Annuality in public budgeting: an exploratory study
This study aims to address these issues by reviewing the limited current evidence available and, most importantly, adding to it by conducting interviews with controllers and budget holders in government organisations, and with those outside of government who have experience of the impact of annuality. 3. Findings 3.1 Annuality: the principle and its rationale Annuality is a widespread and pervasive phenomenon that affects public budgeting throughout the world. It is fundamentally a problem for financial accounting theory, which requires accounts to be prepared on an annual basis, at an arbitrary point in time during the year. In the UK, public sector organisations use ‘1 April to 31 March’ for their financial statements; many businesses and charities use the calendar year; whilst individuals and organisations are required to use ‘6 April to 5 April’ for their tax returns. The fundamental principle of annuality is that budgets (i.e. an authorisation to spend) have a definite time limit and must be spent during the related year. A failure to spend all of the budget (i.e. an under-spending) results in loss of the unspent amount by the budget-holder, whilst an overspending could result in a range of possible penalties, including personal liability of the budget-holder for the overspent amount and other major political and managerial consequences. Typical of many public sector budgets, there are often substantial amounts within the budget that are not strictly controllable by the budget holder. Public sector budgets are forecasts of spending that is determined by outside factors (such as changes in law that grant people the right to government benefits). Because of this, overspendings need to be identified at periodic intervals and funded in some way. It is natural for those who are responsible for the financial control of budget-holders to want to use any under-spending to fund overspends and, therefore, impose annuality, even if other incentives not to impose annuality outweigh this. 3.2 March Madness There is one widely acknowledged effect of annuality. Put simply, annuality can lead to a disproportionately large amount of spending during the final quarter of the financial year (which in the UK public sector means between January and March). This phenomenon is widely known, and is even given the nickname ‘March Madness’ or ‘The Silly Season’.
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Evidence of annuality is often hard to come by without access to an organisation’s accounting system. For many public sector budgets, such as the basic salaries budget, there is no annuality effect. But because the salaries budget tends to be a large proportion of revenue budgets, any increase in spending in the remainder of the budget during the final quarter may be masked. However, although the rush of spending is small as a percentage of budgets, it can amount to large sums of money. One area of public sector expenditure where UK national statistics do provide some evidence of an increase in spending in the final quarter is that of capital expenditure. For example, average capital expenditure in the last quarter of each of the fiscal years from 1998/1999 to 2003/2004 was approximately 45 per cent of the year’s total. What literature there is on annuality tends to judge the disproportionate spending of the final quarter unfavourably: as spending that is uneconomic, inefficient, ineffective and/or of inappropriate quality. However, it is important to distinguish between the timing of spending and the economy, efficiency, effectiveness and quality of spending. Given the imperative not to overspend, it is natural for budget-holders to want, if possible, to wait until the demands of the financial year are clearer before they spend their budgets. In effect, this is the passage of time reducing the period of uncertainty. If this budget profile were planned, and executed as planned, it would be unfair to judge this as a ‘rush’ of spending. However, in some cases even a planned increase in spending can turn into a rush where a budget-holder from a higher authority contacts a lower-level budget-holder to tell them to spend money quickly (often because of the higher-level’s awareness of under-spending elsewhere). Aside from the original agreed need to spend the authorised budget, subsequent under-spending can signal that the authorised budget was not wholly needed and that subsequent budgets could be reduced. Furthermore, the budget director may reprimand the budget-holder for requesting too much last year. Hence the incentive to spend the entire budget by the end of the financial year is often very strong.