

5.8%

12.6%

9.3%

15.2%

6.0%

Table 6 Coefficients for Between-Effects Model Variable

R2 Cons

Current Spending

Capital Spending

.27 .001

Organizational features STAFF_TSF CFO_OFFICE_SIZE REBUDGETING_ON_OTHER_TITLE

–.002 .001 .079 .001*** .006**

23.0% 13.0% 10.7% 5.3% 24.2%

60.3% 26.1% 5.7% 1.7% 1.3%

23.7% 12.9% 7.9% 6.1% 26.8%

57.1% 25.7% 6.0% 2.3% 1.0%

23.0% 13.1% 9.8% 6.2% 29.2%

81.0%

86.8%

76.3%

95.0%

77.4%

92.1%

81.4%

5.1% 4.0% 3.1% 2.2% 4.7%

10.3% 2.0% 0.7% 0.2% 0.0%

6.1% 3.2% 1.8% 0.7% 11.9%

4.8% 0.2% 0.0% 0.0% 0.0%

5.9% 3.0% 2.8% 3.1% 7.8%

6.4% 0.9% 0.3% 0.1% 0.2%

4.9% 2.9% 2.0% 1.9% 6.9%

19.0%

13.2%

23.7%

5.0%

22.6%

7.9%

18.6%

Table 7 Coefficients for Fixed-Effects Model

Degree of incrementalism in the initial budgeting process BUDGET_CHANGE –.209*** SPENDING_CATEGORY_CHANGES .053** SPENDING_PURPOSE_CHANGES –.006 Political variables POLITICAL_ORIENTATION POLITICAL_FRAGMENTATION

54.7% 22.6% 6.1% 2.7% 0.7%

.19 .010 –.044*** — — .002 .006 159.204 –.001 .041**

Financial conditions ACCUMULATED_SURPLUS CURRENT_SURPLUS FINANCIAL_AUTONOMY EXPENDITURE_RIGIDITY NET_BORROWING REVISION_OF_PAST_SURPLUS

.018 –.083*** –.009 –.040 .031*** .290***

–.039 –.359 –.178** –.161 –.001 1.804***

Local socioeconomic conditions LOCAL_GDP_TSF

–.011**

–.067

** Significant at 5%; *** significant at 1%.

initial budget by applying uniform increases to the previous year’s figures, with no differentiation across types of expenditures, do not feel a greater need to adjust their appropriations during the fiscal year. This result is somehow counterintuitive, as the lack of sophistication in the formulation of the initial budget could reasonably be expected to require greater adjustments during the fiscal year. A possible explanation is that the municipalities that apply uniform increases are those that prefer to keep the status quo, do not feel any need to revise this choice during the fiscal year, and consequently have little need for rebudgeting. Hypothesis 2—that political variables will affect rebudgeting— is supported only with respect to the electoral cycle and especially for current spending. More specifically, rebudgeting will be greater both at the beginning of an administration’s term of office (0_YRS_SINCE_LAST_ELECTION and 1_YR_SINCE_ LAST_ELECTION are positive and strongly significant for current spending) and toward its end (4_YRS_SINCE_LAST_ ELECTION is positive and strongly significant for both current

Variable

R2 Cons

Current Spending

Capital Spending

.42

.44

–.060

–1.893

Degree of incrementalism in the initial budgeting process BUDGET_CHANGE –.067*** SPENDING_CATEGORY_CHANGES –.021 SPENDING_PURPOSE_CHANGES .006

–.024*** — —

Political variables POLITICAL_ORIENTATION POLITICAL_FRAGMENTATION 0_YRS_SINCE_LAST_ ELECTION 1_YRS_SINCE_LAST_ ELECTION 3_YRS_SINCE_LAST_ ELECTION 4_YRS_SINCE_LAST_ ELECTION

–.003 –.001 .009*** .009*** .006** .009***

–.009 –.003 .006 .021 .018 .073***

Organizational features CFO_OFFICE_SIZE REBUDGETING_ON_OTHER_TITLE

–.001 .001

.002 –.001

Financial conditions ACCUMULATED_SURPLUS CURRENT_SURPLUS FINANCIAL_AUTONOMY EXPENDITURE_RIGIDITY NET_BORROWING REVISION_OF_PAST_SURPLUS

