The Keys to a Healthy City Finance Department: A Conversation With Shayne Kavanagh

This week, Chuck is joined by Shayne Kavanagh, senior manager of research for the Government Finance Officers Association (GFOA). The GFOA provides training and resources to city finance officers. In his role, Kavanagh develops new approaches to budgeting, financial reporting and revenue that can better address the problems local governments are trying to solve.

Chuck and Kavanagh discuss the role of finance officers as “decision architects.” Kavanagh gives a closer look at the world of local government finance and shares some tactics that finance officers can use to improve their processes.

• Click here for a computer-generated transcript.

  Chuck Marohn 0:00

  Hey, everybody this Chuck Marohn with strong towns. Welcome back to the strong towns podcast. Shayne Kavanagh is the Senior Manager of research at GFOA. GFOA is the government finance, officers, association, and he joins me today. I think from Chicago. Is that right? Shane, you're in Chicago today, that's correct. Chuck Hey, welcome to the strong islands podcast. Nice to talk

  Shayne Kavanagh 0:31

  to you. My pleasure to be here. Thank you for inviting me on. I've been wanting to

  Chuck Marohn 0:35

  have this chat for a while, so I'm glad we can do it. I think maybe the first thing to do is to just talk about what the GFO A is. I think a lot of people, you know, I mean, we understand that cities have budgets, and there's got to be people who put those together, but there's this whole kind of infrastructure under the hood, and I guess I'd like to explore that maybe first, before we get into any of the like Nuance policy stuff. So what's the, what's the GFO a what's, what's the role of that organization? Sure. So

  Shayne Kavanagh 1:07

  GFOA stands for the Government Finance Officers Association. We've been around since 1906 and we are the professional association for local and state finance officials. So the way I typically explain this is the CFO of the town you're in is very likely a member either of the national GFOA, of which I am an employee, or the State Chapter of GFOA. So we have about 25,000 members now, and we do various educational programming and other activities to promote thriving communities through the lens of public finance training.

  Chuck Marohn 1:44

  I know you have a conference. You bring people together in terms of, like, the stuff that people would get into if I'm a mayor, I'm a city council member, I'm looking at a budget. I I go to my city's website. You guys are essentially an organization of the kind of people who put that stuff together is that kind of, maybe the way that absolutely, that's

  Shayne Kavanagh 2:05

  definitely a fair way to describe it some I guess we'll call again, something people that are often quite familiar with. GIF was our budget and financial reporting awards. So these are awards for the presentation of the budget and or the financial report that elected officials often are familiar with. So back when I was an assistant city manager and a gf way member, our elected officials were quite interested in those awards to see that we got them every year. So that would be an example of something that I think elected officials and members of the public might often come into contact with from GF way. But more broadly to your point, Chuck, is our members are the folks that are putting together the budgets, doing the financial management analysis, doing financial reporting, and all those things you would associate with the finance function of law.

  Chuck Marohn 2:51

  So how is this different than, say, the Government Accounting Standards Board or some group like that, and maybe talk a little bit about those Gatsby and the whole like kind of framework and how your organization relates to the stuff that they do,

  Shayne Kavanagh 3:09

  sure. So Gatsby is a body that sets standards for government accounting. So maybe I know your group talks quite a bit about different standards, so I'm sure some of your members are familiar with different Gatsby pronouncements that announcements that require things in the financial report and or the annual financial report, I should say. And we are a membership association, so we do not have any, like, quasi regulatory powers like that. So we don't set like hard and like rules or whatnot that local governments who need to follow in their batch reporting or budgeting. Our work is strictly what I call soft law, which means that we don't have any legal you know, we'll call it power behind what we're doing whatsoever. Ours is purely voluntary, right? And folks participate in the award programs I mentioned earlier because it's a good thing to do. They want to show that they're following professional best practices and things of those nature.

  Chuck Marohn 4:04

  You are the Senior Manager of research. So what, what kind of research are? I want to get into a couple of the things that I know, but just generally, like, I feel you've settled it a little short here, because you're like, hey, we do professional awards. And I'm like, Yeah, you do professional awards, but you're also doing, like, really meaningful work, advising people on how to look at their budget and consider their budget. Can you talk a little bit about the research aspect of that? Yeah,

  Shayne Kavanagh 4:30

  absolutely. So yeah, I do the R and D work for GFOA, and our R and D work nowadays falls into different categories that I will broadly label rethinking projects. So the idea of behind rethinking is, is the name imply taking a second look at how public finance is conceptualized, and we have, rethinking budgeting, rethinking financial reporting, rethinking revenue, are the three major topics. And more recently, watched launched something called rethinking the finance office, which. Call a miniature project, which is more of like kind of inside the organization of the finance office, but sticking to the bigger three ones. So I think that would probably be of most interest to your membership. We're looking at how to approach each of these areas in a fundamentally different way to better address the problems that local governments are trying to solve through budgeting, tax, reporting and revenue, respectively. So let me give you like an example to make that more tangible and retaining budgeting. The Organizing premise is that the local government budget is a commonly owned, shared resource. And I'm sure your audience Chuck is probably familiar with the idea of the tragedy of the commons. And so the idea is that the local government budget is the commons in the tragedy of the common story. And just like in the tragedy of the commons story, where all the farmers surrounding the grazing area have an incentive to get their piece of the pie so they don't next one will ultimately lean to the ruin of the commons, you have the same thing happening in the budget, where all the different Stickles of the budget are incentivized to struggle to get their piece of the pie, because if they don't, next person will, and you have the zero sum game phenomenon that results in stress being put on the budget and over time, that can add up to fairly severe financial distress. So rethink budgeting is essentially about how to solve that tragedy of the commons problem within global government. So that'd be an example of like the sort of research we get into in timing your point Chuck, we have several training programs, resources of all certain different types to help local governments address various aspects of this tragedy of the commons problem. So just to kind of also make that a little bit more tangible. Just very released. Recently, we released some materials on budget games. And I don't mean like the fun kind of budget games, I mean the kind that are the games people play to get more resources, and the one that I'm sure everyone can very easily manage, imagine something called the padding play. And it's basically like high ball pricing and negotiations, where you set a high price and then you get negotiated down, but you end up with a price higher than you would have accepted as your low price. So this happens in budgeting all the time, right? And it's called padding in a budget. Another kind of we'll call it less pejorative way would be self insurance that you might put into your budget, but every department doing this, the cost of that padding on itself insurance adds up tremendously. So in other words, how can you then develop budgets that do not have excess padding, but also account for the uncertainty that padding is therefore in the first place? So you would get into ideas like, well, can we pool the risk across departments, just like you pool your commercial insurance, right? Not very common for departments to all run out and buy their own liability insurance, you pull that across the entire government. So can you similarly pool this budgetary insurance that's being taken out in the form of padding in a centralized contingency, and thereby reduce the total amount of padding? And we've done work with several local governments that have actually done this to this, to this savings of millions of dollars. So this is not just like a theoretical savings, but is a quite a practical concept. So interested like this in rethinking budgeting, and I could go on probably for five podcasts about, like, the sorts of things that we're doing and rethink budgeting, but I'll kind of let you take it to where you think the audience here would be most interested go. I'm going

