Local Government Budgeting: Hungary - United …unpan1.un.org/intradoc/groups/public/documents/untc/unpan013818.pdf · 335 LOCAL GOVERNMENT BUDGETING—HUNGARY this viewpoint, the

C H A P T E R 5

Local Government Budgeting:

Hungary

Á k o s S z a l a i■

F e r e n c Z a y■

M i h á l y H ô g y e■

I z a b e l l a B a r a t i■

Á b e l B e r c z i k

330

L O C A L G O V E R N M E N T B U D G E T I N G •• P A R T I I

331

L O C A L G O V E R N M E N T B U D G E T I N G — H U N G A R Y

Table of Contents

1. Local Government System ............................................................................ 3331.1 Introduction ......................................................................................... 3331.2 Basic Issues of the Municipal System ................................................... 3341.3 Local Politics and Administration ........................................................ 3361.4 Functions of the Municipalities ........................................................... 3371.5 Structure of Revenues ........................................................................... 342

1.5.1 Current Own Source Revenues .................................................. 3421.5.2 Intergovernmental Grants to the Current Budget ...................... 345

1.6 Central Control Over Municipalities ................................................... 346

2. Local Government Budgeting ....................................................................... 3482.1 Budgeting at the National Level ........................................................... 3492.2 Strategic Planning and Short-Term (Annual) Budgeting

at the Local Level .................................................................................. 3502.3 Basic Structure of the Local Budget ..................................................... 352

2.3.1 Fund System .............................................................................. 3522.3.2 Extra-Budget Funds, Off-Budget Units ..................................... 3562.3.3 Classification System .................................................................. 359

2.4 Budgeting Techniques ........................................................................... 3612.5 Major Stages of Budgeting ................................................................... 3692.6 Participants and Actors in Local Government Planning ...................... 3702.7 Information Systems ............................................................................. 3712.8 Budget Implementation ....................................................................... 3752.9 Auditing System ................................................................................... 3802.10 Capital Budgeting ................................................................................ 382

3. Issues and Recommendations ....................................................................... 387

Notes ..................................................................................................................... 392

References ............................................................................................................. 395

332


List of Tables

Table 5.1: Basic Data on the Size of the Municipalities (1999) .......................... 335Table 5.2: Total Expenditures by Function, According to the Tiers (1999) ........ 338Table 5.3: Municipal Current Expenditures

by Functions and Cost Type (1996) ................................................... 340Table 5.4: Sources of Municipality Revenues (1998) .......................................... 343Table 5.5: Local Tax Revenues, According to the Autonomy

of Municipalities (1999) .................................................................... 344Table 5.6: The Assessment of the Hungarian Municipal Budgeting

Techniques Following Meyers’ Criteria for Effective Budgeting ........ 387

333


Local Government Budgeting—Hungary

Á k o s S z a l a i ■ F e r e n c Z a y ■ M i h á l y H ô g y eI z a b e l l a B a r a t i ■ Á b e l B e r c z i k

1. LOCAL GOVERNMENT SYSTEM

1.1 Introduction

In Central and Eastern Europe, the Hungarian municipal sector is considered to be welldeveloped. The importance of local budgeting is most easily demonstrated by consideringthree dimensions: (i) the municipalities deliver many public services and fulfill manytasks (especially in the light of their relatively low average size), (ii) their share of publicfinance is higher than in other countries in the region, and (iii) they have full decision-making power, with many constraints well-known in other developed countries beingabsent in Hungary.

Municipal share of public finance: In 1997–98 the municipal revenue was approxi-mately 28% of the revenues of general government and 11% of GDP. On the expenditureside the related figures were 23% and 11%, respectively. In the major fields of municipalactivity, this share is much higher. For example, in 1998 in the field of education municipalexpenditure was HUF 347 billion, which was 65% of total government spending.1 Themunicipal share from public sector investment was also extremely high at 70–80%.2

Great autonomy in local decision-making: In Hungary, the local budget is constrainedby only very broad centrally defined limits. Many restrictions existing in other countriesare absent. For example, there is no:

• central approval for any part of the budget, e.g., for major capital expenditureprograms or borrowings;

• central provision for a compulsory number of staff, although in the field of lawthere are regulations requiring minimum standards for local public services;

• requirement for keeping the municipal account at the treasury or at the NationalBank, or for a treasury countersignature for bank contracts. The municipalitiesare free to choose banks for their accounts or for other financial services.

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The higher tiers are not required to approve the purpose, the currency, the maturityor other conditions of any loan.

The most important restriction is that which limits the amount of borrowing basedon the amount of own-source revenues.

Our research: In light of the broad range of functions provided, of the significant fundsinvolved and of the wide autonomy given, it is clear that the effectiveness and efficiencyof the local public management are essential for the success of the whole public (governmental)sector. However, municipal management capacity is one of the least known features ofthe system. To assess the capacity of municipal financial administration, our researchconsidered budget preparation to be the most important policy tool in the hands of localgovernments. Owing to time and resource limitations, efforts were focused on the issueof the links between budget preparation and policy-making, so some very importantmanagement problems (e.g., procurement and debt management) were ignored completely,and some others (e.g., the accounting, auditing, reporting and implementation process)were evaluated only from the viewpoint of policy-making. For drawing a more or lessreliable picture about the current budget preparation practices: (i) the current Hungarianlegislation and regulations concerning the municipal budget preparation and financialmanagement process were analyzed, and (ii) the budget preparation process and thefiscal management techniques were evaluated in forty Hungarian municipalities.3 Thisgroup of local governments represents all types of Hungarian municipalities and was selectedin order to cover three geographic areas (Heves, Komárom-Esztergom and Tolna) sothat the information exchange among the neighboring municipalities could be appraised.

1.2 Basic Issues of the Municipal System

In Hungary, the local government system contains two tiers: there are 3,100 municipali-ties and nineteen counties.

There are two exceptions to the two-tier system:• The first exception concerns cities with county rights. They perform both municipal

and county functions. Although this approach is common in western systems,4

in Hungary the number of cities with county status is exceptionally large (22).5

• The second exception is Budapest, which contains 20% of Hungary's popu-lation. The capital is both a municipality and a county, but it is divided into 23districts.6

With an average population of about 3,200, Hungarian municipalities are smallerthan in the most of the OECD countries and are most comparable to the more fragmentedwestern systems (e.g., France and Switzerland). The size of sub-national governmentsmust be appraised solely in conjunction with the issue of their responsibilities. From

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this viewpoint, the main problem of the Hungarian municipal system is that the localgovernments have more functions than in countries with similarly small municipalities.This fact causes problems because the smaller jurisdictions are unable to manage theirfunctions. According to the basic legislation, all local governments regardless of theirsize have the same rights. However, there are some exceptions to this general rule.There is a concept in Hungary that the larger units should undertake more tasks thanthe smaller ones. The current system uses this in some fields (e.g., in social care, in fire-fighting, in building authority, etc.).

Before 1990 the local authorities worked mainly as agencies of the central governmentand the local councils were subordinate to the county councils. In the new system, theintermediate level lost almost every right. Almost every municipal function was transferredto local governments. Moreover, in some fields, the local governments have the option tocreate extra limitations on the actions of the counties. For example, the functions of theintermediate level depend on a local decision, because the local governments have theright to take over any function from the county level (and can become responsible forinstitutions where more than half of the users during the previous four years wereinhabitants of the municipality). But the local level may also choose to give back any ofthese functions (or institutions). The county level must accept and carry out the localdecision.7

Table 5.1Basic Data on the Size of the Municipalities (1999)

Inhabitants Number Population Total Per Capita Capitalof Municipalities Expenditures Expenditures Expenditures

[HUF billion] [HUF thousands] [HUF billion]

Less than 1,674 779,405 62.7 80.45 12.61,000

1,000–5,000 1,180 2,493,565 205.9 82.57 56.1

5,000–10,000 136 952,642 82.5 86.60 21

More than 118 2,267,353 273.3 120.54 56.210,000

Cities with 22 2,062,207 229.8 111.43 39.5county status

Counties 19 178 20.9

Districts 23 1,844,028 152.7 82.81 26.1in Budapest

Budapest 1 197.6 39.3

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1.3 Local Politics and Administration

Mayor: The Hungarian legislation designates the mayor, who is elected by the localinhabitants, as the head of the local government. He chooses the nominees for the vice-mayor(s) who must be ratified by the legislative assembly. According to legislation, thisteam is responsible for fulfilling and administering the decisions of the local government.The mayor is responsible for submitting, among others, the budget proposal to themunicipal body.

Practically, many municipalities attempt to involve formally or informally more localpoliticians in the proposal making process by creating an informal “government” for themunicipality, e.g., from the heads of the committees.

In Kecskemét, in accordance with the law, the work of the mayor is assisted by six consultants.Each consultant has a special field in which he can support the mayor's decision-making,e.g., civil service, tax policy, economy, technical issues, etc. The mayor, together with thesesix consultants, works out the economic plan of the town at the start of this political period.But thereafter, this body does not take part in the annual budget preparation.

Committees of the legislative assembly: The Hungarian municipalities are free to formany committees of their choice, with only one requirement. The Hungarian Law concerningLocal Self Governments requires municipalities with more than 2,000 inhabitants toset up a financial committee. The tasks of the committee are defined by law. Naturally,the municipalities may give additional functions to the financial committee. For example,in many cities, the financial committee is responsible for assessing the business plans ofthe municipal companies as well as playing the central role (instead of the financialdepartment or office of the municipalities) in cases where the company requires financialsupport from the local budget. Another frequent function of the committee is theparticipation of their members in the budget negotiations with the municipal institutions.

In Oroszlány, the mayor, who is a member of FIDESZ, does not have a majority. The headof the committee and two members belong to the Socialist Party. The committee is involvedin every stage of the budgeting process, e.g., they participate in negotiations with theinstitutions. The committee debates each proposal at a minimum of two meetings—initially in a common meeting and secondly in the so-called joint-committee meeting. Inthis joint meeting, every committee meets at the same time to discuss the budget proposal, sothat this can be seen as a municipal meeting extending to all external members of thecommittees. The effectiveness of this method is proven by the fact that, in 2001, no proposalfor modification was submitted at the common municipal meeting. Thanks to the activitiesof the committees, the municipality approved the budget during the first round.

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Administration: In Hungary, the notary is the head of the mayor's office. Thisoffice is responsible for administering the decisions of the local government, but it hasmany functions delegated from the central level through different laws. Therefore, thenotary is the head of the municipal bureaucracy and of the local state administration atthe same time. According to the Law on Public Finance, the notary is responsible forpreparing the budget proposal that the mayor must submit to the legislative assembly.8

The internal structure of the mayor's office is not regulated—this depends fully onthe decision of the notary. Within the field of financial issues, the cities with a smalloffice typically form a single financial department (or financial office) which includes:(i) the budget team (dealing with budget, accounting and financial issues) and (ii) thetax administration. In large municipalities where both fields require large teams, thesetwo functions are separated into different departments and offices. Although theHungarian municipal system does not define special functions for the city managers, inmany cases, the head of the financial department (financial bureau) naturally has aspecial place within the office. Informally, he is the second person in the mayor's officebecause of his special knowledge and skill.9

1.4 Functions of the Municipalities

Local Discretion

In Hungary, the Law on Local Government defines a very broad range of functionsresiding with the local governments. However, the definitions are not clear and thereare inconsistencies between this act and later ones.

According to the Law on Local Government, the principal duties of the localgovernments are as follows:10 township development; environmental protection(protection of important local natural sites, etc.); local housing; water supply, drainage,flood prevention; liquid waste disposal; maintenance of public roads and other publicareas; local public transportation; public cleaning; local government fire brigade as wellas local defense and civil defense duties; participation in the local energy supply;participation in the handling of local unemployment; nursery and primary schooleducation; basic health and social services; support for local child programs; provisionof local public facilities, general education, culture and sciences; support of local sport;ensuring the rights of the national and ethnic minorities and ensuring the opportunityfor healthy life. In another paragraph, the law defines the following functions in additionto the previous ones: the provision of potable water; maintenance of public cemeteries;public lighting; support for local civic organizations.11

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Table 5.2Total Expenditures by Function, According to the Tiers (1999) [HUF millions]

Local Total Public SpendingGovernment (Consolidated)*

1. General public services 173,033 366,198.1

2. Defense 556 98,319.5

3. Public order and safety 14,140 198,609.0

4. Education 393,397 594,091.7

5. Healthcare 224,583 513,095.2

6. Social security and welfare 194,037 1,746,477.1

7. Housing and community services 103,811 92,318.0

8. Recreational, cultural and religious facilities 55,830 120,036.8

9. Fuel and energy 0 2,647.4

10. Agriculture, forestry, fishing and hunting 8,200 157,872.7

11. Mining, manufacturing and construction, 900 7,064.2except fuel and energy

12. Transportation and telecommunication 14,612 119,812.3

13. Other economic affairs 11,648 109,920.8

14. Other functions (including debt management) 10,066 967,140.3

15. Total 1,205,813 5,093,603.1

* Social security contribution paid by government units are included.

SOURCE: OECD (2000).

In addition to these functions, the municipalities have two main options for extendingthe range of their functions.

1) The Hungarian municipalities are free to undertake any functions not prohibitedby law.

2) According to the law, the county should undertake any functions and shouldmaintain any institutions (secondary schools, hospitals, etc.), the effects of whichextend beyond any single local community. But by way of the aforementionedprocess, the local governments may take over or return any of these functions.

Sectorial laws and regulations: Refinement (defining the exact meaning of localservices, setting up standards for local services, etc.) is the task of the sectorial laws. Forexample, they define the compulsory number of workers, their working hours (e.g.,

339


weekly teaching hours for teachers), the professional parameters of the institutions andthe minimum values for the various supplementary income grants. Naturally, thesesectorial laws and other legal regulations limit the decision-making freedom for theprovision of compulsory public services. However, many of these regulations are notenacted by parliament (but instead, by a decree of the ministers or of the government)and therefore can be passed with only a simple majority (a two-thirds majority is notrequired as in case of a constitutional modification or an amendment to the Law onLocal Government). As a result, the municipalities and many politicians (the oppositionparties in every parliament) criticize such laws and regulations in every case becausethey are seen as attempts both to avoid the modification of the basic legislation (with atwo-thirds majority) and to reduce local autonomy.

Healthcare: It is worth presenting the municipal role in the Hungarian health sectorseparately, because this is a convoluted system with many players and with a very complexfinancing structure. As mentioned, the Law on Local Government declared that localgovernments are responsible for organizing basic health services. Basically, at thebeginning of the 1990s, the municipalities became the owner of the facilities used forbasic health as well as in- and out-patient services. The doctors and other staff of thehealth institutions were public employees. According to the basic principles, the healthsystem was financed from two sources: the central level (health fund) financed operationsand the owner (the municipalities) had to make the necessary investments. (The centralgovernment did set up some funding for the investments in local health facilities.) Thecentral level transferred money for local health based on defined performance measures—e.g., the number of patients, the number of different diseases treated, the hours ofservices—but only for the services in those institutions having contracts with the HealthInsurance Fund. The local government treated the transfers from the Health InsuranceFund as an earmarked fund which merely flowed through the local budget. During thepast ten years most general practitioners became entrepreneurs, and some health serviceswere also privatized. These services received a transfer directly from the Health InsuranceFund. But the municipalities remained the owner of the facilities, so they had to continuefinancing the necessary investments, which are also needed for the service of the privatedoctors. Most municipalities view their health services as an independent institution(similarly to the municipal companies analyzed below)—normally they must operateusing their own revenues (i.e., the transfer from Health Insurance Fund), and themunicipality becomes involved only in case of insolvency or of a major investmentprogram.

The mayor's office as an administrative agent of the central government: Most municipalsystems, including the Hungarian system, are not able to separate clearly the functionsof central and local governments. In Hungary, the central government delegates manyfunctions to the local level. The notaries are both the heads of the municipal office as well

340


Tabl

e 5.

