Public & Private Fiscal Policy

Public and Private Budget Preparations

The difference between public and private sector budget preparations are the difference in measuring the effectiveness of the budget. This difference is caused by the nature of public and private sectors. The private sector is driven by profit based budget methodologies. This differs from the public sector because the public sector operates on methods which measure outcomes (Young, 2003). The difference in preparations of public and private sector budgets is a difference in defining objectives and how those objectives need to be measured.

The preparation of public sector budgets entails the use of different tools than the private sector. For example, the mission and goals of the public organization become the most important tools in preparation. Through these standards resources are allocated and utilized.

Performance budgets use statements of missions, goals and objectives to explain why the money is being spent. It is a way to allocate resources to achieve specific objectives based on program goals and measured results (Young, 2003).

An example of this can be seen in a public organization such as Medicare. If Medicare needed to increase benefits to a larger group of clients; the preparation would include forecasting the number of new clients and the cost for these clients (cost per outcome). Most importantly the new client objectives would need to be in agreement with the mission of the organization. I.E., if Medicare serves the elderly the new clients could not be less than a certain age. The goals would be the determining measure of the budgets success along with achieving a cost per outcome. Thus if Medicare budgeted to serve 1,000 new clients and it served these clients as well not exceeding the cost per new client (outcome) then this would be a successful budget.

In contrast, preparing private sector budgets is much less difficult in that cost becomes the primary preparation method. For example, if a company is preparing to open a new store, there are certain costs which must be taken into account when preparing the budget. These costs would include items such as labor, materials, rent/mortgage, etc… The outcome of opening the store is important but is not considered the primary motivation in preparation. Ideally, in private sector budget the costs are calculated in a rational manner and then the object becomes staying on budget but not having time delays. Often managers are rewarded by staying in budgets or by operating below budget. Ultimately for the private sector or corporate budgets cost and profit become the most important concerns when preparing.

There are disadvantages to performance based budgets such that they are fixed and sudden changes in costs due to circumstances, such as inflation or recession, can create negative impacts on budget performance (Kelly, 2011). Many people believe that performance based budgets are also wasteful, at least in the private sector, because they do not account for profit or for saving money. This may be true in some instances where public sector budgets where prepared incorrectly and the forecasted cost per outcomes could not be achieved for whatever reason (Kelly, 2011). However, cost budgeting as performed in the private sector is often fraught with many problems. According to Professor Michael C. Jensen of the Harvard Business School, cost budgeting in the private sector,

It encourages managers to lie and cheat, lowballing targets and inflating results, and it penalizes them for telling the truth. It turns business decisions into elaborate exercises in gaming. It sets colleague against colleague, creating distrust and ill will. And it distorts incentives, motivating people to act in ways that run counter to the best interests of their companies (Jensen, 2001).

From this perspective, it is obvious that corporate budgeting and public budgeting need to meet somewhere in the middle. The need to account for cost is vital but the need to achieve goals and stay within mission focus is also vital to budgeting. For this reason, public and private sector budget preparations may not run counter to one another but may instead hold solutions for their respective fields.

References

Jensen, M. C. (2001, November 26). Why corporate budgeting needs to be fixed. Retrieved from http://hbswk.hbs.edu/item/2647.html

Kelly, J. M. (2011). Performance budgeting for state and local government. (2 ed.). New York: M.E. Sharpe Inc.

Richard D. Young, “Performance-Based Budget Systems,” Public Policy & Practice, January 2003, p. 12

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