  Chuck Marohn 8:23

  to write that down. I want to come back to patting in a little bit. I feel like we should outline what a financial officer does, like what their role is. And I'd, I'd like to, I'd like to start with, you know, what kind of duties they have the things that they're required to do, and then I actually want to get into their role in a in a bigger sense, like as advisor to the Council, as advisor to the rest of the team, like, professionally, like they sit in a very interesting place, the padding discussion kind of highlights that you know, are are they A gatekeeper? Are they an advice like, where are they? So what if you were just a break it down? Like, I'm I'm going to be a financial official. That's what I'm going to do. I'm going to go to school and get that. What kind of things would I be doing day to day, functionally, for a city government? Well, that's a

  Shayne Kavanagh 9:16

  very interesting question, because whenever someone asks, like, describe city or local government generally, right? It's always so hard, because there's so much variation, right, that the average city government, right? You know what? Doesn't exist, because there's all these little variations on to your with the finance right? Well, you might be doing budgeting like so our research shows that the budget offices very often look in the finance department, but not always, right, like, sometimes it falls on the finance department. Sometimes risk management does, sometimes it doesn't. Now, certainly financial reporting is almost always going to fall under the finance department. But even then, there's cases where you might have cities with like, a separate, like auditor, controller versus a kind of separate budgeting department. And you know, even then. It's not always going to be like, you know what is sort of the finance official may or may not be doing financial reporting, but just broadly speaking, I think kind of a fair way to look at it is the general ways in which GFOA divides up its best practices, where you have budgeting and accounting are the, probably the largest areas. But then you also have things like treasury management, which is like the management of cash flow investments, that sort of thing. You have debt which is very important. I know something near and dear to the parts of strong town listeners, is capital improvement planning and the finance officers. Role in that economic development would be a little more niche. But like meaning that's kind of faulted there as well. Some elect, some finance officials have a role in that. Some don't. But I say, broadly speaking, those are the big areas of interest. And I would probably add to that, maybe as another we'll call it sub area is tensions where, you know, again, that would be one where the level of like day to day involvement in that particular topic would vary like so, for instance, if you are a city that is part of a state plan, you might have a lot less to do and a plan that is run by the state, as opposed to if it is a plan directly administered by the city government.

  Chuck Marohn 11:16

  There's a vision I have in mind in my head, not so much today. But I think maybe if I went back 20 years ago, I would have had this vision firmly in my head of the, you know, the person with the visor, the green visor, and they're just sitting there, like counting numbers all day, maybe working on spreadsheets. They got stacks of dollar bills here, and they're moving them over to here. This is a and I don't say this pejoratively. I know that we really, really need these people, but I look at it as, at its core, a bean counter kind of function. I've heard it said once, like, if you have a really good finance officer, you probably never even talk to them or know they're there. You just get, like, good materials, give me the nuance of that, push back on that, or add to that. Wherever you think I'm I'm maybe painting the wrong picture, yeah,

  Shayne Kavanagh 12:08

  and I think, Well, I think that is a fair picture, historically, perhaps. And what we have been doing at GFOA is saying, update that picture. And what we talk about quite a bit, and has resonated with our members is the idea of a finance officer as the decision architect. So in other words, the decision architect is not the one making the decision they are the ones creating a decision making environment that helps the decision makers, ie, elected officials, make the best possible decisions that they can make. And so the it's kind of like the example being like, if you've ever been, I should say that if you ever been, but your listeners have doubtlessly been to a grocery store before in their lives. Right when you walk to a grocery store, the fruits and vegetables are always at the front of the grocery store. And why is it? You might ask is because they know that if you put fruits and vegetables in your cart when you first walk in, you will feel liberated to put ice cream in your cart later on, right? And that's an example architecture. Now they're obviously, you know, called pursuing a certain type of decision. But not all this in architecture is like we'll call that, you know, we'll call it uh, oriented towards achieving a certain purpose, like just the if you present a list of options, the first item on the list tends to get chosen more frequently, or the status quo tends to be the default. Right? These are right. Just is the the that decisions are influenced by the way the decisions are structured or presented. So we encourage our members to be mindful of this and then to work to better shape this as an environment for elect officials, to help them make best decisions. To give you some like very tangible examples of this. One of the we'll call it enemies and good decisions is the narrow framing bias, where we tend to look at things as either or yes or no go or no go. And so we would say this architect, for example, widens the option set by helping people think about, well, how can we get the best of A or B or and B? So like integrated solutions, right? Like win, win, so to speak, or what is Option C that we might not have considered. People also tend to another bias, and decision making is confirmation bias. We tend to look for evidence that confirms our pre existing positions, so decision architect would help folks test their assumptions right. Well, do we have evidence that this is work before in other cities, or can we look at historical analogs to see how this went, rather than just kind of assuming that it will work out as we hope so, things along those lines, I could again, that would be something I go into in greater detail. But I think the kind of bottom line there is that we're looking to update what might be the historical conception of finance officers with the more modern concept of the finance officer. Officer as the decision architect.

