Year-End Expenditure Spike
Welcome to the year-end expenditure spike project!
In the last week of the 2017 fiscal year the federal government exhausted its budget in a myriad of items that caught the attention of the public, as for example $79 thousand in booze by the State Department, $103.4 million in furniture and office supplies across the federal government, or $7.3 million in guns and ammunition by non-military agencies (see Forbes article).
The problem of year-end spikes in expenditure is well known, both in public and private organizations. The most common explanation for this behavior goes like this: in organizations that operate with expiring budgets, bureaucrats will rush to spend any remaining resources before the closure of the annual budget, because otherwise they would lose that monies and maybe even face budget cuts in the future. Although simple, this behavior is not so easy to reconcile with bureaucrats being rational agents. If they know in advance that the budget will expire, why they wait till the end of the year to spend it?
In a recent article, Liebman and Mahoney offer a theory. Bureaucrats do not spend as much during the year because they are saving for the case that the value of social expenditure becomes very high in the future, as for example when there is a natural disaster. With the usual assumption of a concave utility function, this leads to organizations refraining from spending during the year and find themselves at the end of the year sitting over a pile of money they will lose if they do not spend. Hence, they rush to spend that money on whatever they can grab a hand on, even if it has a very low social value.
Although this could definitely be part of the story, it has some shortcuts. Firstly, this explains why expenditure increases as uncertainty over the future value of social expenditure resolves, but does not explain why there is a discontinuous spike at the very end of the year. And more importantly, if expiring budgets are to be blamed from this inefficiency, why do organizations insist in using them?
In this project, we offer an alternative explanation that tackles both points. In contrast to Liebman and Mahoney, we model bureaucrats as agents that dislike spending the budget because that entails exerting costly effort. They do however engage in such an effort because expenditure throughout the year is linked to a benefit they receive at the end of the year when the performance of the organization is assessed, as is actually the case in many organizations (think of year-end performance bonuses or evaluations that determine promotions). Also, we assume that bureaucrats have a present bias, and are naive with respect to their present bias as suggested by some experimental results (see Augenblick and Rabin, 2015). Finally, we allow for year-end-expenditure to represent an indirect form of roll-over, because by accumulating inventories of non-perishable goods an organization indirectly disposes of more resource for the next year. Importantly, this indirect form of transferring resources has a natural limit: there is only so much office supplies that can be accumulated and be useful in the foreseeable future.
This setting leads to a result that can successfully replicate year-end spikes and, more importantly, provides a new perspective on the potential policy implications of allowing budget roll-over. With or without roll-over, bureaucrats tend to procrastinate expenditure because it is costly now and only pays at the end of the year. However, if roll-over is allowed procrastination is less costly at the end of the year, which leads to a systematic under-spending of the budget. That is, expiring budgets limits procrastination between fiscal years by increasing the cost of transferring resources to the following fiscal year.
Considering the result above, it is more easy to understand why organizations use expiring budgets in spite of year-end spikes. To maintain the same level of budget expenditure, a much higher level of compensation would be needed at the end of the year with no expiring budgets. That is, expiring budgets are a relatively cheap way of motivating work in a second-best world where bureaucrats have a propensity to procrastinate the expenditure of the budget.
This website offers a brief exposition of the formal model and online simulations you can run by changing the parameters of the model. You can start by reading the model to understand what is the role of each parameter in the simulations.