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"A popular government without popular information or the means of acquiring it, is but a prologue to a farce or a tragedy or perhaps both."

James Madison

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IN THIS AGE OF CORPORATE SCANDAL AND PUBLIC CONCERN OVER ACCOUNTABILITY, WE MUST BE CERTAIN THAT, AS WOODROW WILSON SAID, GOVERNMENT IS “ALL OUTSIDE AND NO INSIDE.”

• The current budget system promotes unmanaged growth.
  Baseline budgeting makes effective management of the budget nearly impossible.
• Performance metrics and measures are not employed.
  Budgets are not tied to performance measures, and performance results are not measured or tracked.
• Meaningful budget and financial information is not available.
  The state lacks enterprise-wide budget and financial systems that are necessary to produce the information managers' need to plan and manage. Existing technologies are dated and fragmentary.

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California’s state government should reflect the decency, integrity and honesty of the people it serves. In this age of corporate scandal and public concern over accountability, we must be certain that, as Woodrow Wilson said, government is “all outside and no inside.”

At a practical level, this means that our financial systems must keep straightforward and complete records, that we account fully for every government action, and that we practice “government in the sunshine.” Self inspection is the first step to responsible government.

The demands of government accountability do not stop there. We should manage and budget public funds based on defined goals and objectives. Our success— or failure—should be measured against clearly stated standards of performance. We should track how well our agencies and departments do and tie performance to future funding decisions.

HOW WE BUDGET MONEY AND WHAT WE GET FOR THE DOLLARS WE SPEND ARE PERHAPS THE MOST IMPORTANT ISSUES IN GOVERNMENT. RATHER THAN DOLE OUT MONEY BASED ON WHAT AGENCIES RECEIVED LAST YEAR, WE SHOULD TIE BUDGETS TO PERFORMANCE.

Annual incremental budgets that nudge prior years’ allocations ahead by some amount based on flimsy criteria are tantamount to not budgeting at all. Performance should guide all budget decisions, and managers should be held accountable for their use of public funds.

In the area of financial management of the state’s resources, CPR finds the state particularly deficient. Our systems are old and outmoded. The finances of the state do not meet national standards for financial reporting. While agencies of our government demand accountability from corporations in which the state invests, we cannot make the same certain claim of accountability.

Our budget practices also should be improved. The systems used to manage the budget are, again, out of date. More importantly, though, our state’s budget is based on an old style of line-item budgeting that virtually guarantees poor budget decision making, since the Governor and the Legislature do not have all of the information they need to make the best judgments about how to spend the state’s resources.

Budget crises tend to focus the harsh light of reality on how well government does its job. The harsh reality in this area is that we need to do better, much better. This may be one of the most important areas of improvement in this study since it goes to the heart of the public’s trust in our stewardship of government and our use of their hard-earned tax dollars.

How we budget money and what we get for the dollars we spend are perhaps the most important issues in government. Rather than dole out money based on what agencies received last year, we should tie budgets to performance. When resources are scarce, it is important that the Governor and Legislature have the best information available to make informed decisions about the benefits and costs of state programs.

Our financial system cannot provide this essential information today. Budgeting is piecemeal, fiscal data are lacking, and there are no performance measures to gauge the performance of one program among many.

In short, California today is extremely limited in its ability to foresee and react to budget changes. All states have difficulty dealing with unexpected shifts in economic trends, but the best prepared states have fiscal systems that allow adjustments to be made quickly and effectively in a way that doesn’t compromise vital state services.

California’s budget process traditionally examines an individual program’s prior level of funding as a base amount without considering if that amount was necessary. The result is that some California program budgets may be inflated unnecessarily. The process begins with departments preparing baseline budgets to maintain existing services. Departments also may prepare “budget change proposals” to increase or decrease funding.

The Department of Finance (DOF) analyzes the budget change proposals, focusing on the fiscal impact of the proposals and their consistency with the policy priorities of the Governor. For some caseload-driven programs, such as financial assistance to the poor and elderly, the process may differ slightly, although the approach is the same. Instead of submitting budget change proposals, these departments submit a letter outlining proposed changes to their caseload assumptions. These letters typically include program and fiscal changes to the baseline budget.

Instead of appropriating funding for individual items such as personnel costs and equipment, the Legislature in many cases authorizes a lump sum appropriation for a program, which does not limit spending to specific items, but instead permits program managers some decision-making flexibility. These lump-sum appropriations, however, do not identify goals and objectives, or tie the appropriations to performance measures that would demonstrate whether the goals and objectives are met.

