Structural Deficits in Orchestra

Very simply, the term deficit describes a budgetary situation where more is spent than is brought in. A surplus is the opposite: there is more income than expense. Notice that these are budgetary conditions; we are speaking neither about cash flow nor debt.

When used to describe orchestra budgets, the term structural deficit is somewhat of a misnomer. The reason is that it is normally used to describe the budgets of governmental entities such as countries or states. In that context the term has real significance, because it stands in opposition to a cyclical deficit. Economists seem to enjoy arguing about the proper responses to these different deficits. Some believe that unless structural deficits are handled differently than cyclical deficits, the economy will worsen, and the deficit will thus be made worse rather than better. They say that spending must be increased to help a cyclical deficit, but cuts and/or higher taxes are in order for structural deficits.

By way of background, then, let’s look a little more closely at the traditional use of these terms. We won’t attempt to be academically precise here, but we will give a general outline of the more important details.

Governmental agencies raise money by levying taxes. In better economic times, their revenue from these taxes rises. Since there are more people employed at good wages, more income tax is generated. People buy more products, and businesses have good sales and profits, so both sales taxes and business taxes increase. A few terms that describe good economic times are boom, full-employment, and economic upswing.

When the economy sours, there is higher unemployment, more personal and corporate bankruptcies, less buying and less production. Tax revenues decline. Terms that describe this condition include bust, high unemployment, economic downturn, recession, or, if things get really bad, depression. Economies tend to cycle between the good times and the bad, over and over again. Economists delight in attempting to predict when the tops and bottoms of these cycles will occur. They have created many different calculations to try to quantify how the economy is doing. Usually, though, they are much better at identifying turns in the economy in hindsight.

When a government is at the top of such a cycle, if it spends more than it brings in from taxes, it is said to have a structural deficit. The reason is simple. Since it is bringing in as much revenue as can be expected, by spending more than it is bringing in, it is living beyond its means and will necessarily increase debt and operate with a continuing deficit unless something is done to change the situation. When there is an economic downturn and tax revenues decrease, the deficit will increase. A policy change is required. Tax increases, cuts in expenses, and curtailment of services must be considered if the government wishes to avoid such imbalance in the future. Of course, some governments can simply print more money, thus devaluing their currency and causing an inflationary cycle. But that’s getting off the point.

To be a little more precise, consider that, theoretically, there is some point between the top and bottom of the economic cycle when the government receives the average amount of tax revenues. This is called the mid-cycle point. If, on average, the government spends more than it takes in at that point, it has a structural deficit for the same reasons stated before. Of course, the if it is spending less on average, it has a surplus and is building its reserves. You probably see now why a structural deficit is also sometimes called a full-employment deficit, mid-cycle deficit, or cyclically adjusted deficit.

Assume for the moment that Pontevedria[1] is very good at budgeting. It is able to spend exactly what it takes in on average. Does this mean it will never have a deficit? No, it doesn’t. During the economic downturn, it will incur a budget deficit since it will be spending an average amount but taking in less than the average. Such a deficit is called a cyclical deficit. While a structural deficit requires policy change, a cyclical deficit doesn’t. The economic upswing that will follow will balance things out. At least that’s the theory. Since real economies are hard to predict, economists argue about all these things. I’m sure you have all heard the famous George Bernard Shaw quip, “If all the economists were laid end to end, they'd never reach a conclusion.”

Hold onto that thought while I tell you that there is a second standard usage of the term structural deficit. It has to do with ongoing sources of revenue versus one-time sources. To see things from this viewpoint, consider a static economy rather than one going through normal cycles; or, equivalently, consider that there is really not much change between the highs and lows in the economy. Of course, this is just to isolate what we are talking about now in contrast to before. In practice, both types of structural deficits can arise at the same time.

Suppose that, for years and years, Pontevedria has had a static economy with balanced budgets. They have had a stable population, and neither their revenues nor their expenses have increased or decreased over the years. One year, a political fight ensues. The party currently in power, the Static Party, says things have been good just as they are and should be left alone. The challenging party, the Progressive Party, says that people are living in the past—a library system is needed. The Statics ask how it will be paid for. The Progressives say there is a benefactor who so believes in education that the benefactor’s business, Applegate Industries, will pay the entire amount for the construction and stocking of five libraries. Of course, the libraries will be known as the Applegate Libraries, but that is a small price to pay for such generosity.

