Expiring Budgets and Spending Sprees: The Cost of Use-it-or-Lose-it Budgeting

Would you be surprised to learn that the US State Department spent one million dollars on artwork made of granite blocks as the government’s fiscal year came to a close?

According to new research, most government agencies are under pressure to fully expend budgets that are set to expire (the deadline is September 30^th for the US federal government). Jeffery Liebman and Neale Mahoney examine government spending spikes and quality tradeoffs at fiscal year-ends in their September 2013 NBER working paper. The authors empirically demonstrate the staggering fiscal and social costs of these expenditures occurring in the final weeks of each fiscal year.

The authors explain that federal managers face uncertainty over spending demands within a fiscal year. At the same time, government finance procedures do not allow unspent funds to be moved from one fiscal year to the next. As such, agencies tend to underspend and build a “cushion” of money in the first half of the year. If spending needs do not materialize in the latter half of the year, managers rush to spend their funds, often on low-quality projects in the last weeks of the fiscal year. This problem is not unique to the US; in Canada, where March 31^st is the last day of the fiscal year, the Treasury Board President has called for an end to so-called “March Madness.”

Leibman and Mahoney predict that the prospect of expiring funds incentivizes agencies to spend all remaining funds “even if the marginal value is below the social costs of the funds” (the authors’ definition of wasteful spending). The authors test their predictions using contract-level data from the US federal government. Leibman and Mahoney examine a near-universal dataset of procurement spending from 2004 to 2009, totaling $2.6 trillion in expenditures.

The researchers’ findings are revealing. If government spending were uniformly distributed, agencies would spend 1.9 percent of their budgets each week. However, the data shows that agencies spend a full 8.7 percent of their budgets in the last week of the fiscal year, or nearly five times more than if it were uniformly distributed. Year-end spending spikes the most for non time-essential projects such as maintenance, furniture, office equipment, and computers.

The authors also examine the quality of year-end spending by building an Ordinary Least Squares (OLS) regression model. The dataset Liebman and Mahoney use includes a quality index from agencies that includes project costs, performance, and timeliness. They find that projects contracted in the last week of the fiscal year had a 2.2 to 5.6 times higher probability of being low quality.

The authors then examine a control group of expenditures to understand the effect of use-it-or-lose it budgeting, using IT projects at the Department of Justice (DOJ), where the DOJ had secured authority to roll over unused funds into the next fiscal year. As the authors predict, there is substantially less year-end spending on I.T. projects compared to other departments. More importantly, the authors do not find a drop-off in the quality of the purchases.

The authors go further and calibrate their model using estimated levels of wasteful spending and low quality projects to calculate welfare gains from allowing agencies to roll over year-end balances. If Congress were to allow agencies to rollover their budgets, the authors estimate a quality gain of up to 13 percent. In other words, should there be no rollover restrictions, Congress could provide agencies 87 percent of current budgets and would obtain the same value on procurement expenditures as they do today. Nevertheless, the researchers caution against extrapolating the model to the entire Federal Budget as the DOJ control analysis on quality is based on a single agency using a small number of projects.

Despite the limitations, this study confirms the wasteful nature of the “use it or lose it” mantra in government agencies. This research ought to inform policymakers and provide them with additional tools as they look into ways to fight deficits and provide value for taxpayer money.

Feature Photo: cc/(Tracy O)