While the current process has worked during periods of revenue growth and budget surpluses, it does not identify programs that have outlived their purpose. Even when revenues are increasing, it is difficult to address emerging critical needs or new priorities. As the California Constitution Revision Commission noted in 1996, “for members of legislative budget committees or citizens frustrated with the operation of state government, making changes to the status quo is extremely difficult.” Since 1996, that situation has not changed.

When revenues decline and deficits appear, however, the existing process collapses. When budget shortfalls were first projected in May 2001, the DOF abandoned the traditional budget process to balance the budget. DOF conducted internal reviews to identify ways to reduce programs and then asked departments to submit plans to achieve targeted budget reductions. These reviews and plans, however, also worked off the baseline budget.

The state has been unable to reduce expenditures sufficiently over the long haul, and the Fiscal Year 2003–2004 Budget Act relied on approximately $20 billion in borrowing to bridge the shortfall. Because this budget relies heavily on borrowing and one-time solutions, the state faces operating deficits estimated at more than $14 billion annually over the next five years. The Legislative Analyst’s Office has concluded that “the persistent nature of the out-year operating shortfalls—even in the face of an improving economy—indicates that the State will not be able to ‘grow its way out’ of its budget problems.” The current deficits are the result of three years of major imbalances between revenues and expenditures.

Facing similar problems, many private businesses and governments across the nation have looked for an alternative to traditional incremental budgeting. That alternative is performance-based budgeting.

PERFORMANCE-BASED BUDGETING ADAPTS PRIVATE-SECTOR BUDGET PROCESSES TO THE PUBLIC SECTOR.

Performance-based budgeting adapts private-sector budget processes to the public sector. A performance-based budget process identifies what each department is trying to accomplish, how much it is planning to do with its resources, and how well it did with the resources it had last year. Money can then be budgeted based on decisions about the desired service level from each program, and program managers are held accountable for carrying out those decisions.

The advantage of performance-based budgeting is that funding is allocated based on what a program can accomplish. It also allows decision-makers to identify programs that have outlived their purpose. In addition, when budget shortfalls occur, it allows decision-makers to identify which reductions will have the smallest negative impact.

THE ADVANTAGE OF PERFORMANCE-BASED BUDGETING IS THAT FUNDING IS ALLOCATED BASED ON WHAT A PROGRAM CAN ACCOMPLISH. IT ALSO ALLOWS DECISIONMAKERS TO IDENTIFY PROGRAMS THAT HAVE OUTLIVED THEIR PURPOSE.

A number of states have successfully adopted the performance-budgeting approach. In its review, CPR looked at working examples in Florida, Texas and Washington. We also examined the results a pilot program conducted in California during the 1990s.

CPR is not alone in seeing potential value in a budget approach based on measuring and funding for results. The Little Hoover Commission and numerous other organizations have recommended implementing a performance-based budgeting system in California. Specifically, the commission found that “the current process for allocating funds and setting program priorities is not a framework that encourages the best policy decisions, especially in times of economic contraction.” As a result, the May Revision to the Governor’s Budget included proposed legislation to require state agencies and departments to:

• Develop strategic plans;
• Prepare annual action plans which identify objectives, performance targets and the budget resources required for each of their programs; and
• Report program performance at the end of each fiscal year.

We should convert our budget process to a performance-based approach, allowing time for transition and putting into place workable systems to make the process straightforward and useful to managers and to state decision-makers.

Action:The state should move to a performance-based budgeting system, based on statewide goals and objectives.

The Department of Finance should provide instructions to agencies on developing performance-based budget submissions. State agencies and departments should ensure their funding requests conform to and support the statewide vision and goals prepared by the Governor’s Office.

Each action plan should identify objectives, performance targets and the budget resources required. The plans also should identify the service level to be provided along with historical baseline performance data for simple comparisons.

Essentially, departments would submit “bids” to fund each of their core programs at a specific level of service. Departments would no longer be required to report incremental changes, nor employee position details, such as job classifications.

Action: The Department of Finance should identify core programs and performance targets in the Governor’s Budget proposal so the Legislature can review and approve these performance targets.

A number of key elements must be in place for performance-based management to work successfully within an organization. One of these elements is the development and implementation of performance measures, which are practical, realistic and meaningful to management, employees and the public.