.045 .025 .006 .185*** –.013 .215***

.205 .059 –.332** –.248 –.205*** .928***

Local socio-economic conditions LOCAL_GDP_TSF

–.017

–.606***

** Significant at 5%; *** significant at 1%.

and capital spending; 3_YRS_SINCE_LAST_ELECTION is positive and significant for current spending). Toward the end of the term, rebudgeting is probably a way for the administration to increase political consensus and, as a consequence, its own chances of reelection. At the beginning of the term, a possible explanation is that a newly elected administration will use rebudgeting to gradually incorporate its policies into the budgeting process—all the more so in the election year, the budget for which will have been prepared by the outgoing administration. The other political variables (POLITICAL_ORIENTATION and POLITICAL_FRAGMENTATION) are never significant. A possible explanation is that the key functions and issues that municipalities must deal with are not dictated by political ideology but by basic service expectations. Hypothesis 3—that organizational features will affect rebudgeting—is supported only in the between-effects model, by Budgeting and Rebudgeting in Local Governments: Siamese Twins? 881

the positive and statistically significant coefficients for CFO_ OFFICE_SIZE (current spending only) and REBUDGETING_ ON_OTHER_TITLE. Size, as captured by the variable STAFF, is never significant. The positive coefficient for CFO_OFFICE_SIZE seems to suggest that a larger Financial Comptroller Office will use its power to impose fiscal conservatism in the initial budget formulation and to authorize increased spending through rebudgeting only when expected revenues are actually recognized. The positive coefficients for REBUDGETING_ON_OTHER_TITLE apparently confirm the presence of cross-organizational differences in the propensity toward rebudgeting, even after controlling for financial conditions.

The descriptive part of our results indicates that upward revisions to the budget are more frequent than downward adjustments, especially for current spending. This probably reflects a conservative approach to the formulation of the initial budget, whereby initial expenditure appropriations are defined solely on the basis of those revenues whose occurrence is viewed as sufficiently certain. During the fiscal year, as extra revenues are recognized, spending appropriations are increased through rebudgeting. Given that overspending the budget is illegal, but underspending is not, it is in fact surprising that the budget should ever be revised downward. In the presence of decreases in revenues, the administration could simply require the departments to contain spending without asking the city council to formally approve a downward revision of the budget. Possible explanations for the presence of downward revisions include the following: (1) underspending may be perceived by stakeholders as an indicator of poor performance, and downward revisions may be an effective way of concealing it; (2) if budgeting is incremental, downward revisions may be used to set a lower baseline for the next year’s budget; (3) if actual revenues fall short of budgeted ones, downward revisions may be the only effective way of forcing departments to reduce their spending plans, thus preventing the emergence of deficits.

