A Framework for Cost Reduction: U.S. State Government Guide

Key messages

• Twenty months into the recession, state budgets are under considerable pressure, and what follows may include a sustained period of austerity in public spending.
• Government professionals face choices over resource allocation, headcount, capital programs and the need to align their service delivery planning more closely to their minimum statutory commitments
• There are a series of immediate actions public bodies can take to reduce costs, including making tough policy choices, redesigning programs and organizations and rationalizing assets.

Background

The state government response to the budget deficits to date has included slashing programs and headcount, often involving painful choices. These are still not likely to be enough. Reduced expenditure, increased layoffs and raising taxes work against the principle of countercyclical spending and can push the economy deeper into a recession, causing second-order adverse impact on state budgets. Plus expenditure cuts without a careful analysis of underlying cost drivers are rarely helpful or sustainable. Stimulus funds have allowed states to prevent huge cuts in education and health care spending for now, but with unemployment at historic highs — more than double the number of jobs lost during the last big recession in 1981–82—unemployment checks and Medicaid rolls will continue to swell for some time to come, long after the stimulus dollars are gone.

What other options, if any, do state governments have to eliminate budget deficits now and ensure long-term sustainability of government finances? The crisis is not going to go away this year or next; the impact will likely be felt through FY 2012. The crisis could also repeat itself in a few years from now if systemic, structural changes are not made. Below we consider six areas states can find large and sustainable cost savings.

Reform strategies

Reduce unit costs through increased productivity

Public sector efficiency initiatives have become synonymous with large programs that bet considerable political capital on achieving centrally-issued targets. A modified approach is needed, however, to tackle an additional tier of costs that public bodies need to consider: the “hidden costs” that lie between core support services and front line delivery. Before states can determine how to wring out inefficiencies without hurting service quality, they must understand the true costs, both direct and indirect, of delivering these programs and services. The next step is to unleash the creativity of employees to tackle these costs by allowing them to propose and implement changes within the scope of their operations, helping them develop the business case for change, and building new competencies where needed.

Reshaping the workforce

There are a number of alternatives to reduce workforce related costs, apart from layoffs and furloughs. Telecommuting has delinked work location, office space and workforce size. Employees get to share office space at multiple remote locations, apart from the option of working from home. Building a cadre of intrapreneurs can also help reduce costs and deliver better services to end customers. Unleashing the creativity of employees to eliminate hidden costs is another option.

Policy options

Leaders will need to ask some fundamental questions: What should be the core function of government? How expansive should government programs be? Which policy levers can help contain and reduce program costs? This will often involve making difficult choices such as controlling the level and breadth of Medicaid services that account for 20 percent of state budgets, reducing expenditure on education or cutting services for the elderly.

Program redesign

Each program should come with a sell-by date. State governments will need to ask whether certain programs are still relevant, and how services can be produced and delivered more efficiently for the client, and at less cost to the government and thus the taxpayer. Sunset laws and performance reviews are two models that can be used as a means for continuously evaluating and eliminating programs that are no longer relevant.

Asset rationalization and better asset management

As a baseline principle, any public asset that has no policy function could be assessed for possible sale. Assets that do fulfill a policy function are likely to be more sensitive, but in challenging financial conditions, all options need to be considered. The public sector as a whole needs to reverse its mindset from one of having to justify asset sales to one of justifying ownership.

Structure and organizational redesign

In a climate of austerity, successful public bodies will be those that are able to define the size and shape of their organization. The starting point for a strategic redesign program is to understand the context better: What are the overarching purposes and responsibilities of the organization? Are they likely to change if budgets contract significantly? Once these initial questions have been explored, further detail around the structure and size of the organization can be developed. Effective implementation requires engagement at the highest level, and a dedicated team that conducts rigorous and independent analysis to determine the required size and shape and the processes needed to achieve them.

Examples

Making tough policy choices

In 1994, TennCare was heralded as a national model for its unprecedented generosity and broad reach; it provided health care for the uninsured and uninsurable who wouldn’t typically qualify for Medicaid benefits. TennCare benefits exceeded even those of many private health plans. The program was heralded as an experiment in near universal health care. A decade later, after numerous legal battles and bankruptcies of managed care plans, Tennessee was forced to restore the program back to a more traditional one. Full coverage will remain in force for children, but coverage and enrollment for adults has been reduced

Eliminating hidden costs

To close budget gaps, New York City Mayor Rudy Giuliani used a tool known as the Program to Eliminate the Gap (PEG). PEG demanded fiscal savings every year from city agencies. PEG was a continual examination of government spending and of whether government agencies were spending money efficiently. It was a budgetary exercise but also a critical management tool that forced city government to examine its programs and determine what was essential and what was not. PEG’s largest savings achievement was $527 million.

“Sunsetting” obsolete programs

The Texas Sunset Commission, the most successful sunset process in the states, has resulted in 54 agencies being abolished and 12 agencies being consolidated over the years. For every dollar invested in the sunset program, the state has earned a return of $31, resulting in $784.5 million in estimated savings between 1982 and 2007.

Asset inventory optimization

The state of Michigan receives approximately $320 million annually for an indefinite period of time from the Master Settlement Agreement of the Tobacco lawsuit. There is no constitutional restriction on the usage for this revenue. A financial analysis showed that securitizing an additional 10 percent of the annual revenue in a bond fund can generate potential revenues of $300–400 million. Similar opportunities were identified in other areas such as leasing half of the Blue Water Bridge to a private partner with the potential to generate one-time revenue of $100–125 million. All opportunities were ranked based on a rating criteria that included, among other things, revenue magnitude, cost saving, complexity and risk, budget impact and political support.

Creating a culture of efficiency

The State of Iowa launched a pilot program that grants charter status to agencies that volunteer to meet certain performance targets and to deliver $15 million annually in savings or additional revenue. In exchange, agency directors are given authority to make personnel, procurement and information technology decisions in order to meet these targets, and are exempted from certain bureaucratic and statutory requirements.

Next steps

1. Recruit strong leadership. Leaders that take personal ownership of implementing cost reduction, and drive operating reforms will be essential to success. Effective corporate leaders will engage their political stakeholders in cost reduction at an early stage and communicate the nature of difficult choices and the rationale behind them to their wider audiences.
2. Gather good data. A good fact base is critical to making informed decisions; these decisions cannot appear to be based on sentiment, resentment or random selection. Gathering good data will help build a strong business case for change.
3. Dedicate the necessary resources. Cost management does not happen on its own. Determine what financial, human capital and technology resources are necessary to support each program sufficiently.
4. Strengthen accountability and empower staff. Efficiency must be seen to be important to line managers and responsibility for program implementation must be given to individuals who have played an active role in its development.
5. Communicate, communicate, communicate. Cutting sacred calves, creating programs to cut costs, shifting resources and even eliminating jobs—these may be difficult for stakeholders to understand. Communication needs must be focused on gathering support, developing trust and increasing transparency.