Performance Based Budgeting and Zero Based Budgeting

Broadly, in economic literature, there are two theories of budget: the classical ‘Balanced Budget Theory’ and the modern ‘Managed Budget Theory’. The classical theory follows the laissez-faire principle and hence decreases the role of government. In a classical system, the market is given utmost importance, and as the role of the government is limited, the size of the budget is small, and the budget is expected to be balanced. In a balanced budget, revenues and expenditures are equal, and neither a deficit nor a surplus exists in a budget. It is also called as “the accounts balance”.

In contrast to classical theory, the modern theory is based on Keynesian Economics. The classical assumption of full employment is negated in modern theory. It is believed that the normal situation of the economy is a ‘less than full employment’ situation, and to ensure the efficient use and employment of unutilised resources, a flexible budget is needed, which may not be balanced. Rather, modern theory believed in deliberately opting for a ‘deficit budget’ as this will put additional purchasing power in the hands of people and will contribute towards increasing effective demand.

Performance Based Budgeting (PBB)

It was the Hoover Commission of the USA which introduced the term performance budget in 1949. This commission recommended the adoption of this type of budget in the USA as to be based on functions, programmes and activities. The main difference between performance and programme budgeting is that while performance budgeting uses the techniques of cost accounting and scientific management, programme budgeting derives its tools from economic and systems analysis.

Burkhead (19491) defines a performance budget as one which presents the purposes and objectives for which funds are requested, the costs for programming proposed for achieving these objectives and the quantitative data measuring the accomplishments and work performance under each programme.

Traditional vs Performance Based Budgeting (PBB)

Traditional, which is also known as line-item budgeting, relates to the allocation of funds based on line-item costs regardless of the ability to meet the goals. Accountability is for the use of inputs. The line-item budgeting involves focusing on “inputs” – staff, equipment, supplies, etc.

The budget justification is based on new initiatives in the budget and/or an increase in line item costs – an incremental approach. There is a lack of attention to “results” or “impacts” of programmes or “performance.” Managers are encouraged to spend, not to ‘economise’ or ‘innovate’. The accountability criterion involves keeping spending in line with the budget. There are detailed controls and rigid appropriation rules.

Performance budgeting, on the other hand, relates to funding linked to expected “results” or ”outcomes” – what programmes, schemes/components/initiatives of the budget intends to accomplish. Accountability is for results or performance achieved. Performance budgeting focuses on “results”, funding ‘outcomes rather than ‘inputs alone. Assessing “results” by measurable indicators, holding managers responsible for performance, giving flexibility to managers to ‘manage’ and ‘innovate’, and having a medium-term and long-term view of use of resources are some of the significant features of the performance budgeting system which enhance the performance of the departments.

PBB methodology is not new but involves major changes in the format of the budget by placing more demanding standards on project design and planning. By mapping the expected results in advance and by tracing to what extent these have been actually met, this budget format is also a versatile decision-making tool.

PBB seems to be a tool to trim down the organisation and cut spending, but it is not so. While efficiency is certainly to be expected from feedback on performance, PBB does not necessarily sanction a failure to meet targets with resource cuts. Rather, PBB will focus on the question of why performance was below expectancy and enable managers to detect deficiencies. Nor does it expose project directors to disproportionate responsibility by penalising them for subprojects/schemes that have not met the desired results. “Expected results” are not to be understood as unchangeable or permanent targets of production that one would find in commercial enterprises.

Performance-based budgeting aims to improve the efficiency and effectiveness of public expenditure by linking the funding of public sector organizations to the results they deliver, making systematic use of performance information.

Performance-based budgeting should not be seen as an isolated initiative. It should be viewed, rather, as part of a set of broader reforms- often referred to as managing-for-results- designed to focus public management more on results delivered and less on internal processes.

These broader reforms include civil service reforms designed to increase the motivation and incentives of public employees; organizational restructuring to increase the focus on service delivery and improve coordination (e.g., creation of agencies and reduction of the number of ministries); and institutional and oversight changes to strengthen public accountability for performance. Action on these and a range of related fronts is necessary if the efficiency and effectiveness of public expenditure are to be substantially improved.

