June 8, 2011
A critical fiscal process for state and local governments is the planning and funding of capital projects. The literature on best practices for capital budgeting is not as robust as for operating budgets and there is significant variety in the practices of governments. There are a number of factors that add complexity to capital planning, including the multi-year nature of capital projects, the difficulty of accurately estimating project costs and that it is common for the funding of capital projects to be dependent on intergovernmental revenues and debt financing. However, capital budgeting is essential because of the high stakes involved in undertaking large and expensive projects, the fact that the impact of capital decisions usually extends for many years and the amount of time projects take to implement.
The Government Finance Officers Association (GFOA) recommends that state and local governments prepare and adopt comprehensive multi-year capital plans to ensure the effective management of capital assets. The GFOA also recommends that governments prepare and adopt a formal capital budget as part of their annual or bi-annual budget process. The best practice is that capital budgets be adopted by a formal action of the legislative body, either as a component of the operating budget or as a separate capital budget. The capital budget should be directly linked to and flow from the CIP.
The City of Chicago has a Capital Improvement Plan (CIP) that is updated annually. The CIP does not need to be approved by City Council and is not directly incorporated into the annual operating budget process. However, the operating budget does authorize expenditures for debt service associated with capital project bonds and any additional operating and maintenance costs that result from capital programs. The following are the key steps in the City’s CIP process:
- Departments submit five-year capital improvement recommendations to the Office of Budget and Management (OBM) in the winter.
- OBM prepares draft recommendations.
- OBM holds public hearings with the assistance of the Capital Improvement Advisory Committee.
- A draft CIP is reviewed by the Capital Improvement Advisory Committee.
- The CIP is presented for Mayoral approval.
- The CIP is published annually in early summer.
Many governments adopt a capital budget in addition to the CIP. For example, both New York and Los Angeles have capital budgets or equivalent documents that are adopted by their City Councils. In New York, the mayor submits a capital budget with the operating budget each year that proposes funding for capital projects in the coming year as well as the three following years. It is adopted by City Council with the operating budget. Funds that are not committed in the fiscal year that they are appropriated are either re-appropriated in the next capital budget or withdrawn. In Los Angeles, a capital financing plan is prepared in conjunction with the CIP which details the financing for all facilities in the plan, establishes funding priorities and reviews the impact of all borrowings on long-term debt affordability ratios. It is presented for approval as part of the budget.
When selecting capital projects governments need to balance being responsive to stakeholders such as elected officials and the public with utilizing objective criteria that can enhance the effectiveness of capital investments and effectively utilize scarce resources. Experience-based judgment is an approach to capital planning where projects are ranked primarily on the judgment of managers and staff, governing board members, citizens and others and is commonly used by small and medium sized cities. This method has value in that elected officials and other stakeholders are often in touch with the needs and problems facing a local community. However, relying exclusively on experience-based judgment can become problematic when there are many capital requests, complex capital requests and many decision makers. There will always be some level of subjectivity involved in capital planning, but objectivity is enhanced when goals, criteria, rankings or ratings approaches are used to help officials select priorities based on the community’s most pressing needs. The GFOA recommends using a rating system to facilitate decision making in capital planning.