Performance measures are tools used to assess an organization’s success in fulfilling its mission and meeting its goals. Included within these measurements are various indicators, all of which are essential to measure performance accurately. These include:

PERFORMANCE MEASURES ARE TOOLS USED TO ASSESS AN ORGANIZATION’S SUCCESS IN FULFILLING ITS MISSION AND MEETING ITS GOALS.

• Input Indicators—the amount of resources used to provide a specific program or service;
• Output Indicators—the number of units produced, such as the number of citizens served;
• Outcome Indicators—the reports of the results;
• Efficiency Indicators (or Process Indicators)—the cost effectiveness or cost per unit; and
• Explanatory Information—the information that helps the user understand what influenced the results positively and negatively.

Developing these measures has an important role in improving an organization’s performance. They can help managers stay focused on results. By objectively assessing past and current performance, administrators are better equipped to plan for the future. Responsible administrators develop performance measures to ensure state government is using tax dollars wisely and that state employees are held accountable for their decisions.

Performance measures also are an effective way to inform elected officials, oversight agencies, the public and other stakeholders of the results of government programs.

Valid performance measures can be difficult to develop depending on the nature of the work performed by an organization. At times, it can be difficult to develop performance measures that actually reflect what an organization does. This difficulty can be due to lack of training, lack of data, fear of reporting results or lack of agreement on what should be measured and how it should be interpreted.

Despite these obstacles, the use of performance measures is a major step to program improvement. They help reduce the guesswork in government programs and pave the way to both improving services and controlling costs.

GOVERNMENT’S VIEW OF THE FUTURE IS, LIKE THOSE OF OTHER ORGANIZATIONS, LIMITED AND IMPERFECT. IT IS DIFFICULT TO FORESEE AND ACCURATELY PREDICT CHANGES IN NATIONAL ECONOMIC CONDITIONS. IT IS IMPOSSIBLE TO FORESEE NATURAL AND MAN-MADE DISASTERS AND OTHER CIRCUMSTANCES THAT MAY IMPOSE NEW AND UNEXPECTED DEMANDS ON GOVERNMENT.

Action: The Department of Finance should devise and distribute guidelines and procedures to state agencies and departments on how to develop and use viable performance measures.

Agencies can use these guidelines to develop relevant performance measures. Information on these measures should be gathered on a routine basis—e.g., monthly—and reported on a quarterly and annual basis. Results should be incorporated into future agency budget submissions.

Government’s view of the future is, like those of other organizations, limited and imperfect. It is difficult to foresee and accurately predict changes in national economic conditions. It is impossible to foresee natural and manmade disasters and other circumstances that may impose new and unexpected demands on government. On the other hand, as technology writer and editor Herb Brody has written: “Telling the future by looking at the past assumes that conditions remain constant. This is like driving a car by looking in the rearview mirror.”

California does some long-term planning now, but it is limited. The Department of Finance (DOF) and other state departments estimate the long-term fiscal impact of legislation when they analyze individual proposed bills. The DOF also prepares a five-year capital outlay plan each year for the Legislature. Little attention, however, is paid to the long-term impact of budget decisions or the long-term financial condition of the state during the budget development process. The DOF develops comprehensive, long-range projections for credit-rating agencies after the budget is in final form, but these projections often only cover the coming budget year and the year after. In addition, the Legislative Analyst’s Office publishes a comprehensive five-year projection of revenues and expenditures after the Legislature adopts the final budget.

THE CALIFORNIA BALANCED BUDGET ACT, PROPOSITION 58, PASSED BY VOTERS IN MARCH 2004, ENACTED SIGNIFICANT CHANGES TO PROTECT THE STATE FROM CARRYING LARGE DEFICITS IN THE FUTURE. IT REQUIRES THE STATE TO ENACT A BALANCED BUDGET.

In its 1995 review of the state’s fiscal condition, the Little Hoover Commission warned “while California’s budgets appear to be in balance each year when they are adopted, the State has incurred a large structural deficit.” In short, spending was exceeding revenue on an ongoing basis. A decade later, much the same observation applies. The structural problem, in remission in the late 1990s, has recurred. The current deficits were the result of three years of major imbalances between revenues and expenditures.

Since 2001, the Governor has proposed, and the Legislature has adopted, budgets that were balanced in the year they were adopted, but created growing operational deficits in future years. As early as May 2001, the Legislative Analyst’s Office predicted an ongoing structural deficit of $4 billion beginning in Fiscal Year 2002–2003. Although the 2001–2002 Budget Act proposed a $2.6 billion reserve, it did not significantly restrain the growth in state spending. By November 2001, the projected structural deficit had skyrocketed to more than $12 billion (Exhibit 9).