The populace votes in the Progressives. Through the process of eminent domain, land is procured, buildings are cleared, and the libraries are built. Things go happily for a while, but then the economic analyst gives bad news: for the first time ever, there is a deficit creeping into the Pontevedrian budget. It’s a situation almost worthy of an operetta. Now, retired teachers who were willing to work at minimum wage were found to staff all the libraries. Even so, the expense of these fifteen new salaries had not been budgeted. Further, there is the cost of building maintenance and utilities for the five libraries. The analyst says there have been some revenue increases, including library fines and income tax paid by the library staff, but those additional revenues have been more than offset by the decrease in property tax that used to be collected from the former owners of buildings that were demolished to make room for the libraries.

The ousted Statics now proclaim righteously that the libraries never should have been built and should be demolished. The Progressives will hear none of it, though. They say that even more libraries are needed, and that Pontevedrians deserve them. They don’t know how, but they will find funding.

True to their word, the Progressives find funding that was not considered before. It seems that next year’s total eclipse of the sun will best be seen in Pontevedria, and the Progressives are able to pass a tourist tax that, by itself, funds more than two years of the entire the library system, including the building of two more libraries.

This doesn’t satisfy the Statics, though. They say that in another year, Pontevedria will be facing an even worse deficit than in the past, because now there are seven libraries instead of five. Even after the Progressives arrange for a royal marriage to bring in more money to the Pontevedrian coffers, the Statics are still not appeased.

The reason is that the Progressives have created a structural deficit in the second standard sense of that term. They have used one-time sources of revenue to fund ongoing expenses. Notice, though, that in so doing, they have continued to balance the budget. Pontevedrians have yet to incur any debt. But the economic analyst will look into the future and report that there is no identifiable source of revenue to fund the library program.

Does this mean that all the libraries should be demolished? No. That is only one alternative. Perhaps there could be user fees imposed so that library users would fund the library. Or there could be a new tax levied on all Pontevedrians to fund the library system. Or overdue fines could be drastically increased. Or the budget of the Department of Defense could be permanently reduced, and the money used for the library system. Or the Progressives could keep finding new one-time sources of revenue. Regardless, there are fundamental policy decisions that must be made. Are the libraries of sufficient value that they should be maintained? Who should pay for them? What is the relative value of the libraries compared to other services and programs? How important are economic stability, avoidance of debt, and a good report from the economic analyst?

By the way, this second type of structural deficit is well known to nonprofits. Some nonprofits have adopted policies that they will not accept large contributions tied to specific capital expenditures unless there is a corresponding donation earmarked for the operating and maintaining of the capital project. This serves two purposes. It protects the nonprofit from becoming a slave to a new building built from donated funds when the nonprofit may not have the resources to pay for the building’s maintenance and operation. It also helps philanthropists structure their giving in ways that best support the mission of the nonprofit.

Now we’ve examined the two most common uses of the term structural deficit. Why is it normally used in connection with governmental entities rather than businesses such as restaurants, clothing manufacturers, computer stores, or orchestras? It is because, in a very real sense, since businesses can’t levy taxes, all of their revenues are one-time, not ongoing, funding. Of course, some revenue is more reliable or long-term than others. Businesses can make contracts with businesses or governments that are either stable or close to bankruptcy. Businesses can enter into multiyear contracts or make deals that are here today and gone tomorrow. What they cannot do is use the force of law to guarantee a future income stream from their customers. When someone orders a meal in a restaurant, she is under no compulsion to set foot in that restaurant ever again, even if she has been a steady customer for the last twenty-five years. A new competitor might move in next door and take all the business away. Not so with governments.

Please let this fact sink in very deeply, for it is at the very heart of the issue. Even income from an endowment, which is probably the most secure form of income for a nonprofit, does not give the same stability as taxes. With an economic downturn, an endowment might not only produce less income, the corpus of the endowment may actually dwindle, never to return. Consider endowments that were heavily invested in Enron stock. Or an endowment may be spent. Taxes can always be counted upon to produce income.

Since businesses, including orchestras, cannot levy taxes, in order to have a sustainable revenue stream they must constantly prove their worth in the marketplace. Businesses are constantly making decisions that impact their profitability. They decide how to market their products. They spend money on research and development so that they can ready new products that will be competitive when their old products are not. They determine locations for their stores. Naturally, external factors also affect businesses' profitability. Customers may simply tire of eating okra, no matter how well it is prepared. Low-carb diets may become the fashion, much to the detriment of white bread manufacturers.

Businesses are impacted by the same economic cycles that affect governments. In good times, some businesses have better years than in bad times. Not all businesses are like that, however. Do you think that bankruptcy lawyers do better during economic upswings or downturns? Orchestras certainly have components on both sides of this coin. When times are good, people are more willing to contribute because they have more expendable income. They are also more willing to pay higher ticket prices. When times are bad, more people seek to be uplifted and comforted by the arts. Is it a wash? Probably not. But how many managements adapt their marketing to the changing economic times to capitalize on such cycles?

