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Proposing a New Way to Budget in Arlington

For the last several years I’ve been pushing to change the way budgeting is done in Arlington. I’d like to explain my proposal, argue why it is a better process than the one we have today, and make some points about why now is a very good time to make the change.  (This is only about budgeting expenditures, not revenues.)

First, let’s look at the current town budget, in rough numbers. For the sake of example, if the budget was under $1 million, it got lumped into another budget. (You can see a much more detailed version of the FY10 budget here).

DPW $7,206,358
Police $5,847,363
Fire $5,534,923
Libraries $1,974,669
Town Manager $4,293,718
Other Town Depts (BoS, Clerk, etc.) $2,774,195
Schools $38,430,596
Snow and Ice $1,300,000
Warrant Articles $3,736,883
MBTA assessment $2,527,845
MWRA debt service $5,593,112
Capital $8,107,764
Other Expenditures $1,947,781
Pensions $6,595,296
Insurance $18,019,711
Total $113,890,214

Those two last line items are not like the others. I know what the DPW does.  I know what schools do.  I know that the capital budget buys buildings and trucks, and I know the MBTA runs buses in town.  But pensions and insurance are different. They’re not a department, or a service, or a town activity. These two line items are different because they are an aggregation of costs that are incurred in other budgets. The insurance is the cost of providing a current health insurance benefit to our town employees and retirees. The pension is a combination of current and future obligation to provide a retirement benefit for our town employees.Pensions and insurance are related to all of the other line items, but they are secondary, not primary, to a town function.

So what drives the size of pensions and insurance?  Basically, it’s the number of town employees, and the amount of money they earn in wages. The town spends a bit more more than $50 million in wages. That $50 million number can’t be determined from the budget information I posted above; I did a back-of-the-envelope calculation from the various departments’ budget details.

To put it another way: for every dollar the town budgets for wages, it must also budget another $.50. For the purposes of this proposal, I’ll call those numbers “salaries” and “overhead.”

This is the root of why I don’t like the current budget process. Say you’re the Police Chief, and you’re looking a tough budget with unpleasant choices. You’d like to hire an additional patrolman, and you manage to scrape $50,000 out of your expenses budget in order to make it happen. That didn’t leave any budget for the $25,000 in overhead. A different example: say you’re the school Superintendent, and you’re trying to find a way to keep class sizes small in your biggest elementary class. You can’t fire any kids, but you can hire a couple more teachers – you forgo some text books, delay a network upgrade, and find the $100,000 in your budget to hire those teachers. Again, that didn’t leave any budget for the $50,000 in overhead for those new teachers.

I know we hire smart administrators in Arlington. I am certain that the people making these hiring decisions know that the employee benefits cost money. Still, the current budget process doesn’t provide any incentive for them to account for it. Their professionalism keeps them from taking advantage of the system. But when the toughest decisions are being made in the wee hours of the morning, when the edge cases are being decided, they have the luxury of making the overhead cost someone else’s problem. I’ve been on the Finance Committee for five years now, and I know that it happens. I interview the budget writers, I quiz them on their decision process, and I know that it happens. This statement is not meant to blame the town’s administrators. “You get what you measure” is one of my favorite aphorisms. We measure our administrators to deliver services on a limited budget, and we can’t hold it against them when they do that with some creativity.  With our current budget process, the cost of that creativity is hiring decisions that don’t account for the full cost of the employee.

So here’s the alternative. Reshuffle the budgets such that overhead is included in each departmental budget. Apply the cost of the health care and pension at the same place that it is incurred, right with the salary. Here’s what my new budget would look like, roughly (the by-department overhead budgets are very rough estimates):

Old Overhead New
DPW $7,206,358 $2,562,040 $9,768,398
Police $5,847,363 $2,078,883 $7,926,246
Fire $5,534,923 $1,967,803 $7,502,726
Libraries $1,974,669 $702,044 $2,676,713
Town Manager $4,293,718 $1,526,524 $5,820,242
Other Town Depts (BoS, Clerk, etc.) $2,774,195 $986,295 $3,760,490
Schools $38,430,596 $14,791,417 $53,222,013
Snow and Ice $1,300,000 $1,300,000
Warrant Articles $3,736,883 $3,736,883
MBTA assessment $2,527,845 $2,527,845
MWRA debt service $5,593,112 $5,593,112
Capital $8,107,764 $8,107,764
Other Expenditures $1,947,781 $1,947,781
Pensions $6,595,296 $0
Insurance $18,019,711 $0
Total $113,890,214 $113,890,214

Some key points about the model:

  • It’s a net zero-budget change. This doesn’t make any changes in service levels, doesn’t move money from one department to another, and doesn’t save any money (at least not in and of itself).
  • A few people I shared this idea with were concerned that it would be a health privacy (HIPAA) violation to print what insurance various employees are getting. I’m not suggesting that we do that. I’m suggesting we use average healthcare and pension costs, based only on salary and other already-public information. Departments don’t get charged for their individual employee health care decisions. They get charged for the average cost, multiplied by the number of employees.
  • Computationally this is pretty easy. At the start of every budget cycle the Town Manager (or Comptroller or Treasurer or whomever) would publish that year’s overhead rate, and every department would get it in their budget spreadsheet.
  • The insurance budget is always a difficult one to predict, not least because the town sets the rates in December, halfway through the budget cycle. This plan doesn’t help or hurt that risk. It still needs to be managed.
  • No overhead is charged when there is no salary paid.  That’s why budgets like the capital budget would be unaffected.