  Chuck Marohn 15:03

  So not just a pass through bean counter, here's the facts, just the facts, but someone who helps make informed decisions. Yeah?

  Shayne Kavanagh 15:11

  Because there's no really such thing as like, here's just the facts, right? Like, there can't be right. Yeah, yeah. Because which facts you present in which order you present them? How do you present them like, these are all going to influence the student like, the other thing we'll say is the concept, the traditional conception of the finance officers, the umpire calls balls and strikes, right? But it's like, that is just impossible, right? They give the example I gave before, right? Just the simple order that the options are presented in is going to influence how decisions are made, the way the status quo is framed versus like kind of the options for change will also influence decisions that kind of neutrality is not possible,

  Chuck Marohn 15:50

  right, right? Well, even you know, to circle back to the padding conversation. I mean, I think even that commerce, my interpretation of what you said, and tell me if I'm wrong. But I'm running the Rosen Streets Department, and I know I need two and a half million dollars to seal cracks and maintain things, so I will ask for 2.8 million, knowing that they're probably going to cut me back and I'll end up where I need that's what you're talking about with padding, right? Yes, exactly. And even, I think how we talk about and present those decisions is a part of that choice architecture, right?

  Shayne Kavanagh 16:27

  Yeah, absolutely. So like to give you a good example, like of how one could develop a choice architecture system that would discourage petting. So there's something called target based budgeting, which is a way of budgeting in which departments are given a very high degree of autonomy to set their budgets. And what how it works is the finance officer first predicts the amount of revenue that we're going to get. And that is different from traditional budgeting, where you first look at what you spent last year, then you do the revenue forecast, and you figure out what's the difference, and then change your budget incrementally accordingly. So you start with the revenue forecast, you then decide how much of that is going to be available for core services, and typically it's around, let's say 90% for the sake of today's discussion. Well, then the departments are all given their targets, right? This is your budget for core services. You do whatever you want to do within that target. And one of our counties that we're working with that does this is like the CFO there said she told the district attorney, if you want to spend it on gold plated pens, that's your decision. We're not in the finance department going to like, be like, micro managing you to figure this out. And so if you have a budget that is not going to change, meaning you have this clear target, and no matter what you do, that's what you're going to spend, there is zero incentive to pad that budget, right? Because what good does it do? You're still getting the target. You know, whatever number you want to no padding is going to change that. So that would be an example a decision architecture approach where you're really leaning into the power of autonomy to get folks essentially self, self deep, had their budget. If that makes sense. That

  Chuck Marohn 18:07

  makes it makes sense. So I want to talk about the role of the elected officials. Because elected officials, I mean, I I think at the end of the day, they're the ones that approve the budget, they're the ones that accept the budget documents. They're the ones that, in a sense, are serving as the CE the board of directors of this municipal corporation. Maybe we should just answer that first, as their their role on paper, because then I want to kind of explore city councils are weird, right? Mayors are weird, like this, this board of directors. We're not electing accountants and bean counters. We're electing politicians who have objectives and, you know, represent the wills and the desires of people, right or wrong in an ideal like in a theoretical framework. How does the finance official interact with this board of directors, and what is their role, ultimately, in the process of running the city finances? Yeah,

  Shayne Kavanagh 19:08

  it's a great question. So like, you know, called in public administration theory, right? There's this thing called the policy administration dichotomy, where, in theory, the elected officials create policy and the management carries it out via administration, but that gets pretty messy pretty quickly. And like, not always, like the we'll call it, it's not always a stark line where one begins and the other end. So just to give you an example in my just go back to we just talked about this idea of target based budgeting, so you're giving a lot of autonomy to the departments. And so the kind of downside is that if the departments are determining what counts as a core service, the elect officials are not right. And so that is a weakness of that form of budgeting. And so when we tell people about target space budgeting, we say, this is a weakness, like, you know you're signing up for this. So this is something, one of the trade offs you're making now in target based budgeting, I mentioned in my example was 90% was going to core services. So one might ask, what happens at other 10? And in target based budgeting, that other 10 is used for decision packages, where departments compete by making proposals that the elected officials can then weigh and decide which ones are going to be most important for that year. So you would give the elected officials have a role in that form to help shape their policy decisions via deciding on the decision packages that will be approved. So in the budget world, it's essentially setting the big picture direction of what the local government is hoping to accomplish by the act of spending money and then improving a budget that moves the needle on those things that the elected officials believe will end up making the community a better place to live. And then you have, we'll call it on the financial reporting side, you're getting to the idea of accountability and financial probity stewardship and making sure that the local government is staying within the boundaries is supposed to stay within. So to give you an example, a couple of months ago, I interviewed a bunch of elected officials, because, of course, they are, as you mentioned here, a key audience for our membership. And so we said, You know what we got to do, talk some elected officials and find out what they want from the finance officers. So we interviewed a bunch of them, and the number one answer by far was just, are we going to blow our budget like that was like the main thing. And so, for example, we ought to know as finance officers, we ought to give them unambiguous information as to whether or not the local government is staying within the guardrails necessary to stay within the appropriated funds available for the year. So

  Chuck Marohn 21:49

  these are all humans, and I feel like you. I feel like you more than than most people grasp what that means in terms of like fallibility. Let's focus on the elected officials. First, I have seen many local governments where elected officials come in and they say the number one thing is, I'm going to cut taxes. Like taxes are too high. I'm going to cut taxes. I've seen other places where they come in and they kind of just don't care about the budget. They just want to make sure that some spending thing happens. What is the kind of maybe ideal relationship between the financial official the people in you know that you guys represent and train and help? How do you guide them in dealing with public officials that maybe don't have fiscal prudence in mind or are not really sensitive to the budget issues, but have other things that are motivating them that maybe make them say, like, I don't really care about that aspect of it.