3M

unic

ipal

Cur

rent

Exp

endi

ture

s by

Fun

ctio

ns a

nd C

ost

Type

(19

96)

[HU

F m

illio

ns]

Wag

esEm

plo

yer's

Purc

has

ePu

rch

ase

VA

TSu

bsi

die

sO

ther

sTo

tal

& S

alar

ies

Co

ntr

ibu

tio

no

f G

oo

ds

of

Serv

ices

1.G

ener

al p

ublic

ser

vice

s40

,912

15,9

714,

019

8,06

91,

341

26,3

166,

479

103,

109

2.D

efen

se56

2362

7419

00

234

3.Pu

blic

ord

er a

nd s

afet

y4,

471

1,82

752

663

1 1

580

07,

613

4.E

duca

tion

126,

815

56,4

1326

,259

30,1

007,

213

1,99

80

248,

798

Prep

arat

ory

and

prim

ary

scho

ol79

,088

35,3

2212

,114

13,5

573,

173

950

014

4,20

4

Seco

ndar

y sc

hool

31,2

2913

,785

5,32

65,

960

1,39

584

30

58,5

38

5.H

ealt

hcar

e61

,186

27,2

3525

6,65

430

,792

7,70

689

015

2,67

3

Hos

pita

l ope

ratio

n an

d se

rvic

es37

,051

16,5

9218

,906

22,6

825,

677

50

100,

913

Fam

ily p

hysic

ians

and

pae

diat

ricia

n se

rvic

es4,

193

1,77

8 9

301,

116

279

00

8,29

6

Oth

er m

edic

al a

nd d

enta

l ope

ratio

ns18

,856

8,27

65,

040

6,04

71,

512

00

39,4

61

6.So

cial

sec

urity

and

wel

fare

23,7

6111

,621

10,2

0312

,243

3,06

052

,469

011

3,26

7

7.H

ousi

ng a

nd c

omm

unity

ser

vice

s7,

117

3,11

216

,266

19,5

184,

880

9,63

20

60,5

25

8.R

ecre

atio

nal,

cultu

ral a

nd r

elig

ious

fac

ilitie

s12

,260

4,87

16,

238

7,48

71,

873

520

32,7

81

9.Fu

el a

nd e

nerg

y0

10.

Agr

icul

ture

, for

estr

y, f

ishi

ng, a

nd h

untin

g95

2 4

131,

605

1,92

648

20

05,

378

11.

Min

ing,

man

ufac

turi

ng a

nd12

0 5

0 3

4541

510

40

01,

034

cons

truc

tion,

exc

ept

fuel

and

ene

rgy

341


Tabl

e 5.

3 (c

ontin

ued)

Mun

icip

al C

urre

nt E

xpen

ditu

res

by F

unct

ions

and

Cos

t Ty

pe (

1996

)[H

UF

mill

ions

]

Wag

esEm

plo

yer's

Purc

has

ePu

rch

ase

VA

TSu

bsi

die

sO

ther

sTo

tal

& S

alar

ies

Co

ntr

ibu

tio

no

f G

oo

ds

of

Serv

ices

12.

Tran

spor

tatio

n an

d te

leco

mm

unic

atio

ns41

016

63,

616

4,33

91,

084

00

9,61

5

13.

Oth

er e

cono

mic

aff

airs

781

319

1,67

32,

008

502

00

5,28

3

14.

Oth

er f

unct

ions

1,69

92,

039

509

012

,127

16,3

74

15.

Tota

l27

9,46

912

2,33

610

1,70

112

3,87

229

,989

91,7

0618

,606

767,

679

SOU

RC

E:

OE

CD

(19

99)

342


as the representatives of the state administration at the local level. This is useful especiallyin cases where the number of clients is so high that the administrative or compliancecosts of the program are minimized by local administration. Naturally, creating a parallelcentral administration at local level would be very costly, so the cheapest solution is todelegate the function to the local governments.

But in these cases, the incentive problem arises from the fact that the local assembliesappoint a notary as the local officer, which is treated by the state administration as ifindependent of local interests.12 While the central government regulates these functionsin more detail, the administration depends mainly on local decisions—e.g., how themayor's office is organized, whether the local budget includes appropriate funds forthese functions.

Differences According to Municipality Size or Type

The Hungarian Law on Local Government states that each municipality has the samerights, but it is not necessary for each municipality to undertake the same tasks. It is possibleto assign different functions to different types of municipality. This concept appears inthe Law on Local Government where some special municipality forms (cities withcounty rank and Budapest) are defined.

Some sectorial regulations differentiate further among the local governments accordingto their size. For example, the social assistance system requires the larger localities to beresponsible for more social institutions. The larger municipalities (the towns) have someadditional special functions, e.g., they organize: (i) fire stations, (ii) the prevention ofcruelty to children and (iii) the building authority serving their small regions.

1.5 Structure of Revenues

1.5.1 Current Own Source Revenues

According to many textbooks, the main indicator of municipality independence is theshare of own source revenue (a small share of central transfers) in the local budget. InHungary, more than 70% of the municipal operating revenues comes from the centralbudget.13

Local taxes: The most important feature of the Hungarian local tax system is theabsence of the compulsory tax. The Law on Local Taxation only defines the optionsand the municipalities are free to decide which taxes, if any, they levy. The other special

343


feature of the Hungarian local tax system is the predominant share of the local businesstax, which is basically a sales tax. The main advantage of this form is that it is consistentwith the concept of benefit taxation. However, the tax on production can be passed onif the local taxpayer has great market power, so the tax burden can be transferred to theconsumers. Therefore, inhabitants of other localities pay a portion of the local tax. Theother negative effect is that this tax is very dependent on the economic cycle, so thatplanning with revenue from this source is more difficult than with a tax with a morestable tax base such as a property tax. Moreover, the fiscal federalism (decentralization)literature frequently mentions the problems arising from harmful tax competition:differing tax rates on a mobile tax base (capital, income, etc.) encourage a movement tomunicipalities with lower tax rates. The result is a misallocation of factors or an establish-ment of efficiently low rates and public services if the local government reduces taxrates because of this intergovernmental competition.

Table 5.4Sources of Municipality Revenues (1998)

[HUF millions]

Local Government

Own source 339,018

Of which

Local taxes 145,825

Tax sharing on contingent basis 98,387

Current transfers from central government and tax sharing 739,744on non-contingent basis

Of which

unconditional transfers 356,703

conditional transfers* 371,888

matching transfers 3,415

ad hoc transfers 7,738

Other revenues 20,831

Total 1,197,980

* including transfers from the Health Insurance Fund

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Table 5.5Local Tax Revenues, According to the Autonomy of Municipalities (1999)

[HUF millions]

Category a b c d1 d2 d3 d4 e

1000 Taxes on income, profits and capital gains 179,090

1100 Individuals* 179,090

1200 Corporations

2000 Social security contributions

3000 Taxes on payroll and workforce** 1,161

4000 Taxes on wealth and property 27,044 21,528

4100 Recurring taxes on real property*** 18,202 N/A

4200 Recurring wealth taxes N/A

4300 Estate, inheritance and gift taxes N/A

4400 Taxes on financial and N/Acapital transactions

4500 Other non-recurring taxes on property N/A

4600 Other recurring taxes on property**** 8,842 N/A

5000 Other taxes on consumption***** 126,463

6000 Other taxes

Total 154,668 200,618

NOTES: * PIT (Personal Income Tax).** Municipal tax on business.*** In category (b): sum of (i) land tax, (ii) building tax, (iii) municipal personal tax, (iv)

tourist tax (on recreational property); in category (d3): duties.**** Vehicle tax.***** Business turnover tax and tourist tax.

The table does not include revenue from duty (HUF 21,527 million in 1998) because it is not known whatportion comes from duties on gifts and inheritance and what portion is from fees for public administration.

(a) Municipalities set the tax rates and tax base.(b) Municipalities set the tax rates only.(c) Municipalities set the tax base only.(d) Revenues are split.(d1) Municipalities determine the revenue split.(d2) The revenue split can only be changed with the consent of the municipalities.(d3) The revenue split is fixed in legislation and may be changed unilaterally by the central government.(d4) The revenue split is determined by the central government as part of the annual budget.(e) The central government sets the rate and base of municipal taxes.

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The base of this tax is very unequally distributed among the municipalities. Accordingto a calculation of the Ministry of Finance, the gap in the per capita tax base of the localbusiness tax between the rich and poor municipalities is much wider than it would be,e.g., in the case of a property tax—the price of properties is more comparable in differentmunicipalities than the local business revenues.

The other important feature of the Hungarian local tax system is that the countieshave no taxing power. Their tax revenues come solely from taxes the rate of which is setby the central government.

User charges: The other main form of municipal revenues is the user charges (includingadministration fees). In 1996 revenues other than taxes made up some 60% of currentown source revenues in the Hungarian municipal system.

The business function in local governments: In Hungary, the option of the “entrepreneurmunicipalities” was refused at the beginning of the 1990s: the local governments wereonly granted those properties necessary for the provision of public services and for theoperation of public institutions. So in place of the own source revenue from property,the central funds transfers played a significant role on the revenue side of municipal budget.

With respect to investments, Hungarian municipalities are free to act like privatecompanies. The only constraint is that municipalities are not allowed to participate inany companies where their liability would be unlimited. Naturally, the largest part ofmunicipal assets is property, but about one-fourth of the invested capital is in shares.But most of these investments are in public utilities or in public service companies. Asa result, entrepreneurial and property income was only about HUF 19 billion in 1996at the same time that the value of the municipal property was HUF 1,299 billion (andthe value of the shares was HUF 496 billion).

1.5.2 Intergovernmental Grants to the Current Budget

Unconditional (general) grants: The basis of the Hungarian grant system is a formula-based grant. In 2000 there were 26 normative titles that included about 60–65 targetsor formulas, each of which consisted of an index and a per unit cost element. Mostindices reflect the load of the municipal institutions (e.g., how many children study inthe schools, how many elderly persons live in hospices, etc.). A few of them are basedon characteristics of the local community, e.g., in the case of the so-called “socialnorms”—the number of children, pensioners, unemployed people. The per unit costelement is the same for each municipality. The municipalities receive support accordingto these criteria, but they are free to allocate the funds as they desire—the central fundtransfers are not earmarked.

One of the main criticisms of this system is that it consists of many grants based oncapacity and not on performance or need. Local governments have no incentive to set

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up new and perhaps more efficient systems to provide alternative approaches to meetinglocal requirements. The second difficulty is that the Hungarian equalization system(especially the cost element) does not deal with differences in tax and revenue potential.The system has been criticized as unfair, because the resources available to finance the “ownexpenditures” can be quite unequal among communities. Beginning in 1998, the centralgovernment created a fund from the shared-tax revenue for equalization purposes. Thecalculation of local tax capacity is based on the tax base of: (i) the local business tax, (ii)the company tax of the local firms and (iii) the personal income tax (for assessing theincome of those small entrepreneurs who are not subject to the company tax).

Conditional non-matching: The Hungarian public finance system contains many fundsearmarked for specific programs.14

Matching. The Hungarian system contains two main matching grants (investmentsubsidies): the targeted and the addressed grant. The targeted grant is distributed normatively.The central acts define the targeted areas of this grant and divide the fund into sub-funds for these fields.15 All municipal projects in these fields are eligible, but only themost important projects will receive a subsidy in cases where the central sub-fund is notsufficient to finance every project.16 On the other hand, the addressed grant is distributedbased on the municipal application. Separate laws allocate this grant, with the responsibleline ministry revising the allocation system to take into account total costs—and, in recentyears, the local government's own source revenues. This grant is mainly used for localgovernment investments in healthcare (hospitals), culture (theaters) and reconstructionlinked to large-area tasks. According to the law, these investments must be above HUF200 million. The regional development councils can decide on the support of smallerinvestments from their fund, and from the target-type decentralized fund serving tosupport local governments deemed as having unfavourable conditions.

Vis major grants: In Hungary this grant plays a small role in the municipal financesystem, although most municipalities apply for this fund. Therefore most municipalitiesprepare their budget to meet the criteria of this grant.

1.6 Central Control Over Municipalities

Macro-economic control: The Hungarian municipalities are relatively autonomous.• There is no superior external control on borrowing. No approval needs to be

sought in order to borrow or issue bonds. There is no central restriction on thematurity of any loan and borrowing does not come under any separate regulation.

• The only limitation is the restriction on local borrowing: the Law on LocalGovernments limits the amount of loans to 70% of the sum of the principal ownsource revenues of the local government. However, there is no golden ruleabout the use of the loan. The loan can be used for current expenditures as well.

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• Local governments may borrow from any financial institution, in accordancewith market conditions. In general, an invitation to tender precedes borrowing.Usually the bank maintaining the municipality's bank account offers the loanon the most favorable terms.

This weak regulation of municipal borrowing indicates that the Hungarian systemrelies on market discipline: the financial market should assess the municipality's needfor credit, as well as the need of private firms. This system strengthened in 1995, whenHungary adopted a very strict Law on Municipal Bankruptcy, which was the first inEurope. The Law on Municipal Bankruptcy regulates the process in case of insolvency.The insolvency criteria are the same and the process is very similar to the regulation ofbankruptcy in the private sector. It is worth noting that in this law a new view aboutthe municipalities appeared. While the previous acts stressed that municipalities, aspublic sector organizations, need special financial regulation (e.g., in the accountingsystem), this new municipal bankruptcy regulation currently exists only in countrieswhere most municipal activities are under the financial regulation of private companies.

Legal control: The central government continues to keep some control over themunicipalities. This control can be analyzed in two dimensions: (i) the target of thecontrol and (ii) the institutional form. This study concentrates only on the control overthe municipal budget and the budget preparation process.

(i) Targets. The Hungarian municipal control system concentrates almost exclusivelyon the issues of legality. Often only the local finance committee attempts tomake any efficiency analysis and the other partners do not help in this effort. Ifa municipality wants to evaluate the operation of one of its institutions, it musthire an external (often expensive) consulting firm.

(ii) Institutions. The Hungarian system is a typical agency system. Almost everyministry has field offices, but the most important is the County Public Administ-ration Office, which is the agency of the Prime Minister's Office. This officehas the responsibility for investigating the legality and regularity of localdecisions. If decisions on minor issues are against the law, they can overturnthem. However, in the case of a municipal decree, the office must petition themunicipality to change the decree. If the local government does not followsuch a request, the Administration Office may turn to the constitutional courts.

In the field of budget preparation, the most important field office is the TerritorialPublic Finance Office (TÁH) which belongs to the Ministry of Finance. These officesboth collect budget data from local governments as well as provide information to them.In addition, they calculate and account for salaries and other personal payments madeby the municipalities.

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The State Audit Office (SAO) carries out external auditing. However, the organiza-tional system of the SAO and its staff size are not sufficient to inspect the entiremanagement process of the local governments with the necessary frequency (every threeyears) with regard to expedience, efficiency and legal compliance. The relevant legalregulations do not specify the frequency of full-scale audits of each local government.According to the OECD (1999), at the current SAO capacity, a comprehensive auditcan take place at each local government, on average, every 50–60 years.

Each local government with an annual budget above HUF 100 million must hirean external auditor to control the legality of the finance operations and municipalaccounts.

In countries with a state treasury, this generally has a large effect on the local budgetpreparation. In Hungary, the state treasury does not include the municipalities. Butafter the formation of the state treasury, a so-called net financing was introduced:municipalities receive contributions and grants from the treasury, the amount of whichis reduced by the total of taxes and contributions related to personal allowances. Thus,municipal cash management requirements are reduced.

2. LOCAL GOVERNMENT BUDGETING

Our research analyzes municipal budgeting from two aspects.1. Meyers (1996) defined the key characteristics of an effective budget in eleven

points: (i) accountability, (ii) comprehensiveness, (iii) constraint, (iv) cooperation,(v) honesty, (vi) judgment, (vii) legitimacy, (viii) perception, (ix) responsiveness,(x) timeliness and (xi) transparency. The first goal of this paper is to assess whetherthe current municipal budgets fulfill these requirements.