There’s another interesting side-benefit to this method.  The town’s labor contracts are negotiated in two chunks, one by the Town Manager and the other by the school Superintendent.  The current system doesn’t really reward a specific budget when there is a negotiated health care savings.  The new method would permit the parties to come to an agreement that is more specific to the union in question.  If the firefighter’s union wishes to trade higher salary for a smaller health benefit, the new budget system would be able to accommodate that.  Likewise, if the teacher’s union wishes to negotiate a lower salary for a larger health benefit, that isn’t difficult to place into the budget.  This idea isn’t core to my proposal, but it’s worth mentioning.

I’d also like to make the case that now is a better time than any other to make this change:

  • We’re going into the next year without a five-year plan. If we change the budgetary rules in the middle of a planned period, we’d also have to update the plan, and that is contentious. By making this change now, we get to tackle the challenges separately.
  • The town is already in an introspective period. The Town Reorganization Committee is already meeting, and this is a perfect topic for it to consider.
  • The town’s budget process is already changing. Nancy Galkowski has been the budget’s shepherd for a long time, and she has moved on to a different job. The process is certain to change as a new cat herder is brought to the process.

This overhead-based budget process brings the true costs of hiring closer to the hiring decision. Our town budget makers will be reminded of the actual cost of hiring at the time they make their budget. Armed with that information, they can make the best, most-informed decision in the town’s best interests. Now is the right time to make the change.

Comments

Comment from Bob Sprague
Time: January 28, 2010, 8:54 am

I have linked this excellent proposal to YourArlington and hope that town and school leaders will seriously consider it.

Comment from Yoav Shapira
Time: January 28, 2010, 8:59 am

I am neither an Arlingtonian nor have public budgeting experience, but this proposal makes sense to me.

It’s more transparent, easier to read for the novice (me), easier to understand, and thus, I would assume, easier to act upon.

Comment from Susan
Time: January 28, 2010, 9:22 am

The method you described is what I use in program management, and I assume in many other types of businesses. It allocates the costs to where they are being incurred and enables the types of negotiation you described – as well as providing incentive to hire temporary or hourly workers (such as aides) with lower OH/benefits when that option makes sense. I have had favorable experience in business when the decisions are pushed to the lowest level that has full responsibility. In this case, it sounds like DPW, Schools, fire and police have responsibility to provide a service within their budget.
Well said. I hope it is considered and adopted.

Comment from John M
Time: January 28, 2010, 10:54 am

Hi Dan,
I like where you are going with this proposal. I know your table contains rough numbers but do you propose to assign an overhead rate to the entire departmental budgets or just to the salary portion of each budget? Also, how would you assign the insurance and pension liabilities for retired employees? Would you go back and figure out which department they worked for or would you set a cut off point where retiree costs are still consolidated but all current employees are included as overhead in the departments budgets?

Comment from Steve
Time: January 28, 2010, 1:43 pm

Dan,

I also like your idea. For someone not familiar with the overall budgets to the degree that people on the finance committee or administrators are, the budgets are often times difficult to figure out. Your proposal goes a long way in making it easier to know what the true costs are.

My initial reaction to your proposal without putting much thought into it (so I hope I don’t get into trouble here) however would be to just ask why not just include the total costs and then split then out by department and then by personal, capital and overhead and other misc costs??

So in your example if the cost of a position is 50,000 and the overhead is 25,000 why not just include the 75,000 as the true cost?? So if the total police budget was 50 million, and 30 million was the true personnel cost (including the overhead) and 20 million being equipment and other misc costs why not just list it like that. You could include the % that the overhead is so people can figure out what those costs are. Also you could include a separate analysis/breakout for just total insurance and pension costs. As for retirees I would imagine that could be a separate line item regardless of what department they worked in.

I know with my company when we budget for projects we include base salary then include a % for the overhead which gives us the total personnel costs and then we include in the other costs for material etc…

Anyway just an initial thought…

Comment from Dr. Wayne Pitcher
Time: January 28, 2010, 2:36 pm

Dan, your idea makes a lot of sense. The concept of overhead definitely reared its head when I wrote grants at UMass Boston (not that I got any of those grants). Each grant would have overhead calculated for it, though there were weird things like overhead not counting against the dollar amount of the awarded grant (so a $100,000 grant could actually exceed that amount when overhead was factored in). Of course, overhead is one way universities make movey off of grants.

