essays in public finance and industrial organization a dissertation ...

CHAPTER 4. YEAR-END SPENDING 154
but can also signal a lack of need to budget-setters, decreasing funding in future
budget cycles (??). When current spending is explicitly used as the baseline in setting
budgets for the following year, this signaling effect is magnified.
This “use it or lose it” feature of time-limited budget authority has the potential to
result in low value spending—since the opportunity cost to organizations of spending
about-to-expire funds is effectively zero. Exacerbating this problem is the incentive to
build up a rainy day fund over the front end of the budget cycle. Most organizations
are de facto liquidity constrained, facing at the very least a high cost to acquiring mid-
cycle budget authority. When future spending demands are uncertain, organizations
have an incentive to hoard. Thus, at the end of the budget cycle, organizations often
have a buffer-stock of funding which they must rush to spend through.
To illustrate the key mechanisms which create the potential for wasteful year-end
spending, we build a simple model of spending with fixed budgets and expiring funds.
Annual budget cycles are divided into two six-month periods. Spending exhibits de-
creasing returns within each period and is scaled by a productivity parameter that
is unknown in advance. In the face of this uncertainty, organizations engage in pre-
cautionary savings in the first period. In the second period, the prospect of expiring
funds leads to a rush to spend. As a result, average spending is higher and average
quality is lower at the end of the year.
There is some suggestive evidence consistent with these predictions for the U.S.
federal government. A Department of Defense employee interviewed by ? describes
“merchants and contractors camped outside contracting offices on September 30th
(the close of the fiscal year) just in case money came through to fund their contracts.”
A 1980 report by the Senate Subcommittee on Oversight of Government Management
on “Hurry-Up Spending” found that the rush to spend led to poorly defined contracts,
limited competition and inflated prices, and the procurement of goods and services
for which there was no current need (?). At a congressional hearing in 2006, agency
representatives admitted to a “use-it-or-lose-it” mentality and a “rush to obligate”
at year’s end (?). The 2007 Federal Acquisition Advisory Panel concluded that “the
large volume of procurement execution being effected late in the year is having a
negative effect on the contracting process and is a significant motivator for many of