Hypothesis 4—that the municipality’s financial conditions will affect rebudgeting—is generally confirmed, even after controlling for the midyear emergence of past-year net surpluses or deficits, which was found, unsurprisingly, to encourage rebudgeting (REVISION_OF_PAST_SURPLUS > 0 and strongly significant across all specifications). More specifically, municipalities in better financial conditions seemingly require smaller midyear adjustments, presumably because they enjoy greater degrees of freedom during the initial budgeting process. This is consistent with the negative and statistically significant coefficients for CURRENT_ SURPLUS (for current spending in the between-effects model), the The reference to incrementalism leads to the explanatory part of the negative and statistically significant coefficients for FINANCIAL_ article. In this regard, all of the hypotheses were supported, although AUTONOMY (for capital spending in both models), the positive not for all variables and across all specifications, and obviously with and statistically significant coefficients for EXPENDITURE_ direct reference only to the period and governments under study. RIGIDITY (for current expenditure in the fixed-effects specification). The only partial anomaly is NET_BORROWING, whose First and foremost, rebudgeting was confirmed to be a complecoefficient is significantly positive for current expenditure in the ment to the initial budget formulation. The more a policy has been between-effects specification and significantly negative for capital incorporated into the initial budget, the less it needs to be pursued expenditures in the fixed-effects specification. through rebudgeting. In fact, rebudgeting A possible explanation is that, in the presence can be a way to repeal some policies that the The more a policy has been of extensive borrowing, municipalities will administration introduced in the initial budincorporated into the initial initially be very conservative in their current get and, consequently, to realign the budget to budget, the less it needs to be appropriations, only to increase them during the previous year’s situation. pursued through rebudgeting. the fiscal year to the extent that it is possible to do so. At the same time, they will be Under a first type of complementarity, rebudunlikely to further increase capital spendgeting is a way for the municipality to fill a gap ing through rebudgeting because borrowing cannot be further in its initial programming or to adapt its resource allocation to changincreased and because other capital funds becoming available during political priorities. Thus, when initial appropriations are only ing the year (e.g., sale of fixed assets, capital transfers from higher marginally different from the previous year’s, they are less likely to levels of government) will be used to replace budgeted borrowing match the dynamic evolution of needs and thus more likely to require rather than to fund additional capital projects. midyear revisions. In addition, newly elected administrations will make a greater use of rebudgeting because they must operate within Hypothesis 5—that the municipality’s external environment will the budget approved by the outgoing administration and because they affect rebudgeting—finally, is confirmed by the negative and statisti- need some time to fully finalize their policies. Similarly, in the poorer cally significant coefficient of LOCAL_GDP in the between-effects areas of the country, where public management skills are, on average, model for current expenditures and the fixed-effects model for weaker than elsewhere (see, e.g., Anessi-Pessina and Steccolini 2007; capital expenditures. In other words, poorer municipalities (generAnessi-Pessina et al. 2008; Giordano, Tommasino, and Casiraghi ally located in the south) show a greater propensity to revise upward 2009; Nasi and Steccolini 2008; Putnam, Leonardi, and Nanetti their budgeted expenditures during the fiscal year. 1993), municipalities will be less likely to frame the initial budget within a comprehensive programming effort and consequently will Discussion and Conclusions use rebudgeting to a larger extent. The existing literature on budgeting has traditionally focused on the formulation of the initial budget. In contrast, this article argues that Under a second type of complementarity, rebudgeting is a way for budgeting is a yearlong process composed of initial budgeting and politicians to pursue opportunistic goals. In particular, as elections rebudgeting. Our focus, therefore, is on rebudgeting, using five-year approach, politicians will use rebudgeting to increase their chances data from Italian municipalities to test our hypotheses. of reelection. 882

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Under a third type of complementarity, rebudgeting is a way for powerful Financial Comptroller Offices to enforce fiscal conservatism in the formulation of the initial budget. Because underspending the budget is always an option, while overspending is not, if rebudgeting were not allowed, initial budgets would have to ensure the presence of slack resources to face unexpected events and new issues emerging during the year. Thanks to rebudgeting, on the contrary, the formulation of the initial budget can be conservative and spending limits can be gradually relaxed as revenues are actually recognized.

programs into a new budget. Another relevant policy implication is that rebudgeting should be made more transparent. At present, rebudgeting is a much less visible process than budgeting, also because it is often composed of several small amendments to the initial budget, whose total amount is nevertheless important. Consequently, legislation could provide for city councils to devote one or two midyear sessions to budget revisions in order to effectively keep rebudgeting under control and ensure its overall consistency.