  Shayne Kavanagh 22:50

  Yeah, fair. So if I were to sum it up in one word, it would be trust. So for example, our Code of Ethics is just entirely built around the idea that the purpose of ethical conduct is to build your reputation as a trustworthy actor in local government when it comes to elected officials, that means trustworthy advisor to the elected officials. And to your point, like not every elected official is super into finance. In fact, most aren't. So part of being trustworthy, a lot of that goes into like establishing a ideas of fiscal fluency. So how do you communicate what people need to know in a way they can grasp it and in the shortest amount of time possible, right? Like so to give you an example, something we just finished up actually last week was called the mental model challenge. Was a follow on to last year's challenge, which was the fiscal fluency challenge, where the idea was, well, how can you communicate information in a way that elected officials and other non finance public finance experts can get their minds around it most easily? So last year, the city of Arlington won for a series of budget videos they did that explain the budget in like five minutes, and they used it like the budget as a cooking show, the budget as The Lego Movie, right? And I was able to get ready easily. And then the mental model challenge is like, Well, how do we give people just better, easier ways of conceptualizing what can be complicated financial topic. So my favorite example is with rainy day funds is like, maybe one of the most popular topics in G, F ways, 100 plus year history is the Rainy Day Fund is often described as the same accountable government. I'm sure you've probably heard that Chuck, and some of your listeners have too. Now, kind of the rub with that is not wrong, like a famous as famous statistician George Bucha said, all models are wrong, some are useful. So well, the model is not wrong. It's kind of useful where it kind of breaks down a bit is research shows that finance folks like me think of their personal sames account as a hedge against risk. So when I say like, same as account like, I think hedge against risk. Because normal people think of same as account, as deferred spending, like vacation money. So as the officers say to my council, this is our sames account. The council thinks, oh, this is the money to spend. And they're not wrong, because in their mental model, this is deferred spending, right? So we say, well, we need to update our mental model that the reserve is more is the insurance policy of local government. We are self insuring ourselves against the natural catastrophes, recessions, that sort of thing. And when you use change the lingo, like change the mental model, you see the behavior change. It's quite traumatic in some cases where people like, Oh, this is our insurance fund we need. We would not spend our insurance fund like we would our sings account on a vacation. But it also brings up other points, like, you can over insure yourself, like that is a possibility. So it kind of makes people aware to that aspect of reserves, but also brings up questions like, well, how does this then interact with our commercial insurance policy? Are we optimizing both? Right? So it also answers, I think, useful questions, but raises other useful questions for elect officials to think about. And kind of, I think, just the bottom line here. The idea is, can we as finance officers provide better mental models to elected officials to help them more easily conceptualize public finance and make savvy and wise decisions without necessarily having to be miniature CFOs, because, as you point out, not a lot of elected officials have an interest in getting into that little detail, and that is not, you know, a criticism. It's just that it's just not everyone's bag, and neither is it everyone's role, because we only have so much time and energy, of course, right

  Chuck Marohn 26:38

  right at the end of the day, the elected officials are the decision makers. I mean, they, they, they ultimately have to approve the budget and approve the finances and write the checks, and do you know the sign off on all this stuff? I think that idea of these are all humans. And when I say that, I think you understand what I mean. But let me say it explicitly. We're all deeply flawed in human ways, right? We all have human things. One of the I think, stress points that I see with financial officials is I do work for these people. These people are asking me to, in a sense, fix the budget or make the budget work with my priorities. I want to explore some of the like, I'll say bad incentives that creates, structurally without pointing at the financial officers as like the problem. But I do think that financial officers are in this kind of unique role where they know more than the elected officials, and in a sense, can solve today's problem by making tomorrow's problem worse. How do you deal with that tension? How do you deal with it as an organization? How do you advise your your your members to to handle that situation and like, what would be the ideal way to go about that?

  Shayne Kavanagh 28:00

  Yeah, a few different things. So number one, GF, way has been very much a advocate for the idea of long term financial planning local government for many years. And we actually just finished a survey of local governments nationally, and we found that about four in 10 are doing some form of long term financial planning, which honestly, we're pretty happy with. Because when we first started this, like, it was less than 10% of GFOA members, and this is the last survey I did, was of all local governments, so I guarantee you, it's much higher among GFOA members. So this is progress. Now that doesn't mean that we're satisfied with that, you know, as, like, the kind of end point. It just means that this is, uh, moving in the right direction, right? So long term financial planning and having a long term viewpoint is quite important. Can I

  Chuck Marohn 28:52

  pause for section? Yeah, I feel like people would find that stunning, because you're dealing with, I mean, my little city is a $13 million a year budget. I mean, you're, you get into a major city like Chicago, and you're talking, you know, billions of dollars are moving around. 40% are doing long term financial planning. The rest are ostensibly not doing long term financial planning. I think a lot of people would find that that kind of stunning,

