Capital Improvement Programming

Every city divides its budget into two parts--operating expenses and capital improvements. Operating expenses, which include items like salaries and supplies, are the cost of items (like time or paper or space) which are consumed during the span of the budget. They are used up in operating the city's government. Capital improvements, which include streets and buildings, are items whose costs are incurred all at once but whose useful life extends beyond the span of a single budget. The remaining useful life of a capital improvement is an asset and is calculated as part of the net worth of a locality. Capital improvements may be either new acquisitions or the replacement of existing capital assets which have outlived their useful life. In principle, the distinction is simple. In practice, it can get confusing.

Because these long-lived investments also tend to be big-ticket items, it is very important for local managers to plan ahead to insure that they will be able to afford them when the time comes. This is, in fact, one of the two principal functions of a capital improvement plan: it controls the sequence and timing of large expenses that the city can foresee. These decisions have implications for the city's ability to maintain or improve the service which it offers its citizens, and that has political implications (more than one local council campaign has been waged over the issue of potholes).

The second principal function of a capital improvement plan is to serve as one of the major tools for controlling local development. The cost for providing public capital services (sewers, streets, utilities) is estimated at $10,000 to $15,000 per residential lot (depending on local standards and local price structures). It is obviously to a developer's advantage to wait until the city supplies those services, rather than having to build them her/himself (and have to add that cost to the cost of the unit). In the Minneapolis/St. Paul area, the Metropolitan Council has controlled the location and timing of suburban development through its capital plan for extending sewer lines. Developers are free to build in areas which are not yet served by public sewer lines, but in most cases the cost of providing septic fields or private sewers is prohibitive.

Since capital improvement planning has such significant political effects, the process itself involves political considerations. The first issue is to decide how to generate capital projects. The simplest solution is to ask the department heads to submit a list. But what should be on the list? Should it be a wish list or a bare-bones request? What strategy shall the department heads adopt? Should they include throw-aways for negotiating purposes, or risk sending forward only items that are really needed? And do the department heads really know what they will need? Aren't there unforeseen changes that might affect their requests (new technology, a fresh disaster, etc.)?

The second issue is to decide the best way to rank the projects. Who should decide which projects are more important than others? On what basis should someone (or some group) make such a decision? What are the important criteria for evaluating capital projects? How should each project be rated on each of those criteria?

The third issue deals with allocating available funds once the capital improvement projects are ranked among each other. Resources are limited (or, as the philosopher put it, "you can't always get what you want"); how shall one decide to allocate those limited resources? Do you fund all of the projects that you can afford each year, or do you leave some unused capacity to allow for contingencies? Cities operate with several funds; do you fund a low-priority project because there is still money in that fund, even though higher-priority projects are postponed because their fund is exhausted?

There is a fourth issue which is not, strictly speaking, a political issue. Capital assets depreciate each year; accounting principles and simple prudence dictate a capital reserves account. You should transfer the value of each year's depreciation to a capital reserves account so there will be funds available for replacement when the asset is exhausted. However, political principles will often dictate that the budget should be kept as low as possible (so taxes can be kept down). The capital reserves account is a very easy account to raid.

There are no easy answers to these questions. What follows is a technical tool which makes it easier to account for the results of one's answers to such questions. The tool will not answer those questions. In fact, it will make the political questions all the more salient, since the technical issues are taken care of by demanding an answer to the various political questions.

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1996 A.J.Filipovitch
Revised 11 March 2005