For practitioners, our results call for increased Under a fourth type of complementarity, For practitioners, our results call attention to rebudgeting, which clearly emerges as a politically charged, yearlong rebudgeting is a way for municipalities in for increased attention to rebud- process rather than a purely technical matter. dire financial conditions and disadvantaged geting, which clearly emerges as As such, the key question is how rebudgetsocioeconomic environments to meet changes a politically charged, yearlong ing can be used to improve the government’s in the constraints they face. Municipalities performance rather than favor the pursuit of serving wealthier constituencies and characterprocess rather than a purely opportunistic goals. Two considerations stand ized by comparatively larger surpluses, own technical matter. out. revenues, and discretionary expenditures will have more leeway in the formulation of the initial budget and are less likely to revise it in the presence of chang- First, rebudgeting cannot be a one-size-fits-all process. Each organization must develop its own approach and culture to budgeting and ing constraints. rebudgeting and translate it into rules and routines that are consistent with its specific contextual and political conditions. Finally, two further points are worth highlighting. On the one hand, rebudgeting seems to be a consequence of specific organiSecond, in doing so, the organization’s main concern should be zational cultures, in that governments seemingly have different how to manage and steer the flexibility that rebudgeting offers. propensities toward it. On the other hand, the determinants of If properly used, rebudgeting allows the organization to revise its rebudgeting are partially different for current and capital expengoals and priorities in order to keep them aligned with changing ditures. One major difference is that CFO conservatism in the internal and external conditions. Under dire financial circumformulation of the initial budget is apparently stronger for curstances, more specifically, it can be a powerful tool to initially rent spending. This is not surprising, for at least two reasons: (1) impose strict spending constraints, which can gradually be relaxed once authorized in the budget, current spending usually can take as uncertain revenues actually materialize. The risk is for these place without further constraints, while capital spending must changes to be decoupled from the organization’s overall planning go through a more complex process (the sources of funding must and control system. In an overly simplistic approach, a governactually be obtained; a project must be prepared and approved; a ment would align its planning and control system with the initial contractor must be identified, etc.), and consequently it is easier to cancel or postpone; (2) current spending, even for items other than budget: the initial budget presents the spending implications of the organization’s goals and programs; what cannot be funded in the personnel and interest, sets a baseline that is difficult to reduce in initial budget is excluded from the organization’s goals and prothe following years. grams for the current year. As a consequence, the organization will have no plans for the use of additional resources that may materiFrom a research viewpoint, this article sheds some light on the alize during the fiscal year, so that it will be easier to funnel these relationship between budgeting and rebudgeting. Moreover, it resources toward the parochial interests of politicians and bureaumakes a contribution to the traditional studies on incrementalism, crats. Alternatively, should resources prove lower than expected, no which have paid little attention to the implications of incremental budgeting for budget execution. Future research should try to better plans will exist for where to focus the cost containment efforts, so disentangle the determinants of budgeting and rebudgeting. It could that the axe will naturally fall on new initiatives put forward in the initial budget. also analyze the roles played by politicians, managers, and other stakeholders in the rebudgeting process. In conclusion initial budgeting and rebudgeting must be viewed as the components of a yearlong process; they take on specific features From a policy viewpoint, because elections and changes in politiin each organization; they must be designed and managed in an intecal orientation affect rebudgeting, one may wonder whether the grated fashion, as their interactions must be aligned with the organicurrent election timing is consistent with the budget cycle. In Italy, zation’s planning and control system and other managerial tools. for instance, elections are usually held between April and June. The incoming administration thus has to wait six to nine months Acknowledgments before it can formulate its first budget. In the meantime, it has to The authors wish to acknowledge the anonymous reviewers for their operate within the constraints set by the previous administration’s very helpful comments. We would also like to acknowledge funding choices and will resort to rebudgeting to modify such constraints. by the Public Management Department, SDA Bocconi School of An alternative would be to hold elections in the autumn, allowing Management. the incoming administration to translate immediately its electoral Budgeting and Rebudgeting in Local Governments: Siamese Twins? 883

Note 1. The year-end statement includes the actual amounts of revenues and expenditures under the commitment basis of accounting, that is, the “establishments of amounts receivable” and the “legal commitments.” The definitions of revenues and expenditures under the commitment basis of accounting are similar to the European Union’s—see Council regulation (EC, Euratom) no. 1605/2002 of June 25, 2002, on the financial regulation applicable to the general budget of the European Communities. For revenues, the “establishment of an amount receivable is the act by which the authorising officer [ . . . ] (a) verifies that the debt exists; (b) determines or verifies the reality and the amount of the debt; (c) verifies the conditions in which the debt is due. For expenditures, “the legal commitment is the act whereby the authorising officer enters into or establishes an obligation which results in a charge.”

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