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The fiscal crisis grew worse. To alleviate the situation, the Fiscal Year 2002–2003 Budget Act included a year-end reserve but still did not address the underlying structural deficit, because it relied again on short-term expenditure reductions. By 2004, the budget shortfall more than doubled.

The California Balanced Budget Act, Proposition 58, passed by voters in March 2004, enacted significant changes to protect the state from carrying large deficits in the future. It requires the state to enact a balanced budget. It establishes a Budget Stabilization Account of up to $8 billion, or five percent of General Fund revenues, whichever is greater, to cover budget shortfalls. It also provides a process to make mid-year budget adjustments and prohibits future borrowing to cover budget deficits.

These provisions should help California avoid fiscal crises in the future, but they alone cannot bridge budget shortfalls. For example, even the new Budget Stabilization Account would not be sufficient to cover the current deficit. In addition, the restriction on the use of debt to cover budget deficits requires better financial planning on the part of the Executive Branch and the Legislature, if undesirable program reductions and tax increases are to be avoided.

Action: The Governor should direct the Department of Finance to prepare a long-range financial plan for the state of California.

The plan should project revenues and expenditures for five years. It should also reflect the statewide strategic vision and goals. The creation of a long-range plan would provide the Governor and the Legislature the information necessary to assess and adjust when necessary the long-term fiscal impact of their decisions.

ONE OF THE CPR’S PRIMARY RESPONSIBILITIES WAS AN “AUDIT” OF THE STATE’S FINANCIAL SYSTEMS AND REPORTING, BUDGET PROCESSES, FINANCIAL CONTROLS AND STATE OVERSIGHT OF ITS FISCAL AFFAIRS.

One of the CPR’s primary responsibilities was an “audit” of the state’s financial systems and reporting, budget processes, financial controls and state oversight of its fiscal affairs. This process differed from the broader work of the Performance Review, as it used auditors knowledgeable about the state’s fiscal system and was done in accordance with Generally Accepted Government Auditing Standards. The findings provide some important insights that can be applied to the overall review (see also the accompanying article on the line-by-line audit). They include:

• The large number of financial systems is not efficient or effective.
• There is insufficient oversight or audit of the existing systems.
• Many of the existing systems are obsolete due to deferred maintenance.
• California state government is dependent on diminishing staff resources to maintain systems and to use the complex network of systems to ensure data integrity.
• The decentralization of the system has created a risk.
• The design of the systems limits their use and maintenance.
• State laws, regulations and policies have so many complicated requirements that the state cannot use standard commercial software.
• Organizationally, it is unclear who is accountable for financial management—individual departments, the Department of Finance, the Controller or the Treasurer.
• The state lacks a strategic direction in financial management and has no plan to improve its overall system.

These are worrisome conclusions, and their importance should not be underestimated. In 2002, Syracuse University’s six-year Government Performance Project study of state and local government performance reported that financial management is a primary indicator of overall government performance.

California is not a recognized leader in state financial management. In 2001, Governing Magazine conducted a nationwide survey, comparing financial management practices among the 50 states. The magazine awarded California a B- in financial management, finding that the state’s financial systems fail to provide to state officials, the business community and taxpayers timely, accurate and useful financial reports, which gauge the accurate cost of delivering programs.

California has struggled with financial reforms over the past decade, but too often, there has been no follow through on such efforts. Efforts at modernizing the state’s financial management system have occurred only at the individual department level.

FINANCIAL MANAGEMENT IS AT THE CENTER OF INTEGRITY AND PUBLIC TRUST IN GOVERNMENT. CHANGING FINANCIAL MANAGEMENT SYSTEMS IS NOT A SIMPLE OR INEXPENSIVE TASK, BUT IT IS A TASK THAT MUST BE ADDRESSED.

The Department of Finance still requires agencies to use its aging fiscal accounting system, known as the California State Accounting and Reporting System (CALSTARS). A stated goal of CALSTARS is to achieve uniformity between the state’s budgeting and accounting processes. Departmental budget management systems, however, are typically stand-alone and not tied to the CALSTARS accounting system. In addition, departments often modify CALSTARS to fit their own needs or ignore it and devise their own financial information system.