  Shayne Kavanagh 29:18

  right? I guess I should maybe caveat that I that was not including capital planning, sure, sure. I was just so, like, more do capital long term capital plans, so, but I would agree with you, like, more need to do it so we are like, I said, we're not like, saying 40% is, like the end goal, where I'm saying it is certainly progress, like, it's a big improvement, sure. Yes, exactly so. And then I guess the other thing I would say, because, you know, the natural question that is, well, you know, as you're pointing out, like, well, that's still 6% that are not and, like, there is a short term bias to just people generally, and elected officials are certainly people. So what do we do about that? And so that also, I think, goes back to the idea of mental models and how you present this. So this is. Another example I'll give this from a small town in Arizona where they had a pension problem. And the CFO there was explaining things like underfunded actuarial or liabilities and so on and so forth. And, you know, the elected officials, quite understandably, we're really not getting it, because they don't have on these like actual, determined contributions in their daily lives. So it's a little of an abstract concept. So he came with a mental model where this is like the bad debt on a credit card, and everyone can appreciate that, oh, we certainly don't want to pay credit card debt. Like everyone knows that is not value added, because that is debt on a consumer good, right? That you've already consumed is gone. It's not helping you going forward. And same with pension debt, that is money spent essentially in compensation for employees in the past. It is not providing value going forward. So you want that off your books to the extent you can do it. So that really motivated folks to, like, think hard in that city about what sort of policies they could adopt to dramatically reduce their pension debt. In fact, work, not only did it work as it actually also inspired some changes in state policy around pensions for local governments generally. So I would also kind of point to again, just we need better mental models and local government for thinking about a lot of this stuff, and the call that influences decisions that are made when you have just a different way of thinking

  Chuck Marohn 31:25

  about it. Chicago, the city where you're at, I think, you know, famously in strong town circles, you know, hawked their parking revenue for I don't know how many years to fill, like a short term budget hole. I don't know what that internal conversation looked like, but I've seen, like, small versions of that, where the city council says, Hey, we've got a budget gap right now. This is really problematic. They turn to their finance officer and like, can you solve this. And the finance officer, being a human, is like, Sure, I can solve this. We will move this thing out into the future, and it will make this harder for next year's budget, or the year after budget, or the budget five years from now, but it'll make it easier today. How do you, how do you advise your members when things like that are happening? Because I recognize, I mean, I've been on a school board. I did an interim thing for a couple years to help a school board out. And there were times when, you know, the state budget begins July 1, they would defer our payment that was supposed to come in in March to July 1, so we had to do our own kind of goofy accounting to make it work. I understand that these are not always done for like, nefarious reasons or short term thinking. How do you advise your members what is like a best practice in terms of of that kind of trade off? Yeah, so if I

  Shayne Kavanagh 33:01

  think I understand what you're saying correctly, it's you're dealing if you're in a situation of financial stress, or de stress even,

  Chuck Marohn 33:09

  or you just really want to spend more on whatever it is, and you're maybe, you know, I think there's a fiscal stress element to it. There's also, you know, a fiscal prudence element to it. I've kind of seen it both ways, right? Like, I I really want to give this tax cut because taxes are too high, damn it. And, you know, I really want to spend money on this because I really, really believe in this passionate thing that I want to do. It doesn't necessarily have to be fiscal stress. What's the role of the finance officer? In a sense, like solving problems creatively. Let's say, yeah.

  Shayne Kavanagh 33:42

  So I think, like, probably does, even so help think about it, invite distress or not distress? Because, like, the answers differ really dramatically. I think if you're in distress or in your situation, like this scenario you described, so if you're in distress, you know, we have a whole set of guidance about fiscal first aid, and how to essentially deal with cases where you may have to defer expenditures for a year in order just to balance the budget, and how to do that responsibly. So I think the question, the answer to the distress question, is like, well, if you are going to defer expenses, just be transparent and mindful that you are using this as a band aid technique, and at some point the band aid has to come off, and you need to have a more structurally balanced plan. Now, when it comes to like, we'll just call it the more general case, we are a big fan. In fact, have a best practice titled structural balance in your budget, which the idea is that your ongoing revenues have to match your ongoing expenditures and your one time revenue should match your one time expenditures. And that is something that is not only a gf way best practice, but we are in the middle of re imagining, or re I will call it designing our GF way budget award program. We were thinking about, like, how we can use that budget award I mentioned the very beginning of the show to kind of, we'll call it encourage the adoption of, like, these kinds of practices outside of our we'll call it like soft law function, where we have these called professional standards that we promulgate. So to provide multiple we'll call it paths of motivation for folks to adopt these sorts of approaches to thinking about how they balance their budget over the long term.

  Chuck Marohn 35:28

  If we have finance officers and we have City Council, the Board of Directors, we have the shareholders, which is the public, right? Yeah, how should the public understand a balanced budget? Every year we get here in my city and in cities across the country, we get the budget preparation process, which starts at some point for us, in the summer, in the late summer, we get this huge number right, like, oh, taxes are going to have to go up by this much, or we've got this much of a fiscal gap, and everything's really bad. And then they kind of whittle it down. And then we get to a truth in taxation hearing here in Minnesota in December, and everything's fine, and the budget's balanced. And then we go on to the next year. How should we understand that balanced budget? What should as a member of the public when I hear the city's got a balanced budget? What? What should I take away from that?