It’s too bad I can’t fire any of my students. 🙂

Comment from Dr. Wayne Pitcher
Time: January 28, 2010, 2:36 pm

Er, that should be “make money off of grants”

Comment from Quantum Mechanic
Time: January 28, 2010, 7:09 pm

An excellent proposal!

Unfortunately, it makes too much sense to ever get adopted, sadly.

It’s stunning to me that benefits overhead doesn’t “live” in the department budgets already.

Comment from dunster
Time: January 28, 2010, 8:22 pm

Thank you all for your comments.

@JohnM – My suggestion is to apply the overhead to the salary portions of a department budget only. Healthcare is a per-person expense. Pension expense is based on salary.

The question about how to handle retiree benefits is a bit stickier. My initial proposal is to just ignore it, and have the departments bear responsibility for retirees based on current employee counts. I think the “winner” in a plan like this would be the DPW which has reduced the most, and therefore wouldn’t be paying for its past retirees exactly.

The alternative would be to leave retirees as a separate budget line, like is done today. The downside to that is that it would require our actuarial consultant to break the pension assessment into two chunks, the cost of current employees, and the cost of past retirees. I don’t see that as a big win, but it’s an option.

@Steve – If I understand your point correctly, we’re on the same page. The budget does already successfully put the expenses in the right departments – schools pay for their maintenance and heating, police pays for their fuel, etc. That part the town does already. If you take a look at the detailed budget I lined to, and go into the Appendix for budgets, you’ll see it.

The capital budget is trickier. It is by definition very lumpy – huge expenses for a couple years for a specific department, then zeroes for years after that. I don’t think we gain any budgeting successes by including that lumpiness into annual budgets. Drop me an email if I didn’t understand your point.

Comment from Flynn Monks
Time: February 1, 2010, 4:27 pm

This makes total sense. I’m actually quite baffled how it can be that it would be otherwise. So, how does it get implemented asap?

Pingback from Dan Dunn’s Podium » Two Arlington Finance Meetings
Time: February 4, 2010, 1:12 am

[…]  Not much effect this year, but might be a big saver in a few years. There was a discussion about my proposal to use fully loaded budgets.  The Manager was “concerned about putting the actual money in […]

Comment from Craig Colman
Time: February 4, 2010, 10:26 am

While you proposal makes sense, and is exactly the way we run my business, to me an important question is does keeping insurance and pensions as separate line items make it easier for us to tap into other revenue sources ? I heard an idea being batted around that since heathcare costs are increasing so quickly that there might be state or federal funds to help pay for some of the increases. While this might just be a pipe dream, we need to make sure that our budget is set up to be able to take advantage of any potential revenue opportunities.

Comment from Ron Spangler
Time: February 6, 2010, 8:50 am

Dan – I agree with you. This is how most services organizations budget and track costs. (As a former P/L manager, I know it all too well … ) As with out of district Special Education tuitions, which used to be “off budget” for the school department, putting the indirect costs of personnel into an off-budget bucket creates a perverse disincentive to watch those costs. (Before 2006, it actually made more sense for the school department to send a child with special needs to an expensive private school than to accommodate those needs in-district.)

With insurance, when the 2006-09 teachers’ contract was negotiated, the Town Manager took issue with the health insurance deal reached by the Superintendent with the AEA negotiators. I disagreed with the Manager that the school dept. was too generous, but that’s not relevant at the moment.

To make sure we’re all on the same page this time, we made a point of including the Manager in the ongoing AEA negotiations. It’s not what you propose, but it’s a step in that direction.

Ron Spangler

Comment from Sue Doctrow
Time: March 13, 2010, 8:38 pm

Dan, This is an excellent proposal. It would make the budgets much more informative and, as you and others have suggested, provide incentive to pay attention to these costs and factor them into hiring decisions. I have written federal research grant proposals for 20+ years. We always have a “fringe benefit” figure beside each salary. Where I work now, that figure is about 26%, and does not include pensions (pensions? what are those? 😉 Then, we add an “indirect costs” figure as one line item for broader overhead costs that are not directly linked to individual employees. Like most elegant ideas, yours looks so obvious now that I’m seeing it. I hadn’t even thought about the difference between the town budgets and the ones I always write before seeing your post (thanks to Michael Quinn’s link to it on the Arlington List). Anyway, as others have said, I hope your idea will be adopted.

Comment from Gordon Jamieson
Time: March 14, 2010, 9:46 am

Good thoughts Dan (as always)

Yet I believe you need to back out the solid waste collection costs from the DPW budget line item since it represents the cost of services from WM that do not have any town side overhead cost

Cheers, Gordon

Pingback from Dan Dunn’s Podium » Town Meeting ‘10 Session 6
Time: May 13, 2010, 1:57 am

[…] course, am a huge proponent of the overhead budgeting.  You can read more in my previous post on budgeting. Phelps moves the question. Approved on voice […]