Zero-Based Budgeting

by Tom Yamachika, President, Tax Foundation Hawaii

Last week, we spent some time on “variance reports,” which is how our state government agencies report differences in position count and spending from one year to the next. The agencies are also supposed to report on performance measures that they pick themselves, but sometimes still disregard this requirement.

Today, we examine “zero-based budgeting,” an idea that has been around for a while but was recently championed by House Finance Chair Sylvia Luke.  

Zero-based budgeting assumes that nothing, not even the amount the legislature approved the previous year, is approved.  Agencies will have to justify everything, all the dollars they want to spend and all the positions they want to have, from the bottom up. 

This is a whole lot more work than agencies are used to doing, and it generates a lot more information than legislative staffs are used to reviewing during our compressed legislative session, so it’s going to be a tough sell all around – especially for people who don’t understand what ZBB is. 

The international consulting firm McKinsey & Co. defines ZBB as something that goes beyond simply coming up with a budget:

Zero-based budgeting is a repeatable process that organizations use to rigorously review every dollar in the annual budget, manage financial performance on a monthly basis, and build a culture of cost management among all employees. A world-class ZBB process is based on developing deep visibility into cost drivers and using that visibility to set aggressive yet credible budget targets. The annual budgeting process does in fact start from zero and is very detailed, structured, and interactive in order to facilitate meaningful financial debate among managers and executives. Throughout the year, multiple owners are tasked with managing performance and continuing the healthy debate on cost management. Through new system and process controls, and aligned incentive programs, all employees make cost management a part of their daily routine.

One of the key elements of ZBB is visibility. An organization needs to understand what money is being spent on, and why. In government agencies, especially larger ones, it’s difficult to obtain that understanding. Waste and fraud can be buried, not only because of some evil intent but simply because “it’s always been done that way.” It takes work to figure out why a task or process is being done, and only then can it be analyzed to determine if it can be done more efficiently or even if it is needed at all.

Nevertheless, it’s probably worthwhile to periodically take deep dives into an agency’s activities. Advantages of the process include sharpening the agency’s focus on its mission so marginally related activities can be identified and possibly refocused, identifying redundant activities, identifying artificial budget inflation, and increasing the efficiency of resource allocation. Doing things a certain way just because they’ve always been done that way might not be right when the times have changed and the agency’s priorities and needs have changed.

Yes, it takes leadership and hard work to do ZBB correctly. But if it is done correctly, the potential for savings to the public fisc is huge. McKinsey estimates that if properly implemented, ZBB can reduce sales, general, and administrative costs “by 10 to 25 percent, often within as little as six months.” We can’t afford not to try this.