2. The budgeting papers and analysis issued by international organizations (OECD,World Bank) indicate that there are two main trends in the budgeting practice ofdeveloped countries.17 The governments attempt: (i) to allocate resources basedon outputs/outcomes rather than on controlling inputs (performancebudgeting), and (ii) to make budgets with a multi-year horizon. Therefore, thesecond goal of this paper is to study whether or not Hungarian municipalitiesemploy such techniques. If these are not employed, the goal is to examinewhether the current municipal budget preparation and financial managementtechniques are appropriate to introduce these new budgeting methods. We willconcentrate on the key management practices required by these new budgetingmethods: accrual budgeting and accounting, global (vs. line-item) budgeting,and performance measurement.

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2.1 Budgeting at the National Level

Although the main focus of this paper is on local budgets, it is recognized that the centralgovernment could influence the local methods in many ways, especially through: (i)regulation and (ii) central examples. The following pages will present the effects of thecentral legislation in detail. This chapter deals briefly with four issues: (i) the role of theMinistry of Finance, (ii) off-budget activities, (iii) the negotiation process and (iv)political debates.

(i) The Role of the Ministry of FinanceThe key institution of the Hungarian budgeting process is the Ministry ofFinance. All core functions are concentrated here. It is responsible for creatingthe budget proposal and for controlling the execution process. The Ministrycontrols the treasury. (The treasury is an independent institution in the centralbudget.) The most frequently debated point in the system is macro-economicplanning. Every new government has tried to shift this function away from theMinistry of Finance in order to create a center for macro-economic planning andto “terminate the bias toward short-term, fiscal issues.” But every experiment hasfailed. While the Economic Ministry also plays a major role in this field, the Ministryof Finance has kept its central position.

(ii) Off-budget activitiesIn the recent past, one of the main issues in the Hungarian public finance systemwas the move toward a unified and comprehensive budget at the central level.The first goal was to eliminate the great number of extra-budget funds (in theearly 1990s more than ten funds existed). Most of them were merged into theline ministries, and only four of them have survived: the two social security (healthand pension) funds, the labor fund and the nuclear fund. The distribution ofthe activities between the central government and the National Bank was alsoclarified and the quasi-fiscal activities of the bank were terminated, with, forexample, the Ministry of Finance becoming responsible for managing the publicdebt. However, an opposite trend has appeared in the field of investment projects.The government has attempted to find a cheaper and more flexible way forfinancing major investments (especially in infrastructure), so the developmentbank has been strengthened in order to outsource some investment functionswith the necessary funds. Naturally, this method is widely criticized as a step backtoward a less comprehensiveness public finance system. (The companies and banksowned by the state were never part of the public finance system in Hungary.)

(iii)Budget negotiationsOver the years, the main constraint against “fiscal dictatorship” has been the interestreconciliation process. After preparing the budget proposal, the governmenthad to have it accepted in two forums: in parliament and in the Interest

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Reconciliation Council, which was composed of representatives from bothemployers and employees. Due to its composition, the council dealt mainly withthe issues of taxation, social policy, welfare and salaries in the public sector whichhad a great influence on salaries in the private sector. Parliament, despite thefrequent criticisms expressed in political and constitutional debates, was politicallyforced to approve the results of the council agreement. Two years ago, this methodchanged. The new central government, as the part of its strategy against thepower of the trade unions, limited the options of this council to the budgetprocess and attempted to communicate the budget issues directly to the citizens.

(iv) Political debatesBesides some cultural issues (e.g., the functions of the Church, financing thecultural institutions, regulating the media), the most intensive political debateat the central level concerns the budget. The vote for or against the budget proposalof the government is the main indicator of the stability of the government,with the ruling and opposition parties being defined according to their vote onthe budget. This political sensitivity toward budget issues appears only at centrallevel, with most municipal bodies approving the local budget with near unanimity.

2.2 Strategic Planning and Short-Term (Annual)Budgeting at the Local Level

The planning process is one of the weakest points in the Hungarian municipal budgetingprocess. Although central legislation requires that the local governments approve manysectorial local plans, these typically only list the “dreams” without assessing their (financial)reality. The lack of planning first appeared as a bequest of the 1990s when the rapidlychanging economic situation impeded accurate planning. In addition to this, the frequentmodification of the municipal financing system (especially in the central grants) alsostrengthened the resistance of the local politicians to spend much time on creatingreliable plans. Currently, at the end of the great economic transition, planning has becomethe key point of the budgeting process, but the professional skills needed for planning arestill missing at the municipal level. Moreover, in the former period, Socialism discreditedthe word “planning” because the socialist five-year plans were only a very voluntaristic andbasically politically motivated document. Naturally, EU accession will create greatincentives for the Hungarian public finance system to change current practices and tolearn to make realistic plans that are also assessed at the end of the planning period.

Hungary is among those countries where the central legislation contains requirementsto create long- or medium-term sectorial programs (either in the form of general programsor of development plans for the given sectors). The Law on Local Governments states that

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the municipalities have to accept the given economic program (i.e., the four-yeareconomic conception of the newly elected bodies). Other laws and regulations requirethe municipalities to prepare concepts for long- and medium-term plans in almostevery sector. But there is no standard for the data content of these concepts, e.g., whatinformation has to be included and presented. There is no requirement that the cost-effects of the programs be compared to the expected revenues. This leads to the situationwhere the financial constraints are not taken into account during the preparation phase.The result is that the approved tasks cannot be fulfilled owing to a lack of funds.

The Hungarian municipalities employ two methods during the creation of suchprograms to ensure that the annual budget will have sufficient financial resources.

• Most local governments approve these programs without financial information,and the financial department becomes responsible for having the necessaryfinancial resources for the program. Naturally, in this case the local politiciansare aware that in case of a shortage of funds, the program will not be financedin the annual budget and it will be modified or delayed to the next budgetpreparation period.

• The other—far rarer—method is the fiscal analysis of the plans at the time oftheir approval. Naturally, this also causes problems. At the time the program isset, only project expenditures can be assessed with some certainty, but revenuesare very uncertain. And in case the program is approved based on “fiscalinformation,” it is far more problematic to modify the approved programs as aresult of a lack of revenues.

In Oroszlány, some strategies are presented together with their budget consequences, butsome others are approved without this information. In these cases, the municipal bodyemploys the so-called “contingent approval”—the financial department must search forfunds to finance the program, with the municipal body understanding that implementationis contingent on the identification of these funds..

In Dorog, the committee system and its working method also emphasize the importance ofthe budget process. The financial committee, which is responsible for the budget and financialissues, holds its meeting after all the other committees have met. Its members evaluate thedecisions and the proposals coming from the other committees and, in case they have budgetimpacts, they assess the financial consequences of the proposals. The municipal body debatesthe proposals of the committees (Economic, City Development and Environmental Committee,Social and Healthcare Committee, Education, Cultural, Sport and Foreign AffairsCommittee) only if they appear to be appropriate. If the financial committee feels that themunicipal budget will not be able to finance the program, the municipal body omits thedebate of the issue. The other option is that the municipality guarantees only “theoreticalapproval” to programs with uncertain financial resources and declares that the actualimplementation will depend on the financial situation of the municipality.

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2.3 The Basic Structure of the Local Budget

This chapter deals with some basic issues of the required budget structure: (i) the issuesrelated to the fund system, (ii) the off-budget units and (iii) the classification system.

2.3.1 Fund System

Separation of capital and current budget: golden rule, operating deficit. In many countries(e.g., the USA) the public finance system differentiates two funds in the budget: onefor the operating revenues and expenditures and the other for the capital budget. Thesesystems attempt to constrain the cross-financing between these two funds, e.g., throughthe “golden rule” prohibiting a deficit in the current budget. However, most Europeancountries do not follow this rule. In the opinion of opponents of this very rigid regulation,this rule is based on a false assumption, namely on the Harrod-Domar model whichassumes a mechanistic relationship between economic performance and capitalinvestment.18 Moreover, this could result in false incentive effects on the spendingunits. Because they do not have the option to shift funds between the two budgets, theywill attempt to maximize both of them rather than changing the mix of operating andcapital costs.

In Hungary, each level of the government creates a unified budget. There is onlyone fund and there is no “golden rule” requirement. But the public finance (classification)system separates capital expenditures and revenues from operating expenditures andrevenues into different lines of the budget both as a whole and at the institutional budgetlevel as well. The local budget proposals have to include the municipal (cash-based) balancesheet which also indicates the capital and operating items separately. Despite the lack ofa central requirement, almost every municipality in our research states that the balance ofthese funds is one of the most important features of the budget that is analyzed by localpoliticians. Many local governments define the golden rule as their main budget goal.Some of them have declared this goal in different local decrees, e.g., in the Local Decreeon Municipal Property or in the annual budget concept approved in November.However this balance could be achieved only in a few cities. For example, one of thefrequently mentioned “successful municipalities” has a budget in which 40% of theoperating expenditure is financed from capital revenue.

But the technique of separation is criticized frequently because it is based only onthe value of the goods: capital expenditures are purchases above HUF 30,000. (Thislimit grows to HUF 50,000 in 2001.) But this definition does not take into accountthe useful life of the asset. On the revenue side, capital revenues are calculated as thesum of the centrally defined class of revenues. However, this system does not considerwhether the revenue is one-off or recurring. For calculating revenues and expenditures

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(and balances) of the capital and operating parts of the budget, the municipal financesystem provides another definition as well. Because the vis-major grant system requiresthe applicant municipalities to not invest more than the capital revenue, this systemshould allow the treatment of a small portion of the local taxes (on property) as capitalrevenue. Those municipalities applying for this transfer have to employ this definition,but many others also use this method when presenting the operating and capital fundsin the required table of the budget document.

Some municipalities define not only these basic “funds” in their balance sheet, butalso differentiate others either based on central requirements or on local decisions forearmarking some revenues.

In Tatabánya, the municipality declared that they would not approve a budget with adeficit in “the operating budget.” More exactly, the deficit in the operating budget may notbe covered from capital revenue, but instead must be financed from credit. The budgetseparates not only the operating and capital budget. The operating budget is divided intotwo parts: (i) institutions and (ii) “city tasks.” This latter contains mainly those functionswhich were fulfilled formerly by municipal institutions, but since have been contracted out.On the revenue side, the Personal Income Tax (PIT), the vehicle tax and the municipalrevenues are distributed between the two funds. The main principle was that, together withthe institutional revenue and the central grant, PIT would be the only resource to financethe institutional expenditures. But currently 28.5% of the local taxes also finance theexpenditures of the institutions.

Thus, this three-fund-system is a little bit voluntaristic (especially on the revenue side), withrevenue distribution shifts in almost every year. Owing to the reduction in the municipalshare of the PIT, the reduction in the real value of the central grants, and the increased shareof the institutional expenditures, the mentioned “source distribution” has to be modified forincreasing the proportion of the “institutional fund.” Apart from these problems, this methodseems to be an appropriate tool for indicating the budget constraints and limiting theexpenditure requirements.

The municipality created another special fund: the investment fund. The main goal is toensure that revenue from the sale of municipal assets is spent only for investments. Followingthe budget decree, this fund may finance “only the purchase of goods for commercial andindustrial goals and value-added investment programs.” Its sources were defined in formeryears and currently there are no new revenue streams for this fund. The total amountchanges only if the municipality repays the money that was spent for other purposes from thefund in previous years.

Earmarked funds. Almost every budget has special revenue streams that are ear-marked. In Hungary, the central legislation requires the separation of municipal revenuesfrom two sources:

• The housing fund. The central regulation requires that revenues from theprivatization of council flats should be used only within the housing sector.

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The municipalities have to prove that the unspent money from this source isalways on the municipal account. So, the housing fund is a typical fund withdefined revenues and expenses.

• The central operational grants. The central grants do not have well-definedexpenditure goals, but the central legislation forbids that these sources be usedto finance the repayment of municipal debts. It is required that these sourcesbe held in a separate sub-account and that debt repayment is not allowed fromthis sub-account.

The municipalities have unlimited freedom to create other funds and to earmarkother revenues.

• Naturally, the municipalities separate some funds for unexpected expendituresor for contingent programs, e.g., by creating general and special reserve funds.The number and amount of these funds varies within broad limits. The centrallegislation defines some expenditures which must be budgeted for these items.The general hardship (rainy day) fund is one of the most interesting parts ofthe local budget. In some municipalities, these are discretionary funds for themayor, so the local opposition strives to reduce the amount or to set very broadconstraints on its use. In other cities, the fund provides a backup for financingunforeseen expenditures and unrealized revenues. In general, the budget containsonly a small amount for this hardship fund, but this has the adverse effect thatthe financial department is forced to plan additional amounts in other appropria-tions. Thus, the result of constraints placed on hardship funds is non-transparencyof the budget.

In Dombóvár, the local government appropriates every year 5% of the funds (includingboth operating and development funds) granted to the institutions. The rationale for thisappropriation is that the revenues of the local government (either coming from the centralgovernment or from local sources) are uncertain. So the appropriation is an instrument forconstraining institutional expenditures in order to preserve budget equilibrium. Theinstitutions own revenue sources are exempt from this appropriation. The institutions mustmanage to finance their activities with this reduced budget. The municipal government canfree up these funds following an examination of the budget processes of a given institution.

• The other frequent example are funds budgeted for specific politically sensitivepolicies (typically, for social care, healthcare, education, and environmentalissues), the spending authority over which is given to the municipal committees.There are cities where such funds are not used and, at the other extreme, thereare municipalities where all committees have discretionary funds. Naturally,

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the number and the amount of these funds has an effect on the administration ofthe budget decree: the more the budget contains these funds, the more thetools that remain in the hands of the local politicians for influencing theadministration as well as for constraining and controlling the activities of themayor and his office. This results in higher political accountability (the committeeshave more detailed control over the spending), but also in more rigidity in budgetadministration (the administration has to wait for the decisions of the committees).

In Esztergom, the municipality grants special rights to the committees in the administrativeprocess: they shift money among the appropriations of the mayor's office to the sectors of thecommittee. The only limit is that these shifts are prohibited from one main spending categoryto another (e.g., from personnel to goods and services). They use this right without priorapproval from the mayor—the budget decree requires only that he be informed. Naturally,these rights are limited, because the committee decisions have to be signed by the mayor.However, this local decision creates very strong political constraints on the mayor's activity.

• And in some cases, the deliberative bodies are only prepared to levy new localtaxes or other burdens on the local communities if the revenues are earmarked.This is generally viewed as a good method for informing the local taxpayers ofthe reasons for levying a new tax. However, most municipal financial depart-ments are aware of the fact that this earmarking has no effect on real spending:the expenditure for the given policy goals would be financed without earmarkingas well. The earmarked funds do not increase the fund for the given goal—thefunds from other sources are replaced with this new one.

In Oroszlány, the municipality has no earmarked revenue, but the idea for creating oneappeared in 2000. The municipality proposed to levy a tax on residential properties andthey communicated that this revenue would be earmarked for investments. In the end, themunicipality canceled the proposal because of the strong pubic opposition to the plan. (Theplanned tax rate was high.) On the other hand, the earmarking was mainly a PR technique,because this revenue would not have had any effect on investment. The office forecast HUF55 million from this tax, which was an insignificant share of the total investment (for roaddevelopment alone the budget contains HUF 500 million in expenditures per year).

There are some municipalities where the fund is required to be balanced not onlyat the end of the year, but during the year as well (i.e., prior spending is impeded). Inaddition, there are municipalities which separate revenues into subordinate bankaccounts in order to ensure that the money is used only for predetermined goals.

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In Gyôr, the local government created two additional funds. The tourism fund receives thetourism tax and the environmental fund takes in fines and some other special revenues (e.g.,fees for replacing trees which have been cut down). In case of these special funds themunicipality employs a special accounting system. Although the local government has notseparated them into sub-accounts in the bank, the budget requires that, at the end of year,the office show that expenditures equal revenues from the defined sources. The local budgetorders that expenditures from these funds may not exceed realized revenues.