  Shayne Kavanagh 36:27

  That is an interesting question. I say that because I think you're getting at, like, what are the constraints on local government? And, like, I think, I know you're fans of system theory, Chuck and so, like, a totally unconstrained system, right? Like, it's going to be like, probably not produce amazing results. And so when, like, I was a, for example, a gf, one member, assistant city manager in state of Illinois, and the definition of a balanced budget in the state of Illinois is your sources equal your uses. So you could, in theory, sell off city hall in one year and use it to pay police salaries, and you're fine. Like, that's a balanced budget. Obviously, under the definition of the structural balanced budget gave you earlier, that would not be a balanced budget. And same in Illinois, we could issue, like, enough debt that the city would be basically, you know, bankrupt five times over. But under the state of Illinois, you could, and that's not a crisis in the state of Illinois. That's just, these are one size fits all policies, right? Because the state of Illinois has to come up with constraints that go everywhere, from my little village that I was the into, like the state, you know, like the largest cities in the state, like, so what we encourage folks to do is adopt local constraints like some other words, like, what? Define a balanced budget for your city. Define local debt limits for your city and observe those so if you remember the public back to answering your question, I would say, if I heard balanced budget, I would assume it equals means, sources equal uses. But I would also want to know what kind of constraints has my local government adopted to essentially put boundaries on its own decision making. So I'm sure you've all heard good fences make good neighbors. Very similar situation, right? The fences are the constraints. So you need some fences up around the decision making to put boundaries on what is done. So I think you know to where this is probably going, and where your listeners might be interested in is, I think adopting constraints within local government and the foreign financial policies is something that GFO has been a huge advocate of for many years, is a potentially quite powerful device for defining balanced budget and other things like that in a way that really guarantees financial sustainability over the long term. What

  Chuck Marohn 38:43

  are some examples of those constraints? Like, if I, if I hear my my city's got a balanced budget, and that's it. It could possibly be they went and borrowed a ton of money and threw a big party and but and their money coming in equals their money going out, so like, we're all good. Or it could mean that they passed a budget with A, B, C and D, fiscal restraints, and they fit within those restraints. Balanced budget can mean both. What would those fiscal restraints like? What are some examples of those that cities would adopt?

  Shayne Kavanagh 39:14

  So I give several. So one, and probably we'll call it the most famous, is a reserve policy, which is basically, here's the floor and ceiling on the amount of reserves we hope to maintain. So in other words, reserves is kind of like, you know, the closest thing there is. And I say closest because it's not a bottom line for local government, but we'll say the closest thing there is to a bottom line for local government that's easily accessible for folks to understand. And so if that gets too low, that's probably a sign, because the reserves are basically your accumulated surplus and deficits over the history of the city's existence. And so you can imagine, if that were pretty low, that doesn't speak too well the city's ability to generate surpluses and avoid deficits. So. A policy that establishes floor and ceiling on reserves. And because I go back to the ceiling approach, because it goes back to over insurance, like you can over insure anything, so cities could over accumulate reserves, that can be a thing. So that is number one. Number two, I would say, because this one is kind of relatively straightforward and easy to get, kind of get your mind around is a one time revenue policy, or if you get a one time non recurring revenue that is put towards one time non recurring expenditure. So in my example, if you were to sell off City Hall, that would be a one time revenue, so you would not put it towards police sellers, which is a recurring expenditure, right? But if you did want to sell City Hall and buy a new city hall with it, like, all right, yeah, sure, you could do that. That is a, we'll call it, you know, one time in, one time out, sort of situation. You could go beyond that to, like, say, a volatile revenue policy. So I know your, your audience is familiar with the idea of local sales taxes and the that can be of quite a volatile revenue. And if you get like, peak sale taxes one year, you do not, even though, in theory, sales taxes are a recurring revenue, you'd probably not want to spend peak sales taxes. And therefore, do peak, you know, firefighter salaries, right? You'd say, All right, well, this might be a one time thing where we had a little bump this year. We're going to treat that bump as one time revenue and make sure we don't over extend ourselves based on what would be a temporary influx of sales tax, I would also say kind of then the super advanced version of all that is the recurring revenue or the Balanced Budget Policy, the structurally balanced budget policy I hinted at earlier, where you adopt a policy that says, in our city, the definition of a balanced budget is recurring sources equal recurring uses and one time sources equal one time uses. And then the last thing I'd probably add to that is a debt policy that has local limits on debt usage. So in other words, I mentioned earlier, states will have limits on debt usage, but those are often quite high for very good reasons, compared to what might actually be affordable for that local government. So figure out what is locally affordable and then pay your indebtedness against that. Then there's also probably several sub policies one might want to look at, like repayment schedules of debt. Like, you don't want to back load debt so. But if I were like, kind of boil it down to, like, the tip top ones, the ones I just said would be those. But understanding also, there's many elaborations and nuances one can get into to, like, further tune those up.

  Chuck Marohn 42:37

  One thing that I see cities do often is release their bond rating in like a press release say, hey, you know, we've got a double A plus whatever bond rating that is a sign of our our great fiscal management. How would you or how would GFO a look at bond ratings? Is that something that you even ponder or consider is, what would you tell an average voter, if your city saying, Here's where our bond rating is, how should they interpret that?

  Shayne Kavanagh 43:11

  Yeah, bond ratings are definitely a clue, right? Like, so these are all like, kind of, you know, the big thing we're, you know, into on the research, as we'll call, like, information theory and like reductions of uncertainty. So in your example here, right? Remember, the public is trying to reduce their uncertainty around whether or not their local government is well managed, and bond ratings are certainly a clue. They definitely will reduce your uncertainty, but they're not going to eliminate all uncertainty, right? Is not like the one measure that tells you everything you'd ever want to know, but it's a great clue, right? If, like you told me, here are two cities, one triple A and one is B, I will hazard a guess as to which one is better managed, right? I'm not just hazard a guess. I will bet you on which one is better managed, right? I will be willing to put money on it. So definitely a clue, but definitely also not the final word, because a lot goes into bond ratings, besides the low government's financial management, like the strength of the tax base it's sitting on right is taking to account, and that is, you know, just due to circumstances, and not due to the proactive management techniques of the city. And of course, also, we have to realize that bond rating agencies like those, bond ratings are basically a measurement of the bond rating agencies certainty that the local government will repay its debt, which is not the same thing that the public necessarily cares about. Like the public certainly would like the debt to be repaid, but there is more to a thriving community than repaying one's debt, right? So the public cares about, is my community thriving now and in a position to thrive for future years, whereas the debt rain agencies are asking for, boundary agencies are asking for, is the city in a position to repay its debt now and in future years, which not exactly the same thing? You