In 2001, the Senate Advisory Commission on Cost Control in State Government reviewed the state’s attempts at performance measurement and observed that California lacks a statewide, integrated management information system: “There is no uniform management information system available to help the State develop, publish, or obtain data required to manage and monitor the various operations for service, cost effectiveness, or outcomes. Lacking central leadership, agencies are proceeding independently. There are organizations that currently have, or are developing, management information systems using outside vendors. This requires investment of huge amounts of money with no data outputs on a statewide basis.”

The statewide audit by the CPR’s Audit Team found no gross irregularities in state accounting, but with these systems, it is difficult to close the book on any financial issue with confidence and finality. Financial management is at the center of integrity and public trust in government. Changing financial management systems is not a simple or inexpensive task, but it is a task that must be addressed.

Action: The Governor should instruct the Department of Finance to develop a financial management system capable of supporting a performance-based management system.

Action: The Governor should direct the Department of Finance to develop a long-term financial management strategic plan with targeted goals and strategies for accomplishing those goals.

“A line-by-line audit .. .” One of the Governor’s directives to CPR was to conduct a “line-by-line” audit of state government finances in addition to the other work of the Review. The Audit Team CPR assembled was composed of skilled auditors from across government. The Audit Team focused on work performed by existing state audit and control organizations, supplemented by its own original analysis. More than 60 state agencies currently employ more than 4,000 auditors for a range of purposes. Primary responsibility for the state’s overall fiscal review lies with the Department of Finance and the Legislative Analyst’s Office (budget information), the State Controller’s Office (financial accounting and reporting) and the Bureau of State Audits (auditing of the state’s consolidated financial statements). In its work, the Audit Team looked at the work of the key financial organizations within state government. It examined financial reporting to see that revenues and expenditures are accurately stated. It looked at whether funds are used for their legally authorized purposes. The Audit Team also examined the necessity of various programs, although that was part of the larger CPR effort. It surveyed 106 agencies on their financial practices, receiving detailed answers from about 75 percent of those surveyed. The findings and conclusions of the Audit Team’s review of state operations are reported in detail in a separate volume of the CPR report. The main conclusion from the report: “With all these components operating in unison, the state would be reasonably assured that its operations met its objectives. However, we believe that in spite of the best-intended efforts of the parts, the whole is not coordinated and the results are not effective.” SUMMARY OF KEY FINDINGS: Financial Controls The state’s system of internal controls should be improved. Many state agencies have neglected to comply with the applicable law requiring effective systems of internal controls, increasing the risk of waste, fraud and abuse. Many smaller state agencies’ financial information is not adequately reviewed to determine if it is reliable and fairly stated. Numerous smaller agencies do not receive routine audits of their financial information. Most state agencies do not have internal audit units and do not perform routine accounting/administrative control audits. Financial Systems The large number of existing financial systems within state government is not efficient and effective. The existing systems lack sufficient oversight or audit capabilities. Many existing financial systems are obsolete because they have not been properly maintained. The state is dependent on diminishing staff resources to maintain and operate its financial systems and to ensure data integrity. The decentralization of the state’s financial systems has created a risk due to the lack of complete, accurate centralized inventory of fiscal systems. Organizationally, the state lacks a clear definition as to who is accountable for financial management and related systems. The state lacks a strategic direction for financial management and related systems, and currently has no plan to develop such a plan. Strategic Planning/Performance-Based Budgeting There is no centralized tracking or monitoring of statewide strategic planning efforts. A pilot, authorized in 1993, has been largely abandoned. The majority of agencies perform some type of strategic planning, but this planning does not drive the budget process. Half of the agencies surveyed develop strategic plans. Most agencies prepare strategic plans but don’t forward them to the Department of Finance or to the Governor’s Office. Performance Measurement Approximately 90 percent of agencies are currently using benchmarks and performance measures. Agency management teams regularly monitor performance results. Insufficient resources and an inability to develop performance measures often derail efforts to establish or refine performance measures. Performance-Based Budgeting Twenty-four percent of responding agencies have integrated performance measurement into their budgeting processes. Most agencies’ budgetary responsibilities are established and regularly monitored. State agencies claim that a lack of resources precludes them from implementing a performance-based budgeting process. Audit Coverage Over Agencies’ Strategic Planning and Performance Measuring Nearly half of the reporting agencies indicated that their program performance or measures were reviewed or audited. The Bureau of State Audits identified improvements in strategic planning and performance measurement. Some state agencies’ internal auditors conduct performance reviews of operations and programs, including assessment of performance measurement. The state should have centralized control of audits to ensure oversight, guidance and monitoring.

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