2.3.2 Extra-Budget Funds, Off-Budget Units

Creating extra-budget funds and off-budget units: Every public finance system providesthe option to form public entities (e.g., foundations, companies, non-profit organizations)that are not part of the budget. But for the transparency and the efficiency of publicfunds, it is necessary that most revenues be part of a single budget. The Hungarian Lawon Public Finance states that only laws may create separated funds, therefore localgovernments are not allowed to create an extra-budget municipal fund. The municipalcash flow has to be incorporated into a single, unified budget.

The Hungarian municipalities are able to create extra-budget institutions only byestablishing municipal companies or public foundations. But these are not part of thepublic finance system and instead work under the regulation of private laws. Accordingto Hungarian law, local governments are allowed to take any economic action that acommercial unit or a person may do—the only constraint being that the municipalfinancial liability for the company may not exceed its equity in this. Thus, the companymust be a limited liability company. Three main forms could be defined:

• Municipal limited company. These are commercial companies working underthe same rules as private companies. The only difference is that the municipalityis the owner.

• Municipal public interest companies. Public interest companies are firms (workingunder the Civil Law) which: (i) provide public services and (ii) do not paydividends—the profit must be retained in the firms and used to finance thepublic service (the core function).

• Public foundations. The municipalities are allowed to form or join a (public)foundation. The details are not regulated. The only requirement is that theelected officials must decide to support the foundation, so that every decision,irrespective of the amount, must be backed by a decree of the local municipalbody. This form is preferred especially in case the municipality expects that theprivate sector will also support the goals of the foundation. This is the mainform for gathering private money for public goals.

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Reasons: There are two main strategies for creating such off-budget units:(i) Many municipalities think that the management of an independent company

will be more efficient. In this case the municipality signs a (long- or medium-term) contract with the company for providing some public services, and thelocal government pays a fee to the company defined in the service contract.They do not deal with the issue of the costs of the service. Naturally, in case thefirm is underfinanced for an extended period, it will go bankrupt and, in theend, the municipality will have to finance the losses of the firm.

In Paks, two municipal institutions are run as independent, public interest companiesowned by the local government but are excluded from the local budget. There is a differencein the financing of the two companies as well. The broadcaster signs a service contract withthe local government every year, which determines how many minutes of municipal news itwill broadcast and how much subsidy the company will receive in return. In contrast, thearts center must have its yearly activities accepted by the local government: some of itsfunctions are financed by the town in full (e.g., library services) while its programs are onlysponsored partially.

• The other extreme is when the municipality, as owner, keeps very strict (input)control over the management of the companies. The firm works similarly to abudget unit, but with a different legislative background. In this case the mainreason for forming an off-budget unit is to utilize the options that the CivilLaw accepts and that are not allowed for institutions in the public financesystem.

In Dorog, a very important tool in the hands of the city management is outsourcing: thetransformation of many former municipal institutions into public interest companies. Thefirst case was the cultural center in 1996. The functions of this new institution have beenenlarged since then, with it becoming responsible for the management of the other (small)cultural center, for the youth camp, for local celebrations and for publishing the local newspaper(managing the printing). Seeing the success of this project, the out-patient health servicesand the technical city management services were transformed into similar organizations in2000. The community-owned company is responsible for managing the municipality-ownedresidential and non-residential real estate, community services, road maintenance, cleaningand park maintainance.

The main reason for these changes was the higher flexibility of the private units, especially inthe field of human resources. As the example of the community center proves, the policy ofunifying different functions into a single company yields extra savings due to the terminationof parallel services and the reduction of the costs of the joint functions (although the shares ofthe joint functions are relatively low, e.g., the additional payment to the top management.)On the other hand, the (micro)control over these institutions is similar to the former method(when they were budget institutions). The municipality does not finance these institutions

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according to their functions or performance based on service contracts, but rather on theannual budget plans which have to be submitted to the economic department for evaluationsimilar to any request from the budget institutions. Based on this control, in some cases themunicipal body has to make managerial decisions (e.g., whether it is necessary to heat theempty hospital property owned by the Holy Borbála Health Kht.). And the municipality, asthe owner, directs the institutions to administer the municipal decisions.

Consolidation of the budgets: The municipal companies and foundations are notpart of the local budget. The municipalities have ownership control over them. Theyappear in the budget only when cash flows from the municipalities to the companies orfrom the companies to the municipalities, e.g., in case of deficit financing, investmentsubsidy, payment for service, dividend or rent for using municipal assets. These transfersamong the different units and between the units and the municipal budget (support,transfer or free use of municipal asset, dividend, investment on behalf of the municipality,etc.) would create a very complex system. But Hungarian budget regulation does notrequire presenting this information in the local budget.

In most cases, the units with no budget effects (no subsidy, for services, dividendsor rent to the municipality) are controlled through the municipal asset management,e.g., by the representatives of the local governments in the managing board or in thesupervisory board. The members of these bodies inform the legislative assembly legislativeassembly and the local administration about the financial situation. Some large munici-palities set up a special committee for inspecting the asset-management (for among otherthings, the performance of these units) and for dealing with the issues of privatization.

On the other hand, those off-budget units receiving money from the municipalbudget are controlled in the budgeting process as well. In this case the municipality hasto evaluate how much subsidy should be planned for the budget period. If there is noservice contract between the company and the municipality, the municipality mustgather information on the financial situation and financial plans of the firm duringevery budgeting process.

In Gyôr, in the sectors where municipal companies deliver the services, the local investmentcan be financed in two ways. The investment could be part of the municipal budget withthe service provider only receiving the asset for management (e.g., the sewer system). In othercases, the company undertakes the investment and the municipality finances the investmentby increasing the capital of the firm. This latter method is employed only in companies fullyowned (100%) by the municipality, especially in the community and real-estate managementcompanies.

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2.3.3 Classification System

According to the Law on Public Finance, the Hungarian municipal budget has to classify:(i) the titles, (ii) the main lines and (iii) the sub-lines.

The titles are the municipal institutions. These can be fully or semi-independent.The main difference between them is the existence and function of the financial manage-ment in the institutions: the fully independent unit has its own financial management(e.g., accounting, banking), while the semi-independent units fulfill these financialmanagement functions through (fully independent) institutions. The option for limitingthe independence of the budget units is utilized in many municipal budget systems.Three main local strategies can be defined:

• These semi-independent units are under the budget of the mayor's office. This isoften employed for community services or for fire services. In these cases, theeconomic department of the mayor's office is responsible for fulfilling themanagement functions of the units.

• The fully independent institution is an economic agency, which is typically set uponly in order to fulfill these financial management and accounting functionsfor the semi-independent units.

• The semi-independent units working in the same sector are unified into a singleinstitution. Often this is used in the field of social care where the differentservices and institutions are unified into a single budget unit.

The main lines are the total amounts of capital and operating receipts and expenditures(within the units).

The municipal budget has to separate receipts and expenditures according to whetherthey are operating or capital, and it must establish the centrally defined classes or lines.The expenditure lines are for: (i) employee payments, (ii) social and other contributionspaid by the employer, (iii) goods and services, (iv) social transfers, (v) other transfersand (vi) expenditures of the locally defined investments.19

The municipalities can modify this “central list” in many cases. Most municipalitiespresent very detailed appropriations in the budget decrees, especially in the line for“goods and services.”20 The main reason for this separation is the variety of planningmethods. For example, in some municipalities, expenditures for public utilities can beincreased by the inflation rate, but the “other good and services” remain at the previousyear's level. For meals provided by public institutions, the institutions calculate withthe changing local norms. However, this modification in the planning method doesnot require that these expenditure classes be in separate appropriations.

Performance budget: planning at the institutional or program level. Performancebudgeting would require the assignment of institutional costs to services and programs.

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But within the mayor's office the division of expenditures is often presented accordingto the goals (or programs) as well. But in most budgets, this “program budgeting”covers only the “discretionary budget”: the basic structure of the office budget followsthe standard expenditure classification (e.g., salary, contribution to social security, goodsand services) and only the remaining expenditures, especially transfers to other institu-tions or for social policy, must be shown separately. However, there are municipalitieswhere the budget represents the largest expenditure of the mayor's office. (See the examplesof Gyôr and Baja where the budget of the mayor's office is more detailed and provides moreinformation on the costs of different programs.)

The main difference between the performance budgeting technique and the classicalbudget is that the classical budget focuses primarily on compliance and expenditurecontrol, while the performance budget concentrates on the efficiency of the programs.The main issue in the classical budget is the micro-control of the expenditures and ofthe related output, while the performance budget provides information on the performanceof the funded programs and services. Many experts consider the global budget to besynonymous with the performance budget, which consists of one consolidated appro-priation for all operating expenditures. This method enables the institutional and programmanagement to mix the different input types to fit the technical efficiency requirements.

Functional classification is one of the weakest points of the Hungarian system. Thepublic finance information system requires that the municipalities provide informationon the revenues and expenditures of the different “tasks,” but the “tasks” differ fromthe functions. Tasks depend on the spending unit—e.g., in many cases, almost allspending of the mayor's office is accounted for as “administration.” This means that ifthe municipality signs an educational contract with a non-municipal school or withanother municipality and then transfers money to that institution, then this spendingwill be classified as “administrative” and not educational spending. Moreover, themunicipalities are not required to present this classification in their budget documents.

In addition, the previously mentioned detailed classification of line “goods andservices” is especially important because any shift between budget lines requires amunicipal decision, so that if the institutions want to use their money in a differentstructure, they have to apply for municipal approval.

Summary

Current situation: Hungarian budgets contain only one unified fund. There are noseparate capital and operating funds, but most local governments follow the goldenrule. The municipalities have no right to create extra-budget funds, but they can establishcompanies or foundations in order to benefit from either greater management efficiencyor from less restrictive regulation in Civil Law. These institutions, as in many other

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countries, are not part of the public finance system. The central legislation providesminimal restrictions on local autonomy in the budget process. The most importantregulations are: (i) the dedication of some revenues to defined goals and (ii) theclassification system. The classification system requires that the appropriations in themunicipal budgets be approved according to the administrative units and to the objectivesof the spending (and the related revenues).

Advantages of the current system: The current Hungarian system can be judged to bea well-functioning system, which meets the classical requirements for compliance andexpenditure control. The requirement of the single budget and the restriction on creatingextra-budget funds enhances the accountability, the comprehensiveness and thetransparency of the local budget. Moreover, the central authority only imposes minimalrestrictions on the local budgeting process so that local politicians have great autonomyfor creating local budgets appropriate to the local requirements.

Disadvantages of the current situation: The main problem with the current budgetingstructure can be found in the classification system. This does not deal with a functionalclassification. The title system (institutional and non-program budgeting) and the veryrigid virement system (each shift between the appropriations in the budget documentrequiring explicit approval from the municipal body) impedes a change in the focus ofthe budget process toward efficiency. Moreover, many municipal budgets over-emphasizethese “control” requirements, e.g., by creating more rigidity in the local budget thanthe central authority requires. In summary, local politicians and administrative officialsdo not utilize their options for creating the elements of a performance-based budgetingsystem (e.g., global budgeting and outsourcing for greater incentives to efficientmanagement with appropriate consolidation methods).

2.4 Budgeting Techniques

The traditional line-item budgeting considers only the input size of the services andinstitutions. Incremental budgeting, which is the complement to the line-item technique,assesses budget requests using the previous year's input (expenditure) level as a base:this could be multiplied with the defined growth rate in every institution withoutanalyzing the necessity of the expenditure level in the previous year.

Line-Item Techniques in the Hungarian Municipalities

Planning the employee expenditure: Hungarian regulations force municipalities to employincremental and line-item budgeting. The central budget defines the method throughwhich the employee payments (and the contributions related to these payments) are

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calculated. This process has to start by defining the number of staff allowed in thegiven institutions as well as their salary structure. The budget document has to containthe number of the staff allowed and the budget has to be planned based on this data.These figures should be calculated according to the requirements in the central budgetregarding the expected reduction in the number of municipal staff as well.

This method means that, if the municipalities want to reduce employee payments,they also have to define the input structure in detail. Practically, this method requiresthat management decisions be made at the municipal level and not at the institutions.But most municipalities simply accept the number and structure of the current staffand recalculate the necessary number of workers only in case of great shifts in functions.

In Szekszárd, at the start of the budget process, the local government gives the budget principlesto the institutions and they have to construct their own budget on the basis of these principles.The principles are linked to functional indices such as the ratio of pupils to teachers or thenumber of lessons per week per teacher. These functional indices are calculated, e.g., accordingto the Law on Education. Using these indices it is easy to determine the number of teachersa school can employ. According to the calculated number of teachers (number of positions),the school receives funds for the employee expenses from the local government (wages, socialinsurance, etc.). Even if the school employs fewer teachers than calculated, the school is stillobligated to give the legally prescribed number of lessons to the pupils. The school can use thetotal funds for employee expenses, but it has to meet its obligations, whether with overtimepay, contracting extra teachers or through some other solution.

Planning the “goods and services ”: The other main part of the operating budget isthe expenditure for goods and services. The central government does not issue such astrict planning requirement for these items as for employee expenditures. The centralbudget contains only information about the rate of the expected increase in expenditureswhich the central government uses in planning the budget of the overall municipalsector. (This is referred to as an automatic increase.) The municipalities generally adoptthese centrally defined rates. So while they employ line-item budgeting for employeepayments, they use incremental budgeting for goods and services—the previous year'sexpenditures multiplied by the rate of increase.

As seen in the previous chapter, municipalities refine the central techniques bydividing these expenditures according to the types of goods and services and thenmultiplying them by different rates. The actual value of this rate depends on the fiscalpotential of the municipality. In the municipalities contained in our research, priceincreases for public services (utilities) are accepted in almost every municipality basedon the expenditure for these utilities, but the rate of increase for other costs variesbetween zero and the inflation rate.

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In Oroszlány, for planning goods and services, expenditures are divided into three maincategories:

(i) Public utilities, which are forecast based on figures from previous years,

(ii) Meals provided by public institutions,

(iii) Others, which are allocated according to various formulae (e.g., classes, number ofstudents, number of beneficiaries).

Guidelines covering the main points and calculation methods are approved in the budgetdocument in November. According to this document, the municipality does not increaseexpenditures for public utilities or other goods and services. This appears to be unusualespecially in view of the increasing costs for public utilities. However, this practice has beenemployed for years and, despite the absence of additional fund transfers during the year, theexperiments are positive—each institution was able to manage these costs.

Naturally, problems arise with this planning technique if the base year is not repre-sentative. For example, if the heating cost in one year is low as the result of a relativelywarm winter, the appropriation will be inadequate in the next (maybe very cold) heatingperiod, if the budget is calculated on this “warm winter basis.” Some municipalities attemptto avoid these problems by using a moving average method: the quantities of the mostcostly inputs are estimated based on average consumption during the last three years.

New programs with no prior experience: One of the biggest problems that a budgetofficer has to face is the introduction of a new program with no base year experienceconcerning spending requirements. Fortunately most of these programs do not requirenew institutions. Because the current budgeting techniques are based on institutionaland not program budgets, in most cases these programs can be started with no explicitchange in the budget—the institutions are expected to finance these new activities outof the “basic” budget. They can meet this obligation either by employing some previouslyunproductive resource or by more efficient management.

Problems occur only when new inputs and especially new institutions are required.In this case, the budget officer must depend on professional estimates provided by theinternal line office. Naturally, this estimate is rarely accurate. But during the year thebudget office can monitor whether the appropriation is sufficient to finance the newactivity.

Forecasting Revenues and Expenditures

Naturally, forecasting revenues and expenditures is essential for the creation of multi-year budgets. But the single year budget also requires an estimate of revenues andexpenditures for the budget year, especially when the economy is unpredictable, e.g., a

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high inflation rate. Additional problems can arise if the primary own source revenuesare very sensitive to the local economy, as is the case in Hungary. Revenues from theprivatization of assets and from taxes levied on a variable base (i.e., the business turnovertax) are a significant part of the municipal budget. As a result, forecasting is one of themost important tasks in the budget preparation process.

