Institutions and Tools of Budget Preparation (L2)

Richard Allen

METAC Budgeting Workshop

Dead Sea, Jordan, October 12-15, 2015

“Resource allocation decisions in the public sector may be guided by technical analysis but are made through a political process in which technical analysis is but one, and not always the most important, part.”

A. Fozzard, 2001, “The Basic Budgeting Problem: Approaches to Resource Allocation in the Public Sector and their Implications for Pro-Poor Budgeting”, London: Overseas Development Institute.

Outline of the Presentation

I. Context

II. Traditional vs. Emerging Budget Practices

III. Improving Budget Preparation - Key Elements

IV. Advanced Budgeting Techniques – Blessing or Curse?

V. Conclusion

I. ContextMacro-fiscal policy environment

• A starting point for budget preparation is a coherent framework of macroeconomic policies and objectives, e.g., for sustainable management of government borrowing and debt.

• It is essential that a country develops its capability to prepare robust forecasts of macroeconomic aggregates, and of government spending and revenue.

• In recent years, interest in fiscal responsibility laws and fiscal rules that aim to reinforce discipline have grown substantially – e.g., EU convergence criteria - but these have had mixed success.

• Some countries employ a 2-stage budget process where overall fiscal targets and spending ceilings are agreed first (“strategic budgeting”), and detailed appropriations determined later.

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I. ContextFour Fundamental Budget Principles

UnityOne budget and one

budget process

UniversalityAll revenue finances

all expenditure

SpecificityAll appropriations

have a distinct purpose

AnnualityAll appropriations have a pre-defined

end-date

I. ContextBudget credibility is a key requirement

• Credible macroeconomic framework and projections

- Financial programming methods• Realistic revenue forecasting assumptions

- Shortfalls of revenue necessitate cash rationing

- Overestimation of revenues undermines credibility of budget and particularly impacts level of capital spending

• Realistic estimation of expenditures

If the budget is not credible, there is no prospect that that budget as executed will be consistent with the government’s overall fiscal goals/targets

I. ContextMost of the budget is pre-committed spending

• In most countries, at least 90% of the budget is pre-committed in the form of mandated spending (e.g., social welfare or pension obligations), wages and salaries of public servants, which are very hard to change in the short term, pre-existing contracts with suppliers, or increases in prices of goods and services.

• Thus, the margin of maneuver each year in formulating the budget in practice is usually no more than 10% of aggregate expenditure.

II. Traditional vs. Emerging Practices

Characteristics Traditional “Emerging”

Macro-fiscal framework Limited MTFF

Time frame for budgeting

Annual Medium-term

Budget negotiations Incremental, legalistic Challenge with expenditure review

Spending ceilings None Indicative / binding

Coverage of budget Narrow Broad

Appropriation structure Line items Programs

Supplementary budgets Unlimited Limited

Capacity of Budget Dept.

10-20 staff 50-100 staff

ITC systems Manual / Excel FMIS

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II. Traditional vs. Emerging PracticesPossible Way Forward

Emerging countries cannot be expected to achieve the status of advanced countries’ systems in a short period, and they should not attempt to import advanced models (e.g., an MTBF) without adapting to country requirements. They may face challenges of low capacity and institutional constraints, e.g., national planning mechanisms, dual budgets, absence of “strategic budgeting”, weak legislatures.

Instead, emerging countries should consider advancing on a series of fronts – “toning-up the traditional line-item budget” (Peterson). What should these steps comprise?

III. Improving Budget Preparationa. Review Legal Framework

The budget law should provide a comprehensive framework for the budget process, and the roles of the finance ministry and other players. There are many good examples of budget laws in developed and developing countries (e.g., Chile, Cyprus, Korea, S. Africa) that can be adapted elsewhere.

What is the current status of the PFM legal framework in METAC countries? Are there any plans to modernize these laws?

III. Improving Budget Preparationb. Build Capacity in Macro Forecasting

Strong economic and fiscal forecasting capacity underpins a credible budget, together with analysis of fiscal policy options, fiscal risk assessment, debt strategy, tax policy analysis, etc.

Developing such capacity in the finance ministry should be given priority in middle-income countries (e.g., Egypt, Jordan, Kuwait).

What is the assessment of capacity needs in METAC countries?

III. Improving Budget Preparationc. Institutionalize the Budget Cycle

The optimal length of the budget preparation cycle is country-specific – not too short, not too long - and depends on economic and political circumstances. In general, a cycle that starts about six months before submitting the budget to the legislature is appropriate for many countries – see Table 1.

What form does the budget calendar take in METAC countries? Does it include an initial strategic phase where macro targets and spending ceilings are set?

Table 1. Illustrative budget timetable

III. Improving Budget Preparationd. Keep Control of Supplementary Budgets

Amendments to the budget during budget execution should generally receive legislative approval using the same process as the annual budget. The number of supplementary budgets should be restricted, thus avoiding “repetitive budgeting”. Rules for who approves supplementary appropriations should be clear and strictly enforced. Virement rules reduce the need for supplementary budgets.

What are the current practices in METAC countries?

