On End Of Period Spending

Last week US federal agencies were in a hurry to spend the last of their annual budget. Agencies that don’t spend all of their budget not only don’t get to save it for next year, next year’s budget will likely be reduced by the unspent amount. And the manager sacked. This last minute burst of spending is usually less carefully considered, and less useful, than other spending. (More about it all here.)

This situation is mildly puzzling. Why is not spending all of a budget such a bad sign? If needs and opportunities vary in time, spending that varies in time seems appropriate. Perhaps incompetent managers who just can’t plan induce more spending fluctuations. But is that really so much more likely than varying needs and opportunities? Some say that spending less than budgeted shows an agency “needs” less overall. But any tendency for agencies that sometimes spend less than budget to be less valuable seems to me much weaker than the tendency of last minute spending to be less valuable. So why aren’t bursts of last minute spending seen as just as bad or worse?

One explanation is that we developed habits of judging organizations and managers based on their budget habits in contexts where it was much harder to observe the time pattern of spending than the total amount spent. We developed the social norm of disapproving of unspent budgets in that context, and have been slow to adapt to a world where the time pattern of spending is visible.

A related explanation is while spending more near period end looks bad, there is a less clear bright line to coordinate on to say which time patterns of spending look bad. So while we each privately know last minute spending bursts look bad, we don’t coordinate to say it together.

Perhaps there are other plausible explanations. But one relatively robust conclusion here I think is that the political process can be pretty terrible at coordinating to react to simple easily visible info. It isn’t enough that we can all know something. We have to all know that we can know and then coordinate to switch new social norms, so that we all know that we all expect us all to actually look at this visible info sometimes, and to react in a certain easily verified way to that info.

Not very encouraging for folks who hope that government will finally sit up and notice other kinds of relevant policy info that it has long neglected.

Added 11Oct:

Spending in the last week of the year is 4.9 times higher than the rest-of-the-year weekly average. … Quality scores for year-end projects are 2.2 to 5.6 times more likely to be below the central value. Allowing agencies to roll over unused funding into the subsequent year can improve efficiency. We calibrate a dynamic model of spending and show that allowing rollover leads to welfare gains of up to 13 percent. … The one federal agency that has the ability to roll over unused funding for I.T. projects does not exhibit a year-end spike in spending or drop-off in quality in this category of spending. (more)

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  • roystgnr

    It’s hard to decide how much money a sub-bureaucracy needs, so you need some metric to test.

    The metric of “they’ll probably need about as much this year as they needed last year” would actually be a pretty good and an incredibly generally applicable one, if it wasn’t so painfully easy and desirable to game.

    • adrianratnapala

      Yes. In an ideal world, if a sub-org had money left over – and if their performance was otherwise OK – it would be given extra responsibility – taking over from other, related, departments that were overspending. But I suspect it is difficult to come up with institutional arrangements that can do this consistently.

  • Robert Koslover

    Most sub-organizations within the government have to put in genuine effort, in advance, to obtain funding from authorities that are above them in the hierarchy. Part of this effort is documenting and justifying, often (though not always) in considerable detail, how much $ is needed and for what activities those $ are needed. If they then receive the authorization to spend the $, but fail to do so, their earlier claims (for both the need for the $ and regarding their abilities to assess situations accurately) lose credibility. At the same time, government authorities above them, who agree to authorize/distribute funds to the lower organizations, only to learn later that they have provided more funds than necessary, will have their own judgement questioned by their superiors. And this same phenomenon occurs in large private businesses too, not just government. After all, the only ones to directly benefit from spending less $ than previously planned, authorized, or budgeted is the actual people paying. In the case of government, that is the taxpayers. But everyone else in the chain personally benefits from the $ spent being very-nicely equal to the $ that they (again, with great effort) budgeted, proposed, planned, documented, etc., since that result is the only one that demonstrates that their professional analyses and decisions (which is what their jobs are all about!) were right on-target! See? And with so much at stake for all the individual careers involved, this is not easy to fix.

  • http://barrkel.blogspot.com/ barrkel

    I’m not sure if you’re being serious. Everybody knows that they spend any excess at end because they must spend their whole budget, because otherwise they won’t get as much next year; and they need to overallocate because they can’t get emergency funding between budgets, because if that worked, everybody would have “emergencies”.

    It’s little to do with government. It’s to do with any kind of federated budgeting in almost any large organization.