  Chuck Marohn 44:55

  and I have had some discussions about cash accounting, accrual. Counting the effect of infrastructure liabilities long term on you know that that sustainability of the budget, I don't know as you've changed my mind, but you have made me maybe more sensitive to the idea that it's more complex than what I would assume, right? Can you talk just a little bit about that difference between cash accounting and accrual accounting, and why? Why do we account for infrastructure the way we do? And I think our audience is kind of aware of the idea that you know, when you build a road, it's counted as an asset, it depreciates over time. That kind of hides, in a functional way, the expense that you have in the future. Because, you know, I gotta go out and fix that road like that is that that is an obligation of the city, and if I don't do that, I'm kind of reneging on a promise that I have made, but from an accounting standpoint, it's not a promise like it is an there's an option to do it. Can you just talk a little bit about that? I feel like, I feel like our audience would benefit from hearing the nuance from someone who sits in a different role than what I have historically in local government, sure, yeah.

  Shayne Kavanagh 46:22

  So maybe just a little bit of context for your audiences. We have something a project called rethinking financial reporting, which I believe I just mentioned briefly at the outset. And the basic concept there is that, how can we increase the value of financial reporting to all stakeholders. And I say all, I mean all, like, as in, the finance officials who produce it, the elected officials who, well, I was gonna say, read it, but actually don't read it in many cases. But you know, our customers of it, shall we say, the public, or ultimate customers of it, the folks, the participants in the bond market, who are participants of it. And I mentioned earlier. This idea of information theory and decision theory is like a big kind of we'll call element of it. And what we're trying to do is like, think about, well, how do we reduce the uncertainty that everyone has who are involved in this so they can make better decisions? That's what it all really boils down to, and will including information or changing the way information is presented around infrastructure, reduce people's uncertainty or change their decisions, and that is a question that we believe is open to question, right? And are there better ways to go about it? And you know, something I was thinking about before we hop down here, that I thought it would be interesting to explore, because I had a feeling this might come up. Is, I think one of the we'll call it like traditional challenges when it comes to this sort of work in the financial report is we talk about infrastructure. The work of the financial report is mainly done by the finance officer and the auditor, right? And we're talking about infrastructure. Who's missing from that conversation? That engineers, the engineers, right? Yeah, have been part of it. And all right. Well, what does that mean? So, like, I'm sure your audience is all familiar with the idea of straight line depreciation, like, this is a kind of classic win, which things depreciated, but your audience is probably also familiar with that. Is not how things actually depreciate in the real world, they tend to appreciate on S curves. And so you find a lot of this sort of thing and bench reports, and that is not like prism of pan sauce. It's just people tend to think linearly. And the I think the problems that you're talking about and that we're also trying to solve are non linear, and that's where a lot of this problem is coming from. And like the S curves is like curves is like a classic example, another classic example, I think. And I love your opinion on this, because we're just mulling over this morning, so it's kind of a brush off the presses here is like, when you're talking about, like, growth of a city, right? We tend to think about per capita costs and increasing services, right? But that's not actually how it works. It tends to usually proceed in step changes, like, so this is lumpy, yeah, yeah. Then like, so step change, right? And so step changes are non linear, and if you think about like, kind of your service costs as step changes, as opposed to linear, that is going to produce a whole different set of decisions than if you think about it linearly, and also probably super critical. And this is all leading is looking at marginal costs, and is like the unit decision analysis. And marginal cost is definitely not like front and center in traditional financial reporting. So like, marginal cost is where it's at, like in decision making on the margin is a super powerful technique, very powerful technique that just is not part of financial reporting, you know, for a good reason, because it's not operational reporting. It's supposed to be a snapshot of the entire year. It's not supposed to be focusing on these marginal decisions. And that's where I think the problems that kind of you and I are trying to solve are. On the margin in many cases. So we need to, like, think about the kind of on the margin decisions, and also, like, the non linear nature of these problems, neither of which are captured in the financial report and never will be, because it is an annual snapshot, right? And that's where we go back to reading financial reporting, is, how can we just change, like, the information landscape so that like these, this type of information is made available, and is made available much quicker and in a format that is way more accessible than it is now. So like just for example, we just finished a not just finished, let's say finished phase one of a project with the city of Burbank, where we're working with them to develop completely online, AI driven financial reporting methods to get the sort of information people need in front of them much quicker. And I think there's a lot more potential that sort of thing to just essentially go far beyond traditional financial reporting. Is a new information ecosystem that's just fast improvement. I've gotten a

  Chuck Marohn 51:02

  little taste of some of that work that you've done, and it is, it is impressive, and it will open things up a lot. I feel like the place that I struggle the most with is there is a underlying incentive to, in a sense, chase the sugar high of like that new development, you said, step up. And I called it lumpy, the lumpy infrastructure, like, oh my gosh, we just reached a point now we got to build a new water tower, and that's a that's a huge expenditure, and then that creates a sunk cost where you just kind of need to add more users, no matter if that puts you structurally in balance or not. I get a little frustrated, because I think, like the classic case is the developer comes in says, I'll build this new development and then gift you the city all the infrastructure and for in standard accounting that would make the cities, like, you know, financial position look much better. All of a sudden, your assets are way up and you haven't really spent anything. And so I look at cities that are very fast growing, and they have really strong, you know, net financial positions, or, you know, total assets. And I look and say, well, that that doesn't really account for all of that, all of that kind of cumulative promises that they've made for the future. I don't know if there's a clean way to get at that, because, as you said, it's it's really messy, it's really lumpy. How much have you thought about that, Shane, how much has GFOA kind of danced around that issue? Yeah. I mean, I