III. Improving Budget Preparatione. Introduce an MTEF in Stages

“MTEF” is an umbrella term comprising

- MTFF (fiscal framework)

- MTBF (budget framework)

- MTPF (performance framework)

Less advanced countries should probably not advance beyond an MTFF initially, or an aggregated form of MTBF. Examples: Estonia, Indonesia, Morocco, S. Africa.

How far have METAC countries progressed in implementing an MTEF? (See also L4)

III. Improving Budget Preparationf. Improve Public Investment Management

Modernizing PIM requires (i) eliminating dual budgets; (ii) subjecting new investment projects to cost-benefit appraisal; (iii) developing a government balance sheet that shows capital assets; (iv) upgrading techniques of procurement and project management. Not all these steps can be taken immediately, as they require substantial capacity building, e.g., Indonesia, Malaysia.

What progress have METAC countries made in areas (i) through (iv)?

III. Improving Budget Preparationg. Eliminate “Dual Budgets” in 3 Stages

• Presentational integration: separate budget processes for capital and recurrent spending exist, but presentation in the budget document is combined.

• Budget process integration: budget preparation is combined in a single budget calendar/circular, and a single set of budget regulations and instructions.

• Institutional integration: the ministries preparing the capital and recurrent budgets are integrated into a single budget/finance ministry.

At which stage are METAC countries?

III. Improving Budget Preparationh. Assess Key Fiscal Risks

Fiscal risks include: macroeconomic risks; contingent liabilities and quasi-fiscal risks; tax expenditures.

Statement of main fiscal risks can be included in the annual budget document. Does not require sophisticated analysis, accrual accounting or well-developed government balance sheets, e.g., Chile, Indonesia, Slovenia.

How much data on fiscal risks are incorporated in budget decision-making, and are published in METAC countries?

III. Improving Budget Preparationi. Improve Budget Presentation

Many advanced countries have moved ahead in: developing analysis of the macro-fiscal framework for budgeting, simplifying presentation of the budget (e.g., reducing number of line items), eliminating extra-budgetary funds, making budget information more plentiful and accessible (e.g., citizens’ budget), including analysis of fiscal risks and tax expenditures.

Emerging countries can also develop some of these features, e.g., Malaysia, Mauritius, Turkey.How much progress has there been in METAC?

III. Improving Budget Preparationj. Reorganize / Build Capacity in the MoF

Two areas are critical for middle-income countries: (i) develop capability in macroeconomic forecasting and fiscal policy analysis; and (ii) strengthen the institutional capacity of the budget department.

What progress have METAC countries made in areas (i) and (ii)?

See next slide.

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Assessing the Capacity of the Budget Department: Sample Questions

Are systematic comparisons made of ministries spending proposals and outturns?

Is budget credibility systematically assessed (variances between forecast and actual revenues and expenditure)?

Does the Budget Department (BD) employ sector specialists who can assess trends in volume and price of different spending categories in agriculture, education, defense, health?

Do budget analysts employ norms and standard costing tools to evaluate new spending proposals (e.g., class-rooms, roads, fuel, stationary, etc.)?

How are the costs of exceptional events (e.g., floods, inflow of refugees) assessed by the BD?

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IV. Advanced Budgeting Techniques – Blessing or Curse?

a) Performance and Program Budgeting

Middle-income countries should introduce a program classification, but performance-based budgeting is unlikely to add significant value until robust accounting and reporting systems are well established, and the budget has a high proven degree of credibility.

Toning up the traditional line-item, incremental budget should be given priority.

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IV. Advanced Budgeting Techniques – Blessing or Curse?

b) Accrual-based budgeting

Emerging countries should consider the merits of introducing accrual-based accounting (ABA) on a step-by-step basis, but a move to accrual-based budgeting (ABB) is not recommended.

Only a few advanced countries have introduced ABB, with mixed results.

IV. Advanced Budgeting Techniques – Blessing or Curse?

c) Expenditure Reviews

Comprehensive “expenditure reviews” are popular in Australia, Canada, the Netherlands, New Zealand, the U.K., and some other advanced countries, but have more limited applicability in less developed countries. They require strong centers of government, a disciplined approach, and advanced analytical techniques.

Simple tools of expenditure review can be useful, but middle-income countries should focus on strengthening basic budget functions

IV. Advanced Budgeting Techniques – Blessing or Curse?

d) Independent fiscal councils

In many countries, especially in Europe, independent fiscal councils or agencies have been established. These agencies, some of which are modeled on the CBO in the U.S.A., have varying powers, e.g., to make/validate macroeconomic forecasts or advise on the fiscal performance of the executive branch.

Independent budget agencies can play a useful role in advanced countries, but their role in emerging countries, with weaker institutions and more limited capacity, is questionable.

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V. Conclusion

1. The “traditional” line item, incremental budget has many merits (as well as some drawbacks) – the model should be developed and enhanced not scrapped

2. The introduction of “advanced” budgeting techniques based on “good practice” models from other countries should be approached with caution, and adapted to local context – establishing the necessary institutional preconditions is of fundamental importance

3. The transition to more advanced budgeting practices is a learning process that requires the development of human capacity and experience; much less important is the introduction of new systems and processes

4. Some “advanced” budgeting techniques, e.g., performance-related budgeting, accrual-based budgeting, or the establishment of fiscal councils are not appropriate for emerging countries except in the longer-term