  • vaniver

    Consider a case where there are lots of long-term opportunities which are not urgent, and a stochastic number of short-term opportunities that are urgent. If you have a fixed amount of money which replenishes each year, then it makes sense to hold off on the long-term opportunities until you are reasonably confident that there are no upcoming short-term urgent opportunities this budget cycle.

    Now, this implies a cost function where going over budget is much worse than going under budget by a similar amount, which is probably a destructive norm to have. This would also suggest that a continually increasing supply of funds for a project would manage this situation than a supply that increases yearly.

  • Kirk Holden

    In the real world where the detail information about utility of last quarter spending never exists, the ‘3rd Quarter Run-Rate’ method beats what ever is in second place. To guardband useful from non-useful spending in the 4th quarter (and the 5th…) the finance minions truncate the final quarter all together and budget the next 4 quarters of spending based on observed behaviors in the next to last quarter before the reindeer games begin.

    This simple heuristic leaves the spending jedi gasping for air.

    • http://overcomingbias.com RobinHanson

      Where is this the common practice?

  • http://juridicalcoherence.blogspot.com/ Stephen Diamond

    I’m surprised you didn’t invoke homo hypocritus; I think it actually provides the best explanation. (The urge of groups to impose norms is matched by a drive to allow ways to violate them.)

    An empirical implication is that managers take pleasure in the last-minute pressure to spend, which allows them to demonstrate power and to spend on whim.

    [Kirk Holden's comment shows that this isn't rooted in a simple coordination problem.]

  • Peter

    I deal with this daily and the answer in Congress gets mad if you don’t spend the money they appropriated for that purpose. If some Congresscritter gives you $20 million to spend on some widget, he expects you to spend that $20 million on the widget. The financial prudence comes in your budget request; once allocated you are expected to spend what they give you and failure to do so is looked liked some sort of fraud (not legally) as they could have spent that money elsewhere. Basically you not spending what you asked for shows (in their mind) you are incompetent and not to trust your subsequent budget requests.

    • http://overcomingbias.com RobinHanson

      The question is *why* Congress gets mad at one thing, and not at the other.

      • IMASBA

        Maybe it’s yet another disadvantage of district-based election systems (the representative or senator wants to shower their district with federal money)?

      • Peter

        You nailed it from experience. Folk sit on committees that are of import to their locals and send pork that way. You not spending that pork fully goes against their purpose.

        Folk forget it’s not the civil services job to be prudent with allocated tax dollars but to spend what was allocated by the political class. They, not you, determine how much is to be spent, you simply execute their will to the best benefit of your program. Congress doesn’t care if you buy one $1000 wrench or one thousand $1 wrenches as long as you spend that $1000. Your leeway as the civil servant is to determine if you want the one wrench or the thousand.

      • IMASBA

        It’s purely anecdotal evidence but it does seem like politicians from countries with national voting systems do seem a lot more eager to announce some program cost less than previously budgeted. That is not seen as a failure to plan.

      • http://bur.sk/en Viliam Búr

        Maybe the issue is that if you get $20 million, some politician had to argue hard about why you need exactly the $20 million and not less. If that politician showed some uncertainty and said “maybe they will need $20 million, and maybe only $15 million”, you would most likely get only $15 million. So you received $20 million because some politician spent their time arguing that $15 million just isn’t enough.

        Now when you spend only $15 million, you make the politician look like a fool. That’s not good for him, and therefore not good for you.

        (The point is that at some moment “not making the politician who argued for $20 million look like a fool” becomes more important, at least for the politician, than saving $5 million. This is another value in the equation, not included in the naive calculation.)

      • IMASBA

        “Now when you spend only $15 million, you make the politician look like a fool.”

        I do not agree that’s necessarily true. I think the American system (mostly it being district-based) and American culture are geared towards that view but in some European countries politicians win votes by informing the public that something cost less than previously budgeted. In those countries people intuitively expect error margins for budgets and there is no drive for showering local constituencies because the elections are not district-based, plus people expect contractors to be devious, yet at the same time see an active government as fundamentally necessary (less enthousiastic about corporations and more supportive of the state than Americans) so they cheer everytime the government comes out on top.

    • Robert Koslover

      Yes, I agree. And I consider your view to be fully consistent with my earlier comment on this thread. (In the past, I also dealt with it daily — not relating to Congress per se, but in the DoD). I don’t know why so many of the other folks here seem to be either misunderstanding or ignoring both your and my clear and logical explanations which are derived from direct experience.