Tax revenue: Although it is well known that the primary local tax, the businessturnover tax, is very sensitive to the tax base, the municipal officers do not take intoaccount an estimation of the change in the tax base. Most municipalities plan this revenuewith a simple mathematical or incremental method.

• The “mathematical method” uses the previous year’s tax data and calculatesthe tax base which is then assumed to remain constant—only a change in thedefinition of the tax base would result in a modification.21 This “corrected” taxbase is then multiplied with the tax rate. Obviously, this method does not takeinto account any change in the tax base (normally to a change in turnover).

• The “incremental method” is based not on the tax base but instead on the taxrevenue of the previous year. The “expected” tax revenue is calculated simplyby multiplying the base year’s revenue with some economic indicator (usuallythe inflation rate).

Revenue from privatization: Some municipalities view this revenue as being absolutelyunpredictable and therefore do not waste effort and time to forecast it accurately. Instead,this revenue is used to “balance” the budget. Where the budget officers are not preparedto use this “dirty trick,” two methods are typically employed. Either only a small portionof the value of the property available for sale is budgeted or—in case of a moreconservative fiscal policy—only the sum of the signed privatization contracts is used.22

The other main issue with regard to privatization revenues is the publicity of thisdata. Even if the list of property for sale is disclosed, the budget document does notcontain an itemized list of expected revenues so that potential buyers cannot get accurateestimates of the expected sale values.

Performance Budget—The Role of Performance Indicators

As defined by the OECD (1997b), the performance budgeting method links the plannedperformance level with the budget. But this method does not require direct links betweenthe previous year’s performance and current budget. The role of performance indicatorsin the budget is only influential. In general, the ex-post evaluations play a significantrole during the negotiation phase, when the budget officers and the managers ofinstitutions set explicit output/outcome targets. These negotiations often result in anagreement between the financial department and the agency. These agreements are

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very similar to the performance contracts between the public and the private sector.Based on the indicators in these contracts, many countries set up incentive systems forpublic sector managers, e.g., in the form of performance-related payments, either on anindividual (management bonus) or group basis. In many countries (e.g., in New Zealandand Great Britain), this is a widely used, or even obligatory, budget technique.

Hungarian regulations do not require any output or performance information tobe incorporated into the local budget documents. Naturally, because the definition ofthe expected performance is implicit, the legally defined consequences for bad performanceare also missing. Management incentives are not part of the budget system and arebased on the regulations regarding all servants and public employees. This system isfrequently criticized with the argument that the rigid career and salary systems are noteffective for motivating and rewarding management performance.

The municipalities in our research employ quasi-performance based budgeting onlyin three forms.

• Formula-Based Finance (especially for education): Several municipalities haveattempted to create a formula with which the educational fund could bedistributed among the institutions. Strictly viewed, this fund can only containgoods and services—owing to the aforementioned strict planning method foremployee payments. However, this formula has not been implemented in mostcities because according to the calculation of the expert team, this “new”budgeting technique would require more funds than the current appropriation.(This problem appears because some experts use the term formula-based financeas a synonym for zero-based budgeting and, in the Hungarian budgeting literature,zero-based budgeting is a “scientific calculation method” for defining theminimum cost of the necessary input.

• Program Budgeting: In the recent past, program budgeting is the most frequentlymentioned potential reform program in municipal budgeting. This is mainlythe PPBS system. The main difference from the classical line-item budget isthe long list of performance indicators and calculated average cost indicatorscontained in the annex to the budget document. The cities using this methodprovide a very detailed justification for the budget. This justification lists theprograms and the planned activities of each program in very much detail (e.g.,which bushes will be replaced from the park maintenance fund, how much willbe spent to support a small children’s theater group). These contain detailedinformation about the performance of the different programs, but most ofthem measure only the quantity of the program (e.g., how many students attendany given school, how many meals are provided during the year in the publicinstitutions, the size of the real estate used by the institutions) and not thequality of the programs or the public satisfaction. They attempt to calculatethe cost and to define the performance indicators for each program and activity.

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Theo-retically, the method should define objectives and alternative solutionsfor every program, but as in the case of classical PPBS, this analysis is missingfor most programs.

• Most local budgets contain a table which indicates the parameters used forcalculating the central formula-based finance. Some cities have expanded thistable. They provide more detailed information on the duty/performance leveland compare these parameters with, for example, the number of staff in thegiven institution. (It is worth recalling that employee expenditures are the largestpart of the institutional budget.)23

In Baja, the budget document presents some “duty and performance measures” in a table,which also contains the number of workers (planned status) according to the institutions.The numbers of workers are divided into: (i) core workers, (ii) administrators and (iii)economical, technical service. The duty measures are more-or less same as the central statistics.The main exception is for education where the figures do not present the number of students,but the number of classes. The only performance measure in education is the number ofpeople provided with meals in public institutions.

CFOs define two main problems with the implementation of output/outcome-based budgeting. First, the currently used indicators are not appropriate for measuringthe performance of the institutions. Second, there does not exist an effective incentivesystem for institutional management. The quality of the management is assessed typicallyonly at the end of the period of appointment. During their tenure, the heads of theinstitutions are subject to evaluation only if their activities are against the law.

Accrual (Cost-Based) Budgeting or Cash-Based Budgeting

While most countries use a cash basis in the budget process, some countries have changedto an accrual basis.24 The new GFS standards (GFS 2000) and the EU standards (ESA95) also require that an accrual basis be used in the public finance system and that thedeficit be calculated using accrual accounting. Although these standards are guidelinesfor reporting only and not for budgeting, it is clear that this change in reporting methodis relevant only if it aids in the formulation of policy (budgeting for output, outcome).

In accrual budgeting and accounting, revenues and expenses are recognized whenincurred and not when cash is received or paid.

Contrary to these suggestions, Hungarian regulations concerning public finance definethe budget as “a financial plan and the related funds containing the allowed expenditure[...] in the budget period” (Law on Public Finance Section 7). This is clear—Hungarian

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budgets have to be prepared on the cash basis. Thus, Hungarian local governments areforced to employ the cash basis for budgeting. However, most CFOs not only employthese techniques, but also agree with the cited differences between commercial and publicaccounting.

The accounting for capital expenditures also differs in the two systems. Accrualaccounting, similarly to private sector accounting, spreads these costs during the usefullife of the asset (through depreciation), while the cash-basis budget records the entireexpense in the year of the investment. The utilization of the assets is one of the problemsthat the mentioned “program budgeting” technique attempts to solve—but this techniqueis built on the comparison of the net (depreciated) value of an asset to its gross (original,historical market) value. The aforementioned annexes contain such information forevery institution.25 Naturally, this method is far from accurate because the mentionedratio between the gross and net value is very sensitive to the time of acquisition, especiallyduring periods of high inflation. But this can be viewed as a first step.

Multi-year, Guaranteed Budget

In Hungary, there are two main tools to extend the planning period in the budget pre-paration process.

Biennial budget: Beginning in 2000, the central budget of Hungary will have beenenacted for two years. The new regulation allows the municipalities to prepare a budgetfor two years. However, most municipalities do not utilize this new option becausethey consider that most factors affecting the budget are unforeseeable in advance fortwo years.

Baja is among those few municipalities which utilize the new centrally created option tocreate a biennial budget. They are able to do it because the most important parts of themunicipal budget (the employee payments and the central grants) are defined for two yearsin the central legislation. Because Baja has many institutions, the central grant is by far themost important revenue source. Moreover, in planning for goods and services expenditures,the municipality uses only the centrally defined expected growth rates, the institutions mustcalculate their expenditures by multiplying the previous level with these rates. The mostimportant difficulty was in planning the own source revenues. For operating revenues (19%of total revenues), the biennial local decrees (e.g., on the fees for services) create a strong basisfor the planning of these revenues, and where this is not sufficient (e.g., in case of the localtax revenue) they also employ the centrally defined growth rate. The own capital revenuewas planned at the level of HUF 207 million in 2001 and HUF 232 million in 2002.This source is only a minimal portion (3%) of the total revenue. Moreover, as the basis forthis planned revenue, the budget classified real estate valued at about HUF 600 million(according to the financial department estimate) as property for sale.

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Rolling budget: The Law on Public Finance requires that the municipal budgetshow the full scope of the effects of the current year programs on the next two years.This would be useful for creating and analyzing the multi-year effects of differentfinancing options for the same programs. But the local governments view this only asan unnecessary function because the data are unforeseeable. So the local rolling budgetscannot be used as a basis for budget decisions (e.g., timing the start of the significantprograms).

Multi-year forecasting: Naturally, the key issue in multi-year budgeting is what datato use for the calculations. Most municipalities employ the centrally supplied forecasts.(The central government issues annual guidelines containing the financial andeconomical forecasts of the central governments. These guidelines contain the centralexpectations on economic growth, other macro-economic indices,26 inflation, wageincreases, the rate of social contributions, minimum wages and minimum pensions.27

In this document the central government indicates the centrally planned revenues andexpenditures of the municipal sector as a whole, as well as the main lines of the cash-based municipal balance.)

Multi-year liabilities: The regulation attempts to limit liabilities. According to thebasic principles, multi-year programs can be approved only if certain future revenueswill be enough to finance the programs and the operation of other municipal functions.Practically, this means that the legislative assembly should enact such programs by wayof municipal decree.

Summary

Current situation: Although there is no explicit central requirement for using line-item(or incremental) budgeting techniques, some points of the regulations (e.g., concerningthe budgeting for employee payments) impede the use of other techniques. Amongmany others, this is one of the reasons why many municipalities use the incrementalbudgeting techniques in as many cases as they can—especially in the field of “goodsand services.” Strangely, this method is also used in many municipalities also forpredicting the main own source revenues (the business tax and privatization revenue).

The current Hungarian public finance system requires the use of the cash basis forbudgeting with three-year projections of the effects of the current year budget (rollingbudget). From 2001 the municipalities have the option to prepare a biennial budget,but the majority of them (almost all municipalities) have chosen to remain with theannual period. Currently, the figures in most local rolling budgets are unreliable andnot appropriate for analyzing the different options of the given local programs becausethese are calculated only by multiplying the base year data with the centrally suppliedgrowth rate without analyzing the foreseeable local changes.

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Disadvantages of the current situation: While the Hungarian techniques meet thetraditional requirements concerning the public finance systems, the new performance-based method is almost absolutely unknown at the municipal level. Although somelocal governments attempt to compare the performance of their related institutions(especially schools), performance-based budgeting techniques are not used. Becausethe current Hungarian regulation concerning civil servants and public employees definesa very rigid career system, most municipalities do not have an option for creatingincentives (e.g., performance-related payments or other benefits).

The instability of the primary own source revenues in the Hungarian municipalsystem results in many budgeting problems. In particular, because many budgetingtechniques used locally only calculate the expected revenues from these sources basedon the prior year's figures, they do not analyze the potential (and likely) changes.

2.5 Major Stages of Budgeting

The Hungarian budget year runs from January 1 to December 31. This applies to boththe central and local budget.

The first step of the municipal budget making process is the government submissionto parliament of the guiding principles for the following year's budget (by May 15) andthe concurrent notification to the local governments of the main directions of budgetpolicy.

In the next phase, based on these guidelines, the mayor's office must collect theplans of the budget institutions for the next year. The revenues must be estimated;based on these estimates, the mayor's office prepares the budget ideas for submission(by November 30) to the municipal body. To support this process, the central levelprovides information concerning the amount of funds expected to be made available tothe municipality in the budget year.

After acceptance of the central budget, the Minister of Finance and the Minister ofthe Interior publish, in a joint decree, the central sources per local government and perlegal title.

By February 15 or by the forty-fifth day following the acceptance of the centralbudget, the mayor must submit the local budget proposal prepared by the notary to themunicipal body. The municipalities have the right to act by local decree on the interimbudget for the budget period before the final budget is accepted.

During the year, the municipalities have an unlimited right to modify the budget.The central government defines only a very flexible standard concerning when themayor may submit a modification: “The mayor can submit a proposal for modifyingthe budget to the legislative assembly, if conditions have changed so much that theimplementation of the budget is jeopardized to a great extent.”

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Each year, local governments must prepare quarterly reports for the public financeinformation system by April 15, June 15 and October 15. In addition, semi-annualand annual reports are due by August 10 and by March 15, respectively.

By April 30, the mayor submits the final accounts and the reports prepared by thenotary. These documents must be supported by an audit report, if the municipality isrequired to hire an external auditor.

Local variations: All municipalities prepare and most of them ratify the two requireddecrees on time (the budget concept by November 15 and the budget proposal beforeFebruary 15). However, the remaining points of the centrally set timetable are not fullyaccepted at municipal level. The main variance is the point when the institutions enterinto the budget process. Many local governments only collect the initial budget plansof the institutions in January, following the approval of the amount of the centraltransfers and the local budget concept in November. Many municipalities define themain guidelines for institutional budgets according to this concept. The main reasonfor this policy is to avoid having the institutions prepare unaccepted budget plans inmany versions.

Modification to the local budget: Most municipalities do not define explicitly thecrisis situations requiring a modification to the local budget. Primarily, this is due tothe fact that the local budget must be revised regularly every three months when theunplanned funds (e.g., from central transfers) must be recorded in the budget. (Thereare some cities where small budget modifications are discussed at every meeting of themunicipal body.) The municipal officers view this frequency (every three months) asbeing appropriate for responding to the budget problems as well.

2.6 Participants and Actors in Local Government Planning

In Hungary, the central government does not regulate in detail the range of the localparticipants. The only exception to this is for public employees. The regulation concerninginterest reconciliation forces municipalities to form an Interest Reconciliation Boardfor the Budget Institutions. This board includes representatives from the public employeeand civil servant unions and is given the task to negotiate the main issues of the localbudget. Some municipalities extend the membership of these groups and institutionsto include local civic groups.

Leaders of the institutions: In many cases, the heads of the budget units are membersof the municipal body (or of the committees), especially in the smaller municipalities.In the opinion of the CFOs, they constrain many reforms that would cut their funds orreduce their financial power.

The role of external experts in the committees: Most financial committees have externalmembers, and many of them are financial or tax experts. (However, in large municipalities,

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most of the committee members are delegated by their respective political parties.) Somemunicipalities attempt to make use of these experts by enlarging the role of the committees(e.g., when they participate in the budget negotiations or when all committee membersparticipate in meetings organized by the municipality as in the workshop in Dorog.)

Publicity

At the municipal level, the dissemination of the budget is achieved primarily throughtwo channels: (1) the public hearings organized during the budget preparation and (2)the local (county) media.

Public hearings: Public hearings, as required by the Law on Local Governments, arean open forum in which each participant can express an opinion on the performance ofthe municipal institutions and programs. According to the law, such a hearing must beorganized annually. Many municipalities hold this meeting in the first months duringwhich the new budget is being debated. In the opinion of the local officers, the outcomeof these hearings is not very significant because the inhabitants” wishes are very biasedin favor of investments and infrastructure developments. (Local politicians formulatesimilar wishes in the municipal bodies.) Voters and politicians are not interested in theproblems of operating the public services, especially social care or education.

Local media: Most Hungarian cities utilize the media for disseminating informationabout the local budget to the voters. Budget information is disclosed in local media intwo main forms:

(i) Live broadcast of the meetings. Many communities have their own local TVbroadcast. The meetings of the municipal body meetings (and in some placesthe most important committee meetings) are broadcast on television.

(ii) Short news articles. Because tax experts in the local media are relatively rare, localcommittee members or members of the mayor's team tend to write the articlesreporting the local budget. These articles indicate issues which, in the opinionof the authors, seem to be most interesting or relevant for the local community.Typically, these concern tax rates and planned tax revenues (how much thecitizens will pay for the municipality), the planned investments (especially withregard to major investments planned to start in the coming year) and the primaryfinancial data (the total, the amount of the deficit, the planned financing, etc.).

2.7 Information Systems

This chapter is structured according to two information types: fiscal (financial) andperformance.

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Fiscal Information Contained in the Budget Document

Information in the budget document: The budget proposal is prepared for politiciansand the local community, so it should include all relevant information needed to assessthe efficiency, effectiveness and fairness of the budget.