Orchestras, just like other businesses, also must make decisions that impact their bottom line. They must decide on programming and soloists. They must determine what marketing campaigns they will launch. They must plan social events. These are the very management decisions that managers make and upon which they should be judged. So then why is it that, when we are told that we are in a crisis, that expenses must be contained, and that our orchestra must be “run like a business,” it is by the very manager who has put us into the situation we face or by a board that has come to the defense of such a manager? Is that how other businesses operate?

Can a case be made that some orchestras might hypothetically develop structural deficits? In limited circumstances, probably. Even though the terminology is strange, it could, for example, make sense in a case where additional programs or services are taken due to an initial donation and then kept in place without sufficient ongoing funding. For example, a donor might give a million dollars for a specific recording project. After the money is gone, the music director may desire to continue recording. A management and board may agree to this and search out additional funds. They may be successful or not. Either way, when the one-time funding is gone, if they continue to record it could be said that they have created a structural deficit that, at some point, should be dealt with. How, of course, is the big question. Like the Pontevedrians, they have many options. The recordings could be curtailed. A different program could be reduced or eliminated to fund the recordings. Operating efficiencies could be improved to reduce operating budgets in other areas. New donors who have a personal desire to see the orchestra record might happily fund more recordings. Or, the board and management could commit to raising more contributed income to cover this program along with the orchestra’s others. Notice that if the board does commit to raising those additional funds, there is no structural deficit, even if the board and management do not meet their commitment. What there is in that case is a board and management failure. The board and management are always capable of raising less than they need.

Another case where the term structural deficit might make sense would be when a management negotiates a contract at a time when revenues are high due to a cyclical swing in an orchestra’s fortunes. Perhaps last year was the opening of a new hall, or the first year of a new music director, or the city’s economy was especially good. If management predicts that its revenues will continue at the same rate of increase as it did in the previous year and the cycle turns downward, the actual revenues will very likely not meet projections. It could be said in such case that there is a structural deficit.

It could also be said in such a case that there has been bad management. After all, isn’t it management’s job to have a grip on how the business is doing and why? Is more money being brought in because of the multiyear donor program that was instituted? Because of the ingenious marketing campaign that has attracted hundreds of new subscribers? Did marketing research show that, even though record amounts were spent on a new marketing campaign offering large discounts through coupons, it was actually the changed programming that was responsible for the increase in attendance? Was the new hall or new music director factored into the equation? If management is on the ball, it will make reasonable income projections that take such factors into account. In fact, and this is an important point to consider, management should have predicted that additional income from a hall opening or new music director would surely be one-time income, and used it to budget a surplus to ease the downturns that eventually are bound to occur, not to fund ongoing operations. If that was not done, surely the board must question the expertise of their management. If such responsibility was not demanded from management, the board has shirked one of its primary duties, that of oversight.

This brings about another issue, however: management performance. In the private sector, managers are held accountable for the performance of a company. They have complete supervisory control over everyone who can impact the bottom line. If there is a department that is not adhering to budget projections, the manager is expected to take action, either to get better performance from that department or to make budget adjustments that will take the actual performance into account. With symphony organizations, although there are some similarities, the are also significant differences.

Take, for example, a hypothetical symphony that has been having financial problems and that has seen the departure of its executive director. Let us assume that one reason for the financial problems has been that the board of directors is not of sufficient stature within the community to give the organization the connections it needs for fundraising, political favors, and social standing. Being good people who want to see their symphony continue as a community resource, the board does a search and hires a new executive director from the few candidates who are available and willing to take on such a challenge. As the new executive director soon learns, things are worse than even the board suspected. Subscriptions are down, contributed income is down, and the staff is unhappy and overworked. On the positive side, the orchestra has never sounded better.

Without turning this into a study on troubled orchestras, consider that the board and the executive director concur that their goal will be to bring in a balanced budget. They already have a contract in place with the musicians and stagehands, so those expenses are set. Looking to cut expenses, when they view the other departments that have sizeable budgets, marketing and development, it is realized that these are the very departments that will be looked to for increased sales and contributions. So the executive director turns to the board members and tells them that they must step up to the plate. They must make increased contributions themselves; they must identify other community resources for contributions and then help to secure them; they must use their clout to get in-kind services from community suppliers; they must become a sales force that will inspire community groups to buy tickets; they must locate sources of funds that will help ease cash flow and fund the marketing campaign that must get off the ground today if not sooner.