Benefits of Performance Based Budgeting (PBB):

Benefits: Performance-based budgeting is beneficial to various stakeholders in many ways:

● Policy-makers find it advantageous as the system focuses on goals, clear information is available on the usefulness of programmes, and evidence-based policy choices can be made. Policymakers are equipped to monitor and evaluate the efficiency and effectiveness of financial allocation to meet the desired outcomes- as performance measurement is an integral part of budgeting.

● Department Heads work with well-defined expectations, having flexibility for innovation and performance. It integrates resources and objectives – budget and performance and suggests public managers focus on economy, efficiency and effectiveness.

● Public Understands the connection between tax money spent and services provided.

Performance Based Budgeting (PBB) Implementation Steps:

Performance budgeting relates / links funds allocated to measurable results. By connecting funding and results, performance budgeting also encourages the budgetary authority to think about budgeting in broader terms and to take into account how well resources are used when prioritizing expenditure. It also enhances financial accountability to citizens and monitoring bodies, as it allows better management and evaluation.

Main concepts employed in Performance Based Budgeting (PBB):

1. Objectives: “An objective is a statement of what one is trying to achieve”[OECD]

Objectives represent what we want to accomplish, not how we should do it. In other words, objectives are not equivalent to strategies, activities, processes or outputs. Thus, activities such as studying, providing support, advising, and cooperating with others are not proper objectives. Rather, objectives should be formulated along the following lines: to reduce/increase, to change, to make progress towards, to strengthen, etc. (Note that objectives are expressed in the infinitive form of a verb).

• Objectives are extremely important as they are the base for performance indicators and targets.
• They should describe the outcome that the activity/programme as a whole seeks to achieve.

2. Performance Indicators and Targets: Performance indicators are measurable factors of extreme importance to any organisation in achieving its strategic goals, objectives, vision and values. A performance indicator provides quantitative or qualitative information on the effectiveness and efficiency of programmes or activities. Both quantitative and qualitative information can illustrate the progress in meeting objectives and achieving desired outcomes. It is advisable to use quantitative indicators as much as possible. It is also useful to make use of targets and milestones. Milestones are usually used as an action ‘checkpoint’ in order to verify how the project is progressing and revalidate work if needed. They tell us where we should be at a certain point if we are to meet our overall objective within the time available.

3. Action: Work carried out over a certain period of time, consuming resources and producing outputs. Actions are the most detailed level of the management plan’s structure that is politically significant and separately manageable (i.e. objectives must be defined and resources allocated by the head of a unit). Each action is related to one activity only.

4. Activity: Coherent area of action, with objectives and resources. Normally, each activity is related to one policy area only.

5. Activity Statement: Document attached to the preliminary draft budget (PDB) containing information on objectives and indicators to justify the appropriations.

6. Expenditure Related Outputs: Outputs delivered by the DG/service and requiring financial intervention.

7. Impact: More indirect or longer-term effects on society

8. Indicator: Characteristic or attribute that can be measured or verified to assess to what extent objectives have been met.

9. Mission statement: Up-to-date and concise document defining the “raison d’être”

10. Output: Output objectives and indicators may be defined in terms of what should be delivered and at what time.

11. Resources: Human, financial and physical resources used to produce an output.

12. Result: Direct and immediate effect on a target group.

Zero Based Budgeting (ZBB)

Zero-based budgeting (ZBB) is a method of budgeting in which all expenditures must be justified for each new period. Zero-based budgeting starts from a “zero base”, and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one.

The budget should be appraised occasionally, and the request for a grant of funds should be properly reviewed. Generally, in practicality, there is a tendency to scrutinize only the changes in particular budget items rather than to extend over every aspect of the whole programme structure. The past levels of expenditures are taken as given, and only new additions to or reductions from the past outlay are examined. This type of budgeting is called as ‘incremental budgeting’.

Since every outlay in the budget has some attainment objective, either short run or long run, it is necessary to regularly examine the expenditure components in the light of anticipated results. In the case of budgeted expenditure having been associated with long-term objectives, the time-bound expected result component should be examined occasionally. This is what is done by Zero-based budgeting (ZBB). Zero-based budgeting means that while framing the budget for the ensuing year, one should start from Zero point instead of treating the current budget as the starting point.