Hungarian legislation lists tables required in the municipal budget documents, butnaturally the municipalities are absolutely free to include other information in theirown budget format as well. Central legislation defines only the format of the budgetreport required for the Finance Ministry's field offices (TÁH).

According to the regulation, this final summarized report concerning the budgetimplementation must contain: (i) a cash flow statement, (ii) a balance sheet (accordingto the accrual basis), (iii) an accounting for unspent funds and (iv) income statement.

Nearly every Hungarian budget contains, as the central regulation requires, tablespresenting

• revenues according to sources,• operating expenditures in total according to budget units (municipal institutions)

and in detail according to lines (categories) in the institutional budgets,• capital budgets according to goals (programs),• expenditures of the mayor's office, in total according to the goals (programs)

and in detail according to: (i) the general and (ii) the special reserve funds,• the number of staff (public employees) permitted within the budget units,• a rolling budget of the multi-year projects,• a cash flow statement with separate lines for operating and capital expenditures,

for revenues and for planned borrowing,• the budget of the local governments for the national minorities.

In 2001 the municipal budget documents were required to contain the monthlyfinancial plans in order to estimate the liquidity situation of the municipal budget.

Most, but not all, budgets indicate tax expenditures as well. Some cities (e.g.,Tatabánya) list not only tax expenditures, but also the revenues lost as a result of reducedrents from the users of real estate owned by the municipalities.

Most Hungarian municipal budgets typically analyze the following three issues:• Balance. Naturally, almost every document contains some paragraphs stressing

that the municipality must follow conservative fiscal policy in the next period,that spending should be cut, that the appropriateness of the institutional structureshould be analyzed, that the parallel functions should be terminated, etc. It isinteresting to note that these paragraphs vary with respect to the definition ofthe deficit. Some budgets consider total revenues (including debt financing)

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and expenditures, while others define the deficit to be the overall credit in thebudget and even others analyze the attainment of the golden rule.28

In Tatabánya, within the “city tasks” (see footnote 20), the budget attempts to present theamount of discretionary spending options available to politicians. There are separate titlesfor funds appropriated in long-term contracts and those which are available for “free”budget (political) decisions. Almost 22% of the “city task” is appropriated through contracts,so they can not be modified simply through a budget decision. But not all unappropriatedexpenditures are “free money,” e.g., the line for communal service contains both appropriatedand unappropriated amounts in the same line—but the split is clear from informationavailable in the annex to the budget. The other important example of unappropriated yetunavailable funds arises when the social policy defined by central legislation lists the criteriafor eligibility and size of payments.

• Changes in expenditures and revenues from the previous years: In most cases, theannexes include tables indicating the amounts shown in different lines in previousyear(s) as well as a written analysis comparing the intertemporal differences ofthe various aggregated expenditure and revenue categories (at the level of themain lines). Typically the written analysis concentrates on the revenue side, i.e.,why the revenue mix shifted or by how much the amount of the central transferwas reduced.

• Expenditure level for different institutions and programs: In addition, many budgetscontain inter-institutional comparisons in order to indicate the proportion oftotal expenditures covered by the central formula-based transfers. Especiallyfor institutions in the same sector (primarily in the area of education), mostbudgets compare average expenditures of the institutions as well.

Inflated Data Requirements: Nearly all municipal officers complain of the greatamount of unnecessary information that must be incorporated into the budget. Someof this information is viewed as being unreliable—most CFOs mentioned the rollingbudget in this group. Other information would be useful, but the politicians do notuse it, or worse, misunderstand it. This problem occurs frequently when informationprovided in the municipal budget has a different meaning than that used in thecommercial sector—e.g., the structure and the total amount shown in the balance sheet.

However, the data requirements are not inflated in every budget. Some officesattempt to protect politicians from an unlimited amount of information by preparinga budget of only ten to twenty pages. In some cases, this results in the omission of somecentrally required data. At the other extreme, the aforementioned program budgetingtechnique creates documents with many annexes—the total length of which is morethan 200 pages for a medium-sized city.

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Performance Information

For analysis of the measurement of performance, the research concentrates only on twokey issues of a performance information (audit) system: (i) the measurement and (ii)the criteria used for assessment.

Measurement: Theoretically, performance measurement should indicate the effi-ciency and effectiveness of the programs and should provide useful information fordecision-making (both for institutional managers and for budget makers). This wouldrequire adequate data that is limited in number and in complexity as well as theappropriate analytical tools for assessing the results.

As mentioned in the chapter on performance budgeting, the Hungarian municipalbudget usually contains some “task” or quantity measures for the institutions (programs),but there is no data about program quality or the related satisfaction of the citizens.Not only is this data missing from the budget document, but the whole performancemeasurement system at the municipal level is also very weak (almost completely missingin most cities). The formal municipal channels for gathering performance informationfrom the institutions is missing because the institutional management is overloaded(especially in the preparation of many statistical reports that are never used) and themayor's offices do not want to ask them to provide additional information.

However, it is more interesting to note that while most municipalities commissionpublic opinion surveys to assess the work and popularity of the local politicians and themayor's office, this information is not used in the budget process nor is it used in mostcities for strategic planning or for measuring the progress of medium-term programs.

Assessment: The performance information can be utilized effectively only bycomparing it with a database. In order to avoid arbitrary goal setting, a municipalityshould use intertemporal and intergovernmental benchmarks.

• Intertemporal comparisons. As discussed in the section concerning fiscalinformation, the comparison of fiscal indices with similar data from the previousyears is widespread. But in most cases, such comparisons do not give indicationsabout the performance level. This data is presented in the budget not in orderto measure the output or the task of the institutions, but only in order to informthe decision-makers about the calculation method used in the central grants.

• Intergovernmental comparisons. In Hungary, as was previously shown, the fieldoffices of the Finance Ministry (TÁH) collect “task” information. They prepareand publicize some basic indicators for use as benchmarks. Typically, these arenational averages concerning local expenditures (e.g., expenses per pupil,expenses per hospital bed, etc.) listed separately by county and according to thesize (and type) of the municipality. But the budget-makers do not employthese indicators during the preparation of the budget because of their high

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level of generality—the main statistical method (averaging) is not sensitive todifferences in the number of clients (i.e., economies of scale) or to the varyingfiscal potential among the municipalities. The typical case against a comparisonbased on average costs is that “...there are no two municipalities in the samesituation....” On the other hand, occasionally, municipalities attempt to gatherinformation from similar municipalities (e.g., cities with county right or similarlysized cities in the same county or region). However, these comparisons arerarely used for budget issues, but instead for the setting of fees for local publicservices, for tax policy and for use in special and infrequent problems (especiallywhen the local government establishes medium-term sectorial programs or hasplans to restructure some institution such as a theater or TV).

Summary

Current situation: The central legislation defines the information (tables) required inthe local budget. These tables concentrate almost exclusively on fiscal (financial) infor-mation. This list contains the most important fiscal measures, so that if the municipalityfollows the rules the local politicians are provided with much important information.Although the exact contents of this list can be debated, it does provide informationrelevant for more-or-less all important fiscal issues.

Disadvantages of the current situation: The main problems connected to the informationsystem arise from two facts. First, the centrally required information is vast and theamount is increasing continuously. Second, the central list does not contain any infor-mation about performance. Although the public information system does collect muchdata concerning performance, this data is not required to be included in the budgetdocuments and the centrally administered databases are not analyzed and distributedadequately. As a result, local politicians must make budget decisions without reliableinformation about public services. Naturally, they would prefer to define additionalrequirements, but owing to the large amount of information required by the centralregulation these extra demands would make the budget documents unmanageably large.

2.8 Budget Implementation

The budgeting process contains not only budget preparation, but also implementationand execution. The finished budget is just a document. The overall quality of thebudget also depends on its management and administration.

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Cash Management Practices

Cash management has two extreme methods: a centralized treasury system or decentra-lization based on the principle of management autonomy. The primary reasons forestablishing a treasury are the resulting specialization (and concentration) of knowledge,the simplicity of balancing the cash surpluses and deficits of individual agencies, thehigher interest rates received on short-term (e.g., overnight) deposits and the specialbank conditions given for large account balances. However, in this case, alternativemeasures of an institution's financial management performance may be required methodsbecause the cash performance, which is one of the best indicators of the performance ofthe financial management, is not available.

Central regulations concerning the rights of the institutional management. The centraldefinitions of the main forms of the budget institutions are based on the main characteristicsof their financial management (functions). According to central decree, the independentbudget units must fulfill the following tasks: (i) planning, (ii) appropriating, (iii) establishingresponsibility (i.e., set by laws or decrees), (iv) setting up the functions of the institution(operation, maintenance, investment), (v) utilizing the assets, (vi) managing labor, (vii)managing cash, (viii) accounting and reporting and (ix) gathering and providing therequired information. The independent budget unit has its own CFO who is nominatedby the head of the institution and approved by the municipality. All other employerrights are in the hands of the head of the institution. The CFO has the right to decideon financial and economic issues.

Local treasuries. The Hungarian municipalities are free to decide whether to employa single centralized account system or to maintain the decentralized financial managementof the institutions. Naturally, if the municipality establishes a local treasury, the fullyindependent units will be downgraded to semi-independent ones.

In the municipalities, opinions vary regarding the problems (costs) and benefits associatedwith the centralization of the cash management system.

Although the central government employs and urges the centralized system, thereare only a few municipalities which have a hard treasury with a single account andcentralized accounting control.29 As mentioned, in smaller cities having fewer fiscalexperts, the financial management was traditionally centralized in a single independenteconomic agency.

While completely centralized cash management is rare, other forms of local treasuryare set up in many municipalities:

• In a passive treasury, institutional payments are made directly through the municipalaccount—the office sets limits on the total amount of transfers made in thename of the institutions, but does not control the individual payments.

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In Oroszlány, every institution has its own bank account and the financial management isable to achieve most of the benefits of the single-account system. The institutions keep theirown source revenues at their bank account. The municipality does not transfer money tothese accounts. As long as the institutional account is not depleted, the institutions arerequired to finance their activities without municipal transfers (i.e., from their own sourcerevenues). When the balance of the account falls to zero, the municipality establishes a limitfor payments initiated by the institution directly from the municipal central account. Themoney remains on the central account, but the bank accepts the payment orders sent by theinstitutions unless the established limits are exceeded.

• In a multi-account system, the municipality attempts to avoid having a shortage(and the resulting bank borrowing) in some accounts when at the same timethere are surpluses in other accounts. Methods used include ad hoc financingwhen account balances fall to zero and transfers from the central account havenot been received, the collection of money each night for deposit in its centralaccount, the creation of an incentive system involving the sharing between thecentral and institutional accounts of interest earned on the institutional funds.

In Gyôr, the so called ad hoc financing model is functioning. The basis for cash managementconsists of: (i) the monthly financial plan approved in the budget and (ii) the special “ad hocfinancing” of the institutions. Ad hoc financing means that the mayor's office does nottransfer money regularly (monthly, weekly) to the bank accounts of the institutions. Instead,transfers are made only when the account of the institution is depleted or when it must paya bill exceeding the balance in the bank account. In this way, excessive amounts of non-interest-bearing funds in institutional accounts is avoided. The only exception to this is forthe support received from the central government for vocational training, this being the onlysignificant fund allowed to “lay” freely on the accounts. (The other own source revenues,typically, have to be paid almost immediately for the related expenditures of the programsgenerating these revenues—e.g., fees for meals, rent for the assets of institutions, etc.) Themayor's office controls the schedule of the institutional spending only in order to preventexcessive overspending by the institutions.

In Keszthely, the institutions have their own bank accounts. But every night these accountsare cleared, with all money exceeding HUF 1,000 being transferred to the central accountand the bank paying liquidity interest on the amount in this central account. The institutionalaccounts do not earn interest. Due to its special status as part of the Health Fund, the hospitalis not involved in this clearing mechanism.

Tatabánya employs a multi-account system. If the institutions have temporarily free, unspentmoney on their account, they have two options.

(i) They can transfer this fund to the central account, with the municipality then grantingsupplementary appropriations as “interest.”

(ii) The money can remain on the institutional account, but in this case the municipalitytakes this into account when calculating the weekly municipal transfer, thus reducingthe municipal support.

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The institutions do not have interest-bearing accounts, so the only way for them to receiveadditional funds is to “lend to the municipality.” This incentive system results in theelimination of surpluses on the institutional accounts while at the same time maintainingthe financial autonomy of the institutions. In return, the interest on the municipal account(and the savings arising from the avoidance of short-term borrowing) is shared with theinstitutions which disburse funds at a slower than planned rate.

Investment policy for surplus funds and short-term borrowing. The Hungarian munici-palities are free to select a bank for account keeping. However, the local governmentsare prohibited from keeping multiple budget accounts (for budgeted cash flows). TheDecree on Public Finance defines those revenues (targets) for which the municipality isallowed to open sub-accounts.30 The budget institutions are obliged to keep theiraccounts in the same bank used for the municipal budget.

The central regulation permits deposits to be held in other banks as well, but paymentsfor budgeted expenditures must be made from the budget account. The municipalitiesare absolutely free to purchase securities, bonds or shares. Previously, there was a regulationwhich allowed the municipalities to buy only securities backed by a state guarantee, butthis restriction has been eliminated. However, many municipalities have maintainedthis regulation. The municipal decrees typically delegate decision-making about short-term borrowing and investing activities to the mayor with limits placed: (i) on the amountof the credit and (ii) on the form of the investment (i.e., only with state guarantee).

Controlling the Budgets of Service Organizations(Expenditures and Own Revenues)

Municipal services are provided by more or less independent units: in- or off-budgetmunicipal units, companies, private partnerships, etc. Management autonomy in theunits is crucial if the municipalities want to employ a performance-based incentive(e.g., performance budget) system. On the other hand, financial information aboutthese units is also essential.

Management autonomy in the budget preparation. The key difference between theperformance and classical budgeting method is not the line-item format of the budget.The performance budget can be structured in a line-item format as well. The majordifferences of the new method are institutional and involve management autonomy todetermine the structure of inputs (operational costs), to make virement and to saveunspent money for future expenditures.31 For program management to be responsiblefor the efficiency and effectiveness of the programs, they have to have autonomy fordeciding the expenditure mix.

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However, Hungarian regulations limit the freedom of institutional management.They do not have a centrally defined role in the budget-making process. The centrallegislation requires only that the budget preparation process start by collecting theinstitutional requirements for the next year plans and programs. But, as seen in manymunicipalities, institutional management is responsible only for calculating properlythe budget request according to a very detailed calculation method and guidelines issuedby the municipal office.

The municipal decree (i.e., the municipal budget) defines the roles of the differentlevels in the virement process. Thus, there is ample opportunity to leave power in thehands of the institutional (program) management. But the central regulation limits themanagement freedom for efficient and effective performance by establishing rigidconstraints on planning and changing personnel expenditures. (The main reason forthis is to prevent an institution from incurring an unfunded liability for the next year.)

In addition to planning and virement, the third main fiscal option in the hands ofinstitutional management would be the free use of any undisbursed appropriations andthe freedom to carry them over from one year to other. However, the central regulationrequires institutions to explain any unspent funds. In any case, the institutions arerequired to return these funds to the municipalities, which is then free to redistributethese funds or to leave them in the hands of the efficient management. At this pointmost municipalities attempt to create an incentive system by extending managementautonomy with the declaration that any unspent funds will remain with the institutionas long as these funds are not the result of some tasks that were planned but not carriedout. But there are also other examples: some municipalities deprive the institutions ofthe funds remaining as a result of cost-effective management, while some others earmarkthese funds but leave them in the hands of the institutions.

With these conditions, management autonomy could be mandated in Hungaryonly as part of the political process. Among other issues, the limitations on managementautonomy (and the fight for resources) are among the main incentives for institutionalleaders to become members of the municipal body or of committees where they caninfluence the final decisions not just about the total amount of the institutional budget,but also about the mix of expenditures.