What does the new executive director do if the board doesn’t comply, either out of disinterest or inability? The board is his employer. At the same time, the members of the board are directly responsible for the success or failure of the institution, not merely in a supervisory role, but as active participants in the funding of the organization. That is far from the normal business model. If the executive director is too demanding, he will be fired. If he is less demanding, he won’t get what the organization needs from the board. One way that he will do well with the board is to reduce what is expected from them by negotiating concessions from the musicians. But will this make such an organization healthy? Unless major changes are made in board composition, structure, and functioning, the organization is still left with all the problems it had, but it will probably also be left with the sorry situation of having an orchestra that will see much of its talent leave.

When such a situation arises, it is easy for the participants to start placing blame and pointing fingers. Let us step back from the situation, though, and say what never gets said. The problem arose much earlier. The board failed when it did not demand more of the previous executive director and of itself. Probably it was being told everything was all right. It probably was paying that previous executive director a good salary and was giving pay raises to the very same executive director who was allowing them to ignore their responsibilities. But a board has an independent duty to hold a manager accountable for the health of the organization. This means it must have ways to quantify what has been accomplished or not, what is due to the manager’s efforts and what is not, what is due to the economy and what is not, and how the symphony is doing relative to other arts and cultural organizations in the community such as dance, theater, and opera companies and museums. It also means that the board must understand its own role and importance in the proper functioning of a nonprofit. It must constantly find ways to improve its own stature in the community, to find new people to take over the stewardship of an important organization, to ensure that the staff is relating well to the public, and to raise the funds needed by the organization.

It is clear that these functions of the board are not only the responsibility of the board but also those of a professional manager. The manager is the one who is supposed to know the business and to know what is required. The board members are lay people who are volunteers for what they presumably think is a worthy cause. A manager who does not “manage up” in a nonprofit by educating and motivating board members is not doing his or her job. A well-functioning board should be constantly seeking new community members who care enough about their organization to become actively involved. To be successful, they must have programs in place in which community members can participate. Through such programs, friends of the organization should be educated as to what the function and duties of the board are. When new board members are selected, they should already have this background on what the board does and what will be expected of them. They should have already proven their worth by their past participation in the organization, before they were given the honor of becoming board members. Such people are far less likely to shirk their own responsibilities and look to the musicians to make the task of funding the organization easier. They will voluntarily want to be of service to an organization they value and will understand that everything has its cost, including the orchestra and its musicians.

How many managers are willing to put members on their symphony board who have never had any previous involvement with the symphony, simply because they are willing to make a financial contribution? Of course, there may be times when that’s appropriate, but only if the prospective board member shows true dedication to the organization (or the size of the contribution itself proves such dedication). I believe there have even been cases where managers have solicited people to join boards not for their ability to fund and grow the organization, but rather because of their professed desire to contain expenses and “run it like a business.”

When managers are willing to take hefty salaries while allowing their boards to function poorly and without being properly educated as to what their duties and responsibilities are, is it proper for them to call themselves professional managers? Naturally, not all managers are so lax, and some boards, even after tireless efforts by a manager to correct board deficiencies, simply remain obstacles. Isn’t it obvious, though, that a manager who actively encourages a board to stagnate by putting few demands on it while allowing board members to believe they are doing all they can is not acting in the organization’s best interest? Such a manager may be doing what best protects his own job and income, but the long-term health of the orchestra is put at risk.

For this reason, managers who consider themselves professional should encourage their boards to evaluate both management and board performance. Unlike businesses that compete for business, most orchestras have quite distinct audience bases and do not compete with one another. Boards should be constantly in communication with one another to find out what is or isn’t working in other places. They should be constantly keeping up with how successful boards function and making adjustments to their own organization. They should demand of their managers that proper funding sources be found and should show the necessary community leadership in the process. They should also demand that budgets be properly balanced, even considering cyclical or one-time revenues. And they should certainly recognize that it is their job to see that such funding occurs to enable the organization to realize its mission—not at the expense of their musicians who are, after all, their very product.

But is this what we are seeing? It doesn’t appear so. What we see looks more like collusion between managers and boards. Budgets get approved based on plans and projections made by management. Contracts are entered into based on input from management. Then why, when a board finds itself incapable of fulfilling a contract do we not get the manager’s head on a silver platter? Figuratively, of course. Instead, we are more likely to be told that the task at hand is just too much for anyone. That the manager is as good as anyone in the business. That every orchestra is having problems. But that’s not true. Some orchestras are posting surpluses. Other businesses are able to operate with rising expenses and stiff competition. Where is the accountability? Maybe we should be the ones asking why our boards don’t run our orchestras more like a business.

[1] Any similarity to the Duchy of Pontevedria from Lehar’s The Merry Widow is purely intentional.