  Shayne Kavanagh 52:32

  think you bring up a great point. And I know your audiences, I'm sure familiar with Joe Minicozzi's work like so Joe has been intimately involved. Jeff away for many years. And I think, you know, as we talk about new I will call it kind of information, like making the sort of, like geospatial and financially integrated data available, combined with, like, what we just talked about with, like kind of, we'll call it like the marginal cost and like the non linearities that are involved here, like way more apparent than They are now, because right now it's like, you give a you know, what's the console gets is like a spreadsheet. It's a road numbers, and it's highly abstract. And again, it's not a criticism of the finance officers. This is the medium that they have to work with. And it's just, well, it could

  Chuck Marohn 53:16

  be part of my engineers, right? Yeah. I mean, the engineer and the planners are part of this too, because they're saying, build this without a real, like, fiscal analysis of the of the project most times, right?

  Shayne Kavanagh 53:29

  Yeah, yeah, exactly so. And I think it's, you know, one of the you're being a very good point, which I also think is just called, like, the siloed nature, right? Of low government work, you tend to have science officers in one silo, the engineers in another, and the planners in yet another. And we've done several projects at GFA way to, like, try and bridge those gaps. And we've actually got a very exciting thing happening right now, now that you're mentioning it, that I think could be pretty thrilling, as we'll have several opportunities in the coming months for finance officers to invite in their colleagues from different departments, to collaborate on different subjects will be of interest to some of their colleagues. So it is very much on something on our to do list is to bridge those gaps, and that could be perhaps an opportunity for strong towns and GF way to work together, because kind of, what you know, really kind of our hesitation when it comes to the financial reporting areas. You then start to, if you put things in a financial report now, you make it the province of the auditor and the finance and the CFO to like get done for compliance purpose. And it's, no, it's not a decision making tool. It's a compliance tool. And we don't want compliance tool, we want it to be a decision tool, and that doesn't happen when it's thrown into the financial reporting bucket.

  Chuck Marohn 54:46

  Yeah, yeah. Respect that. I know we're out of time. I wanted to give you just a couple minutes to talk about the Rethinking budgeting stuff you've been doing. I I know you've been working on this a long time, and I know there's a bunch of different facets to it, but you guys. Are rolling out some of the R and D that you've been intimately involved in. Just give an overview of that, because I think people would be interested in how you're giving advice and the tools you're making available to local finance officials.

  Shayne Kavanagh 55:14

  Yeah. So the idea of rethinking and budgeting is, just to recap. The premise is that the local government budget is essentially like the Commons and the tragedy of the commons. And for those that aren't familiar with this metaphor, the idea is, there's a it's an old economic parable where there is a grazing area, and the folks that surround this grazing area, the farmers that surround this grazing area, collectively own it. Because they all collectively own it, they have the same incentive send your animal onto the grazing area as much as possible, because if you don't, the other farmers will so your animal be sitting at home, not eating while the others are out getting fat and happy. So everyone sends their animal, and the grazing gets grazed down to nothing and becomes barren. Local Government is in the same situation, but there is a whole series of ideas, articulated most clearly by Eleanor Ostrom, who's a Nobel Prize winning economist, about how to solve the tragedy of the common so we are essentially bringing those ideas to public clients and translating them over to public finance and proving them out. So there are whole different like set of concepts can be brought in. And the good news is you don't have to do all of them. You just have to do some of them. Of them in our experience, and you can get dramatically different results. And so just to give one example we described earlier was this idea of target based budgeting, relatively simple budget innovation that can have some fairly dramatic effects in reducing padding and like that, particularly, that's one aspect of byproduct of this tragedy of the common situation, and also has several other helpful we'll call it effects. But there's not just target based budgeting. We have several different options within the retaining budgeting, collection of resources for local governments to approach this problem in a way that's going to best suit their own circumstances. So we talk about this idea of be a chef, not a cook. So in other words, don't follow the recipe, because the recipe is not going to fit your situation, right? It never does. So you have to be a cook and you're prepared to work that you've got to make the meal that is going to take advantage of what ingredients you do have available and suit your audience. So that's kind of, I guess, in the kind of most boiled down way how I could describe rethinking budgeting, and we're very excited to have officially launched that within the past couple months, after a couple years of research on it, and we're starting to now integrate it into all our training programs, budget award programs and other elements that we have at GF, way that equip finance officers to bring this to their local governments.

  Chuck Marohn 57:46

  I know your website is G F O, a.org people who want more information want to get a hold of you. I'm not going to give out your email address because it's not on the website, but G, F O, a.org/bio/cavanaugh, there's actually a little form. If you want to get a hold of Shane, all his information is there. You can actually, like, fill out a little form, and it will send an email to Shane, and he'll decide if it's where they get back to so ask him good questions. If you got stuff you want to follow up with them, don't give don't send him those, like, eight page emails you guys send me. You got to be concise and ask a good question, but Shane, that's the best place to get a hold of you. I'm assuming

  Shayne Kavanagh 58:25

  that works. I'm also on LinkedIn, so my LinkedIn profile is also super easy to find, and I

  Chuck Marohn 58:32

  Yeah, all right. Shane KAMNA, Senior Manager of research for the Government Finance Officers Association, thanks for taking the time this has been really, really, really helpful, so I appreciate it.

  Shayne Kavanagh 58:44

  All right. Thank you. Chuck my pleasure to be here. Hey.

  Chuck Marohn 58:47

  Thanks everybody for listening. Keep doing what you can to build a strong town. Take care.

ADDITIONAL SHOW NOTES

• Connect with Shayne Kavanagh:

  • GFOA site

  • LinkedIn

• Chuck Marohn (Substack)

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