Expenditure: proper authorization for disbursement. The other side of managementautonomy must be the control over the level of spending in order to avoid financialmismanagement, deficits and over-spending (e.g., as a result of the enlargement ofexpenditures without a related increase in revenues). Efficient cash management requiresdisbursements to be based on proper authorization.

The Law on Public Finance states that the head (or CFO) of the budget institutionhas the right to disburse the funds of the institutions. But the disbursement must bebased on a plan (timing) for using the funds. The Law requires only that the spendinghas to be linked to the time of the flow of the revenues.

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Institutional managers only play a minimal role during the preparation of the budgetand in many cases have similarly limited autonomy in cash management. However, thefinancial managers of the independent units are unconstrained during the commitmentand verification stages. There is no ex ante control of future obligations to pay except inthe case of a multi-year contract or forward commitment.

The central regulation requires that steps be taken only in case of significant levelsof arrears. The central decree defines the limits as follows: arrears 30 days after theirdue date may not exceed 10% of the institutional budget or HUF 100 million. Themunicipalities must define the exact (e.g., stricter) conditions. If these requirements areviolated, the municipality must appoint a municipal commissioner to the institutionswho has the right to control all payments. In this case all disbursements will be validonly with his/her signature.

The other limit on institutional spending concerns the amount of any single disburse-ment. Some municipalities have created other special constraints as well. Examples ofthese are the case where:

• each commitment and/or payment above a specified limit must be disbursedby the mayor's office;

• the municipal institutions are not allowed to submit a tender above a specifiedlimit without municipal authorization.

2.9 Audit System

The main parts of the auditing process, the performance and compliance audit, wereanalyzed in other parts of the study. This chapter deals with: (i) the auditor, (ii)authorization and (iii) the subject of the audit.

Auditor: Hungarian legislation contains many points dealing with the financialcontrol and audit of municipalities. Each municipality: (i) has to organize an internalaudit, (ii) has to form a financial committee and (iii) is subject to audit by SAO.32

Practically, however, these institutions do not operate effectively.The larger municipalities and those with significant debt must hire an external

auditor as well. (Currently approximately 800 municipal budgets are subject to such anaudit.) The main tasks of the external auditor are the auditing of: (i) the invested municipalcapital, (ii) the municipal supplies (reserve), (iii) the cash flow, (iv) the municipal claimsand obligations and (v) the unspent funds. He/she has the right to participate in themeetings of the legislative assembly and to discuss any subject. But the actual functioningof the system can be criticized. Because many auditors have no professional backgroundin budgeting and have only limited information on the special requirements of thepublic sector, the municipal officers have a significant information advantage overthem. As a result, the conclusions issued by the auditors are unreliable in many cases.

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As in most countries, the Hungarian State Audit Office (SAO) has responsibilityfor auditing the municipalities. As has been previously mentioned, the main problemof the current work of the SAO is the infrequency of the compliance audit and the lackof the performance audit. The problem with the SAO is not only that they have in-sufficient resources for frequent audits, but also that they have to concentrate on issuesimportant for central legislation and not the problems of interest to local governments.33

Currently, the main forms of the municipal audit focus on issues of compliance.The internal audit offices generally deal with the issue of whether the activities of theinstitutional management and of the municipal budget (financial office) comply withthe central or local regulations. The contracts with the external auditors typically coveronly the compliance audit and the tasks required by the central legislation. However, theyare occasionally requested—based on separate contracts—to analyze performance as well.

But in most cases, only the financial committees evaluate the effectiveness (performance)of the municipal activities. This is very problematic, for while the other two institutionscan employ professionals with appropriate skills, the municipal committees typicallydo not have sufficient funds for hiring external experts and must rely on the skills oftheir members.

Authorization: There is no requirement for authorizing any part of the local budgetby a central agency. Naturally, the central level attempts to ensure that the municipalbudget complies with the few regulated points. The main tool for this is the authorizationby the municipal external auditor. His/her prior authorization is necessary because,when the budget is enacted, it is the only guarantee that the municipal budget is legal.Without this authorization, the central government does not approve the municipalbudget and the municipality does not receive central grants.

Subject of audit: As mentioned, in case the municipality has off-budget units, mis-management can have significant effects on the municipal budget as well. But the municipalcompanies are not part of the public finance system—they are incorporated underprivate law. The result is that the audit of the companies depends only on a decision bythe board of directors. Therefore, the municipalities must typically depend on the boardof directors to control (audit) these units because the municipal (internal or external)audit is not permitted into these units. However, there are two options to extend the“normal” forms of municipal control over the off-budget units.

• Internal audit by the municipality. In Tatabánya, the municipal internal auditteam can control the activity of the service provider because the city signed aservice contract which stipulates that the municipal team is allowed to inspectthe cost of the municipally funded activities and the use of the municipal funds.

• External auditor of the municipality. Many municipalities exercise their owner-ship rights and hire an external auditor of the municipality for auditing thecompanies as well.

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Summary

Current situation: The central level defines the potential forms of the budget units:fully- and semi-independent units. This definition regulates the autonomy of theinstitutional management in the budget implementation process. According to theseregulations, management autonomy is almost unlimited during the execution of thebudget execution as long as the institutions are acting legally and they do not spend morethan the appropriation. On the other hand, the management of the institutions does nothave, or only has a minimal, role in the budget preparation process—the municipalityapproves the appropriations and any change during the year is possible only based onmunicipal decisions. Also undisbursed funds can be carried over into the next budgetperiod only with municipal approval. While central legislation grants significant autonomyto the management of the independent budget institutions, there are central incentivesfor creating a hard treasury, i.e., a single bank account system. This would eliminatethe financial independence of the institutions. However, it appears that most localgovernments maintain a local cash management system that is not fully centralized foras long as possible. Currently, passive treasury or the multi-account systems are still themost frequently employed techniques.

The auditing system in Hungary is based on three institutions: the SAO, the externalauditor and the Financial Committees. The key focus of these is on compliance andlegal issues, and in most cases only the committee deals with the performance audit.

Disadvantage of the current situation: The role of institutional management is verylimited in the budget-making process, owing to the very detailed appropriation systemand to the very rigid limitation on virement and on the use of undisbursed funds. Thecurrent practices make it impossible to elicit higher efficiency from the institutions.Without the appropriate authorization, management is not able to enhance theirperformance. On the other hand, if the municipality does not have a locally implementedtreasury (or other well-functioning cash management system) to inform the budgetofficers of the financial activities of the institutions (especially with regard to commit-ments), it is faced with the problem of managing their obligations.

2.10 Capital Budgeting

Capital budgeting is one of the biggest issues in the budgeting literature. However,owing to limited space, some very important issues have to be omitted here, e.g., theimplementation process, project management (e.g., public procurement, contracting,financing, borrowing and debt management, etc.) and the alternative service deliveryoptions (e.g., privatization, concession, contracting out, regulation of a private service

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provider, etc.). This chapter concentrates only on the methods (the steps) of capitalbudgeting.

It is generally accepted that formal links between planning and budgeting shouldbe established and that the (capital) budget should be set up on the basis of medium- orlong-term development plans and programs. In the process of capital budgeting, threekey points can be defined: (i) long-term planning (creating development plans), (ii)selecting programs from the development plans, (iii) creating financial plans for theselected programs.

Establishing Long-Term Development Plans

Realistic development plans cannot be set up if there does not exist an up-to-date list ofexisting capital infrastructure listing the age, condition and other important characteris-tics of each facility. This picture of the current situation should be compared with thegoals for the quantity and quality of different services using this infrastructure. (See thefirst chapter in Part II.) Based on this information the municipality is able to define thegap (the required investments) and to prioritize the needs.

Asset registers with false value. In Hungary, the municipalities have to separate theirproperties into three groups: marketable, semi-marketable and non-marketable accordingto their role in the main function of the municipal activities. The property used in thecore functions (e.g., education and health) are treated as non-marketable, or semi-marketable. In contrast to their commercial activities, the municipalities have to providebasic services in all cases, so these assets can not be sold even in case of fiscal crisis.

The central regulation requires that the municipal asset be recorded in the municipalcadaster. This should list all (real estate) property owned by the municipality. Theassets in these cadasters are valued at their historical cost less accumulated depreciation.Naturally these recorded book values are far from the real market value. Moreover,most municipalities do not plan regular, periodic revaluations.34 They attempt to avoidthe task of maintaining records of the actual market value for the assets. Generally, themunicipalities are ready to register the current value of those assets and propertieswhich have well-defined market prices, but the valuation of non-marketable assets orof properties with fluctuating market values seems to be just wasted effort.

For assets with fluctuating market values or with market values that can not beassessed easily and at low cost (e.g., for real estate), the municipalities are not eager tomaintain records of current values or to bear the transaction costs of frequent revalua-tions. They assess these properties at the time of sale (in many cases, this is required inthe local decree on the asset management), but they are opposed to spending time andmoney for annual revaluations.

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In Gyôr, although the “values” in the cadaster and the books of the municipality are not thecurrent market values, the municipality attempts to follow the shifting values in the real-estate market, but these registers are not able to provide accurate data. But if the propertyvalue in the balance sheet is below the real level, then at the time of privatization (at marketor near market prices) the difference between the two values is presented as a gain or losswithout any real change in the value.

For example, at the time of the sale of the local cable network, the value of the municipalassets was reduced by a few million HUF (the registered book value of these assets) and thecash was increased by several hundred million HUF (the real market value). The wealth ofthe municipality seems to increase to a great extent, although it is caused only by a trans-action which replaced the registered book value of the assets with its real market value.

Selecting the Capital Investment Programs

Based on long-term plans, the municipality should select and schedule those programswhich can be implemented in the medium-term Capital Investment Plan (CIP). Afterselecting the programs with net positive social benefits, municipalities should forecasttheir own expenditures and revenues in the baseline budget (budget without the effectsof the planned project) and, based on this, the investment projects should be scheduled.This multi-year CIP should ensure that the annual revenues will be sufficient to financethe direct costs and the repayment of related debts (and depreciation, in the case ofaccrual accounting) of the projects.

Lack of medium-term planning and forecasting: While some municipalities preparerealistic economic plans and rolling budgets, most of them regard these documentsonly as an obligatory task. As a result of this lack of assessment of the expected budgetconditions (and of the expected financial requirements of the program as well), it is notsure that the investment programs in these plans will be implemented.

As seen in the sub-chapter on the multi-year budgeting method, owing to the absenceof foreseeable economic conditions and to unpredictable shifts in central sources fromyear to year, most municipalities prepare a rolling budget using a very simple “multiplyingmethod.” Although most municipalities see the central macro-economic forecast asunreliable, only a few of them make the effort to gather information from other sources(e.g., from publications of economic research institutes).

As sources of funds for investments, most Hungarian municipalities do not calculatewith revenue generated by economic changes and economic growth, e.g., by broadeningthe local tax base. Typically, the Hungarian budget officers are ready to accept only twotypes of change in their budget as a solid basis for financing additional investments.

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• A reduction of current operating expenditures. One typical solution is the reductionof operating costs, especially through the termination and consolidation ofinstitutions (or the transfer of them back to the county level). In this case, theannual municipal support to the institution (expenditures less the own sourcerevenues) can be seen as a potential source for investment in following years.

• Repayment of the current debt. According to central requirements, cities withdebt have to indicate the amount of repayments scheduled for the followingyears. The budget officers of these cities often view the reduction (or elimination)of the annual repayment burden as an increase in sources for new investmentprograms.

Selection among the programs according to available central transfers: One of the mostcriticized features of the Hungarian municipal investment system is that they are drivenalmost totally by central transfers. Most municipalities in this research indicated thatthe main selection criteria for choosing among the potential and necessary programs isthe possibility of receiving a central grant. There are municipal budgets containingsignificant reserve funds for use in funding several major programs. In some cases, thetotal amount of these funds exceeds the financial requirements. However, they initiatethese programs only after receipt of the central funds, because if a program is startedprior to receipt of the central transfer, the option of funding with central grants ispractically lost. It appears that the primary reason for this policy is the prohibition ontransferring central funds for ongoing municipal projects.

Developing Financial Plans for an Individual Project

At the start of the project, the municipality should have secured the necessary financingfor the project expenditures. They have to decide between borrowing the money fromthe capital markets and increasing the own source revenues (e.g., taxes, user charges).

The central government does not set explicit planning requirements for localinvestments, except in the case of applications for central grants. In these cases, themunicipalities must submit implementation plans containing the financial plans forthe planned program. The main parts of the financial plans are defined in centraldecrees. The implementation plan should analyze: (i) whether the program is economical,(ii) whether it is the best way to meet the requirements after due consideration of thealternative options, (iii) whether it can be financed in case the economic conditions ofthe municipality and the local residents changes, and (iv) the size of future operatingexpenses. This plan must present the expected total expenditures of the investment, itsannual cash flow plan and the mix of the planned sources as well. In addition, it should

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contain emergency plans in case expected revenues are not realized. A prediction mustbe made of the fee levels, of the fee-structures and of other additional burdens placedon the local residents as a result of the investment. The plan also should study the expectedoperating costs following the implementation, and this amount should be comparedwith the operating costs in the baseline (i.e., without the investment) case. For use inestimating the relative costs of a program, the central government publishes annuallythe sectorial average costs.

Since municipalities apply for grants for almost every significant program, nearlyall investment plans contain such financial plans. The main problem with these plans isthe reliability of the financial information contained in them.

Sources for municipal investments: The municipalities select among the potentialsources almost exclusively based on cost. Naturally, the most preferred source is the(locally free) central transfer. In second place is the annual revenue in the municipalbudget. Naturally this comes mainly from the sale of assets and properties.

Project financing is not widely used in the Hungarian municipal sector. Typically,the sources for the financing of projects are neither the special revenue generated by theproject nor the tax levied on the future users based on the benefit principles. Thiseffects the credit market as well because the financing of the project requires loans tobridge the gap between the time of the expenditures and of the start of the revenuestream generated by the project. In most municipalities, a loan is considered to be a(temporary) source of financing for municipal investments only used in the worst casein order to avoid levying an additional local tax or increasing the service fees on thelocal residents. Also, the repayment of the debt is not usually planned to be made fromincreased local fees or taxes, but instead from the “normal revenue” contained in thebaseline budget (typically from privatization revenues).

Summary

In summary, the system of capital budgeting in Hungarian municipalities is similar tomany of the previously analyzed problems and can be viewed as a legally well-developedsystem that is not functioning well because of a lack of local expertise. The mostimportant problems can be summarized in three points:

• The registration and assessment of municipal assets is obligatory, but a regularand periodic revaluation is missing, so the data in the asset register are unreliable.Even though these figures misinform the decision-makers about the real valuesof municipal property, the high transaction costs involved in appraising themarket values are a significant barrier to showing the assets in the register attheir actual values.

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• The absence of an assessment of future fiscal conditions leads to the situationwhere it is uncertain whether the selected investment programs can be financed.

• While the central level finances local investments following a well-developedcapital transfer system, the municipal programs depend enormously on thesegrants. The main selection criteria for programs and for the financing mix isthe availability of the central grants. This dependency could be reduced by: (i)reforming the central transfer system (e.g., by creating incentives for privateparticipation in the project, thus reducing the required share of central financing),(ii) enlarging the share of the own source revenues of the municipalities (e.g.,by terminating some central grants, by reducing centrally collected taxes andby concurrently increasing local taxes).

3. ISSUES AND RECOMMENDATIONS

Before formulating the recommendations, it is worth remembering Meyers’ criteria foreffective budgeting which were mentioned in the first paragraphs of this chapter. Table5.6 provides a short assessment of the current Hungarian municipal budgeting techniquesfollowing Meyers’ criteria.

Table 5.6The Assessment of the Hungarian Municipal Budgeting Techniques

Following Meyers’ Criteria for Effective Budgeting

Term Criteria Hungarian System

Accountability Detailed controls should be The Hungarian municipal budget does notestablished which have the goal contain explicit policy directives and goals,of ensuring that policy directives due to a lack of realistic planning methodsare carried out by managers, necessary for their preparation. Thus, managerscontractors and all concerned and other participants are unable to carry outparties. the unknown policy directives.