      • http://juridicalcoherence.blogspot.com/ Stephen Diamond

        I don’t know why so many of the other folks here seem to be either misunderstanding or ignoring both your and my clear and logical explanations which are derived from direct experience.

        Fair question, since after rereading your post with a little more care, you have an interesting hypothesis. I think the answer to why it was ignored, generalizing from my own experience, is that you buried your main claim, which I take to be this: “If they then receive the authorization to spend the $, but fail to do so, their earlier claims (for both the need for the $ and regarding their abilities to assess situations accurately) lose credibility.”

        In other words, failure to spend all your money signals lack of credibility because it contradicts earlier claims.

        But this explanation is rather limited in depth. It doesn’t explain why institutions haven”t adopted procedures (like those Kirk Holden described) to change the incentives.

  • blogospheroid

    The body of Theory of constraints by Eli Goldratt rails against all sorts of decision making guided by local optima. Budgets are just one example. TOC suggests using constraint based accounting or throughput accounting as a measure to overcome this.

    Another place where I read that budgeting as a practice needs to be revised is Science of success by Charles Koch. If I remember correctly, he believes that instead of strict budgets, people should be able to pull in money for anything that can noticeably improve the bottom line. I don’t remember the details, but when I had read it, it sounded similar to throughput accounting.

  • IMASBA

    “If needs and opportunities vary in time, spending that varies in time seems appropriate. Perhaps incompetent managers who just can’t plan induce more spending fluctuations. But is that really so much more likely than varying needs and opportunities?”

    It’s precisely because the higher-ups DO know there will always be natural fluctuations that they can’t do much about last quarter overspending (they’d have to prove it was overspending instead of a natural fluctuation). Plus what Vaniver said: it’s normal to wait to spend on long term stuff when you first have to ensure there’s anything left after spending on short term stuff.

    All of this is of course equally applicable to corporations and let’s not forget that many departments in governments are severely limited in their 4th quarter binge spending (for example they can’t book phantom unemployment benefits), so the 4th quarter overspending may be relatively small compared to the total budget. For solutions I’d recommend not to reinvent the wheel: surely many governments and corporations have looked into the problem already.

  • DanT

    Local optima is the logical economic actor answer. If I spend the last 20% of my budget for only 5% improvement (i.e. end-of-year spending is only 25% effective), I still improve 5% versus 0% for not spending it. There are absolutely no incentives to not spend.
    There is also a disconnect between ability to spend and ability to measure improvement. In government spending, especially at the lower-organizational levels, there is no way to directly measure improvement due to lag in the improvement and general lack of organizational ability to measure its own output. So when you say end-of-year spending is less useful, that cannot be proven. I also agree with the comment that sometimes end-of-year spending is for longer-term initiatives that are important but not urgent.
    Organizations tend to metricize what is easy – especially when the mission of the organization is not well-defined or easy to measure. Dollars are easy to measure and are always a primary metric. Usefulness of spending is not easy to measure and tends to become absorbed into the process – you don’t get funding unless you can justify it. Funding is justified by plans (often too high level to show spending details and not taking other things into account) and spending is real and allowed to be re-allocated (re-programmed) when plans need to change. So, the ability to find something (presumably useful) to do with all the money becomes roughly equivalent to how skilled you are at adjusting your plans and spending. As we saw above, you can’t really measure usefulness; so if you spend it all your boss may think you know what you are doing – but if you don’t your boss knows you don’t know what you are doing.

  • Sam

    More generally. Stupid public policy doesn’t have a market test. I’m sure private companies throughout history have tried stupid techiques for managing budgets but then made less money and changed their behaviour. In government there are so many equilibria because a dumb policy can be imposed for no real reason whatever and have a lot of inertia.

    • Daniel Carrier

      Does this not happen in the private sector?

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  • VV

    I’m not sure this is really overspending.

    Each year managers known that they will have to allocate money on various things, some of these things are mandatory, others are important, others are rather optional.

    Since managers have uncertainty about the actual costs of these things, they will naturally want to spend first on the most important ones, so they are sure they will not run out of money, and save the less important things for the end of the fiscal year to spend on if they have any money left.

  • http://overcomingbias.com RobinHanson

    I just added to this post.

    • IMASBA

      So being allowed to carry over money to the next year reduces end-of-period spending. Now the question is, does it also reduce total spending?