Read More in: Theory of Public Finance

1. Public Finance: Meaning, Nature & Scope
2. Role of Government in Economy
3. Role of Government in Mixed Economy: Public & Private Sector
4. Role of Government under Cooperation and Competition
5. Role of Government in Economic Development and Planning
6. Concept of Public Goods, Private Goods, and Merit Goods
7. Concept of Market Failure and Functions of Government
8. Market Failure and Functions of Government: Decreasing Costs
9. Market Failure and Functions of Government: Externalities
10. Market Failure and Functions of Government: Public Goods
11. Future Market: Meaning, Role & Uncertainty
12. Concept of Information Asymmetry
13. Theory of Second Best: Concept & Explanation
14. Problem of Allocation of Resources: Public & Private Mechanisms
15. Preferences: Meaning, Types & Problems of Preference Revelation
16. Preference Aggregation & Its Mechanism
17. Voting Systems, Direct Democracy, Representative Democracy, Leviathan Hypothesis & Arrow’s Impossibility Theorem
18. Economic Theory of Democracy: Concept & Explanation
19. Politico Eco Bureaucracy: Concept & Explanation
20. Rent-Seeking and Directly Unproductive Profit-Seeking Activities
21. Rationale for Public Goods: Concept & Explanation
22. Benefit Theory or Voluntary Exchange Theory
23. Lindahl Model: Concept, Equilibrium & Limitations
24. Bowen Model: Concept, Advantages & Limitations
25. Samuelson’s Model of Public Expenditure
26. Musgrave’s Model of Public Expenditures
27. Demand Revealing Schemes for Public Goods
28. Vickery-Clarke-Groves Mechanism
29. Groves-Ledyard Mechanism
30. Tiebout Model: Concept, Assumptions Equilibrium & Simple Tiebout Model
31. Theory of Club Goods
32. Keynesian Principles of Stabilization Policy
33. Difference Between Keynesian Economic Thought and Others
34. Role of Expectations and Uncertainty in Formulating Stabilization Policy
35. Intertemporal Markets Efficiency & Failure
36. Liquidity Preference Theory
37. Diamond-Dybvig Banking Model
38. Preference Shocks, Adverse Selection & Central Bank
39. Equilibrium Deposit Contract
40. Social Goods and Its Effect on Stabilization Policy
41. Effect of Infrastructural Facilities on Stabilization Policy
42. Effect of Distributional Inequality on Stabilization Policy
43. Effect of Regional Imbalances on Stabilization Policy
44. Wagner’s Law of Increasing State Activities: Explanation, Graph & Criticism
45. Peacock-Wiseman Hypothesis: Explanation, Graph & Criticism
46. Public Expenditure: Concept, Objectives, & Public vs Private Expenditure
47. Pure Theory of Public Expenditure
48. Structure & Growth of Public Expenditure in India
49. Trends, Lessons & Priorities in Public Expenditure in India
50. Social Cost-Benefit Analysis: Project Evaluation, Estimation of Costs & Discount Rate
51. Performance Based Budgeting and Zero Based Budgeting
52. Theories of Tax Incidence: Concentration Theory, Diffusion Theory & Modern Theory
53. Tax System and Its Principles
54. Equity Principle and Efficiency Principle of Taxation: Meaning, Explanation & Examples
55. Ability to Pay and Benefits Received Principle of Taxation
56. Theory of Optimal Taxation: Excess Burden & Distortions of Taxation
57. Deadweight Loss of Taxation: Causes, Measurement & Example
58. Concept of Equity & Efficiency in Economics
59. Trade-Off Between Equity and Efficiency: Meaning & Example
60. Theory of Measurement of Dead Weight Loss
61. Double Taxation: Meaning, Desirability, Forms & Solution
62. Solution to Problem of Double Taxation: Intra-Country & International
63. Double Taxation Avoidance Agreement (DTAA) and Indian Policy
64. Classical View on Public Debt
65. Compensatory Aspect of Public Debt Policy
66. Public Debt or Borrowings: Concept, Need, Sources & Types
67. Concept of Public Debt or Public Borrowings
68. Need for Public Debt or Public Borrowing
69. Sources of Public Debt
70. Classification of Public Debt
71. Burden of Public Debt: Meaning, Types & Explanation
72. Debt Through Created Money or Deficit Financing
73. Public Debt (Public Borrowings) and Inflation (Price Level)
74. Crowding Out of Private Investment and Activity
75. Principle of Public Debt Management and Debt Repayment