Comprehen- Includes all uses of the The Hungarian system includes all of thesiveness government's financial resources institutions which are typically part of the public

finance system. The municipal companies andpublic foundations are excluded in almostall countries.

Constraint Contains limitations on the One of the most important goals of theamount of money that need be Hungarian public finance system is the constraintacquired by government on public spending.

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Table 5.6 (continued)The Assessment of the Hungarian Municipal Budgeting Techniques

Following Meyers’ Criteria for Effective Budgeting

Term Criteria Hungarian System

Cooperation Budgeting should exist in When funds are short, the budget alwaysharmony with other decision dominates the other decision processes.processes and should not be Most municipal budgets clearly define whichdominant. former decisions can be implemented and

which ones must be altered or delayed.

Honesty Contains unbiased projections Projections are missing from almost all localbudgets. The frequent modifications to the localbudget give an indication that the local politiciansare aware that the approved and the “real” budgetwill differ.

Judgment Encourages participants to seek Most municipal budgeting systems do notthe most effect at the least cost compare costs and benefits. Assessment is based

only on whether the expenditure is minimal andis made independently of any benefit.

Legitimacy The budget process should Proper authorization is the cornerstone of thereserve important decisions Hungarian municipal budgeting system.to legally appropriate authorities. Maybe this criteria is over-stressed, especially

when institutional appropriations areextremely detailed.

Perception Considers both the near- Due to the rapidly changing economic conditionsand long-term and the unpredictable central grant system,

planning has become one of the weakest pointsof the system.

Responsiveness The budget must adopt policies The information gathering about publicto match public preferences. preferences is missing. The current system “tests”

public satisfaction only through regularelections—so the public's preferences appearonly through their choice of representatives.

Timeliness A budget process should The municipal budgeting process has very rigidcomplete regular tasks deadlines with hard punishments in cases ofwhen expected failure. The budget implementation process is also

very limited in time, with appropriations whichare not disbursed by December 31 not allowed tobe carried over into the following budget periodwithout explicit municipal approval.

Transparency The budget and budget The Hungarian budgets, due to their largeprocedures should be information content, are a little bit too complex,understood by participants and the specialized knowledge of the participantsand outside stakeholders. and of the other stakeholders is relatively low in

the field of budgeting.

SOURCE: Meyers, Roy T.: Is There a Key to the Normative Budgeting Lock, (The World Bank, WashingtonDC, 1996).

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Following the former chapters and the assessment in Table 5.6, it would appear tobe a very simple task to formulate recommendations for modernizing the Hungarianmunicipal budgeting process, but it must be remembered that the municipal budgetsare a part of the overall public finance system. Comprehensiveness requires that anychanges in the local budget preparation process be consistent with the entire system.For example, a new method implemented at the local level with no related change inthe central budgeting system could result in non-transparent government operations.This report concentrates only on the municipal level and does not examine the reformsneeded in the entire system (e.g., accounting/budgeting on an accrual basis or changesin the classification system needed to move toward performance budgeting).

Connection to the Other Elements of the Public Finance System

It is worth recalling that the aforementioned comprehensiveness is relevant only at twostages: for the public information system and for financial reporting and accounting.However, as in the new GFS and European standards for accrual accounting which donot deal with budgeting techniques and instead concentrate only on financial reporting,it is possible to modify the budget-making process at municipal level, while stillmaintaining the reporting and accounting practices of the entire system. Naturally, thereform would be more effective if the entire system would move toward performancebudgeting because the differences between the categories contained in the local budgetand those contained in the public financial information or reporting system wouldrequire double-work at municipal level.

Based on our findings, some points of the municipal finance system and thebudgeting regulation can be identified as the potential subject for reform. The followingare worth considering:

1) To establish an additional option in the municipal decision-making process—the conditional approval which would delay the fiscal implication of the newpolicy until the deadline when it is included in an approved budget. (Forexample, the municipal body would approve the program, but the annual budgetwould define the implementation date, the amount of payment or other fiscallyimportant points.)

2) To define budget appropriations which are not voted on annually (e.g., long-term contracts, debt repayment, some social assistance required by the centralgovernment). Of course, the budget would provide information to the decision-makers about the amounts, with the budget clearly showing these obligationsseparately from the discretionary spending, thus indicating that any potentialdelay in the approval of the budget would not impede making payments onthese commitments.

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3) To allow the calculation of the municipal borrowing limits in a new way in additionto the current method. The new method would state that the annual borrowingis not allowed to exceed the capital spending less the capital revenue. This balancecould be checked not only in the approved budget, but at the end of the year aswell.

4) To formulate explicit rules against institutional overspending. The mayor's officewould be empowered to set up ex-ante control over financial commitments evenfor the independent institutions, to refuse payment orders and to establish sanctionsfor institutions and programs that are overspending.

Enable the Municipality to Create its Own Budgeting Process

It seems that over-regulation is one of the most important problems in municipal budgeting.While the municipal system leaves the municipalities almost absolutely unconstrained,the public finance system contains many unnecessary requirements that reduce the flex-ibility of the municipality to adjust the local budget to fit the local requirements. Thenumber of regulations concerning municipal budgeting, especially about the informationcontained in the budget document, should be reduced. Currently, the local budgetdocument includes much information that is not of interest to local politicians or thatis not directly relevant for the local budget (e.g., the expenditures following a rigidclassification system). Naturally, according to the rules, the municipal budget can containother information in addition to that defined by central requirements, but in this casethe budget containing both requirements becomes unwieldy.

Municipal discretion: The municipalities should be allowed to select information thatis of local importance. This would be especially important for the budget classificationsystem. The local governments would then be able to move toward performance budgetingif desired. This would involve,

• setting up new titles and headings,• creating a new classification system (global budgets or block appropriations for

programs),• regulating the virement and the procedure for carrying any undisbursed appro-

priation over into the next budget period,• omitting some of the stages of the budget preparation process currently required,

e.g., the initial (open-ended) budget proposals from institutions.

On the other hand, the central regulations could concentrate on soft information.For example, the budget should specify policy objectives, the economic framework usedfor forecasting revenues and expenditures, the major identifiable fiscal risks. Currently,most local budgets do not provide appropriate information on these issues.

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An additional benefit from this deregulation would be the resulting differentiationamong municipalities according to size, to the size of their budget, to their functions orto other important factors. The new central regulation (i.e., the suggested methods) fordifferent types of municipalities could vary. For example, a sophisticated methodappropriate for a city with a budget of HUF 20 billion does not fit a small village withexpenditures of HUF 100-200 million.

Unified information system: Naturally, the public finance information system mustrequire data that is consistent with central requirements. This demand combined withinstitutional sclerosis are likely to result in the continued usage of the methods currentlyemployed in most municipalities, but some reformers could follow their own pathwhile still providing the centrally required information.

Training and Information from Central Level Instead of Just Regulation

Our research has proven the hypothesis that the local offices are not aware of the policyin other, even neighboring, municipalities. There are many cases where the municipalitiesin one area face problems that have already been resolved in other areas, but the solutionsare not disseminated. Because municipal associations are very weak in Hungary, thecentral government and its field offices must play a central role in arranging this informationexchange. As some examples (e.g., the treasury system or the program budgeting usedin budgeting the central investment program) indicate, the local governments are readyto follow the centrally used or suggested methods, especially if the central budget contains“incentive funds” and conditional grants for covering a part of the implementation costs.

The shift in the central focus from regulation toward information systems and theinfluencing techniques could yield an additional benefit. The problem with regulationis not only that it cannot be varied according to the local demands, but that it requiresthe implementation of new methods everywhere without prior experience. If the policyfails, every municipality has to cope with the same problems. However, flexibility wouldenable the central government to set up pilot projects. They would have the opportunityto test the policies and analyze the findings before a widespread implementation. In thecase of parallel projects in several cities, the analysis would also indicate the main variableseffecting the results (e.g., size, revenue mix, tax capacity and institutional structure).

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NOTES

1 OECD (2000)2 OECD (1999)3 The cities are: Eger, Gyôr, Kaposvár, Kecskemét, Székesfehérvár, Szekszárd, Szolnok,

Tatabánya (cities with county right); Ajka, Baja, Cegléd, Dombovár, Dorog, Dunakeszi,Esztergom, Göd, Gödöllô, Gyöngyös, Hatvan, Keszthely, Komárom, Oroszlány,Paks, Szentes, Tapolca, Tata (medium-sized settlements with more than 10,000inhabitants); Andornaktálya, Boldog, Gyöngyöstarján, Hort, Istenmezeje, Kerecsend,Lôrinci, Ostoros, Parád, Tamási, Tiszanána, Veresegyház (settlements with less thanten thousand inhabitants); a district in Budapest (Ferencváros); and a county (Pest).

Parallel to this research, the Center organized another municipal program for thePrime Minister's Office which aimed to prepare a proposal for the MunicipalGuarantee Fund. Nine of these municipalities were assessed in that project, butbased on similar terms of reference (questionnaire). Beside the 31 cities in thisresearch, the results of nine case studies prepared for the other project were usedhere as well.

4 For example, British conurbations.5 There are eight cities with county rank in our case studies. (Gyôr, Tatabánya,

Kecskemét, Kaposvár, Szekszárd, Eger, Széksefehérvár, Szolnok)6 Because of the special situation in the capital, the municipalities in Budapest were

left out from the research.7 There are only two limitations to these processes. First, the municipalities have to

decide on these claims within the first few months of every election cycle. Second,if they take over the institution, they are not allowed to transfer it back within thenext three years.

8 The Hungarian legislation defines tasks for the notary and not for the office (andnot for the departments within the office, which are not legal entities). So, whenthe law says the “Notary prepares the budget proposal,” it means that the mayor’soffice is led by the notary in the preparation of the proposal.

9 Our research collected information mainly from the financial departments.Naturally, in most cases, the heads of these departments do not feel (or do notconcede explicitly) that they would be the “second person.”

10 Law on Local Government section 8 (1).11 Law on Local Government section 8 (3).

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12 For example, the notaries are responsible for the administration of some forms ofsocial assistance which are paid for both from central funds and from the localbudget. This situation encourages the notary to push the “local poor” to the centralprograms. As a result of these experiences, the central Welfare Ministry has attemptedto reduce the number of delegated functions which must be funded from the centralbudget.

13 This share falls to 63% without the shared tax and to 57% without the transferfrom the Health Fund. (The Health Fund finances the operating costs of the healthsystem, but this grant is earmarked, so the municipalities are not able to use thismoney to finance other sectors.)

14 According to the titles in the Budget 2000/2001, there are funds for: some specificeducation programs, income support for unemployed people, fire fighting, liquidwaste management, municipalities in economic trouble, subsidizing water priceswhere they are extremely high, ferries, checkpoints, the support of people withhigh housing debt, the operation of the local minority governments, programs tochildren and youths, supporting minority education, public libraries, official muni-cipal orchestras and choirs, staff reduction, obligatory external audits, the implemen-tation of the local treasury functions, improving the local waste management andtheaters.

15 Currently, these include investments in the water system, sewers, various fields ofeducation or healthcare.

16 In the recent past, the sewer sub-funds were not able to finance every municipalsewer project, so the grant in fact was not distributed normatively, but insteaddepended on the application of the specific municipality.

17 See, Bouckaert (1992), Bouckaert and Halachmi (1996), OECD (1997a), OECD(1997b), OECD (1997c), OECD (1998), Schaeffer (2000).

18 See OECD (2001) or Ter-Minassian (1997).19 After approving the municipal budget the local government has to make an elementary

budget to the TÁH (within 30 days after the deadline for submitting the budgetproposal to the legislative assembly) in which they have to show the very detailedannual expenditure and revenue plans.

20 In Baja, the budget contains 35 revenue and 8 expenditure categories.21 In the recent past, the tax base has changed continuously, with turnover being reduced

by 33, 66 and then 100% of material costs.22 Some municipalities criticize this later method as being unnecessary and/or

unreliable, because almost every municipality has had the experience where thecontractual price was not received.

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23 Indicators in the program budgets. According to the basic principles of the programbudgeting, the budget also classifies expenditures according to programs. For everyprogram, the municipality attempts to create performance (i.e., output) measures. There-after, the budget contains some specific measures: the unit-cost index based on thesemeasures and the expenditure data. The Annex to the budget presents these measuresand indicators. The Annex can provide a solid basis for intertemporal comparison.For example, Szentes is able to present the figures of the previous five years.

The presented measures can be divided into two main groups: (i) specific sectorialmeasures and (ii) “institutional measures.” In most sectors, the specific measuresprovide information on the number of clients, the capacity of the program (institutions)and the number of workers (separated into core and technical workers).

The most frequently used “institutional measures” are: (i) the size of the property(separated according to their use for core activities and the technical places), (ii) thesize of green areas, (iii) the volume of heated space and (iv) the size of lit areas.Generally, the unit costs for assessing the efficiency and effectiveness of the technicalexpenditures are calculated by dividing these measures by the number of clientsand/or the expenditures for property maintenance.

24 For example, Australia, New Zealand, Great Britain and the Netherlands.25 This capital cost (depreciation) is not distributed into programs, but instead is treated

as institutional level data.26 For example, exports, imports, consumption and investments.27 These are used for calculating some social expenses.28 In Tatabánya, within the “city tasks,” the budget attempts to present the amount of

discretionary spending options for politicians. There are separate titles for fundsappropriated in long-term contracts and those which are available for “free” budget(political) decisions. Almost 22% of the “city task” is appropriated through contracts,so they cannot be modified simply through a budget decision. But not all unappro-priated expenditures are “free money,” e.g., the line for Communal service containsboth appropriated and unappropriated amounts in the same line—but the split isclear from information available in the annex to the budget. The other importantexample of unappropriated yet unavailable funds arises when the social policy definedby central legislation lists the criteria for eligibility and size of payments.

29 The central budget of 2001/2002 contains a strong incentive: in addition to theexpected financial gains arising from a centralized cash management, the governmentcreated a new grant for the municipalities establishing a local treasury.

30 For example, for funds from the privatization of municipal flats, for the local govern-ment budget for the minorities, for the financing for the local family doctors, for

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the financing for dentists, for those funds required by the central level to be handledseparately, for funds used as security for the debt management, for separating shortterm investments, for earmarked funds.

31 Transfering expenditure provisions from one line-item to another during the budgetyear.

32 For municipalities with more than 2,000 inhabitants.33 The State Audit Office is an institution of the Hungarian Parliament.34 This process will cause significant problems if the new GFS standard becomes a require-

ment in the Hungarian public sector. According to GFS 2000, all assets and liabilitiesmust be valued at market prices, so they have to be revalued every year.

REFERENCES

Bouckaert, Geert: Productivity analysis in the public service: the case of the fire service.In: International Review of Administrative Sciences, Vol. 58 (1992), pp.175–200.

Bouckaert, Geert and Arie Halachmi: The Range of Performance 296 Indicators in thePublic Sector: Theory vs. Practice. In: Arie Halachmi and David Grant (eds.): Re-engineering and Performance Measurement in Criminal Justice and Social Programs,(Brussels: International Institute of Administrative Sciences; Perth. WesternAustralia: Ministry of Justice, 1996), pp.91–106.

Meyers, Roy T.: Is There a Key to the Normative Budgeting Lock. (Washington DC: TheWorld Bank, 1996).

OECD: Accrual Accounting in the Netherlands and the United Kingdom. (Paris: OECD,1997a), OCDE/GD(97)179.

OECD: In: Search for Results—Performance Management Services. (Paris: OECD, 1997b).

OECD: Integrating Financial Management and Performance Management. (Paris:OECD, 1997c), PUMA/SBO(99)4/FINAL.

OECD: Modern Financial Management Practices. (Paris: OECD, 1998), PUMA/SBO(98)8.

OECD: Fiscal Design Across Levels of Government. Country Report: Hungary. (Paris:OECD, 1999).

OECD: Fiscal Design Across Levels of Government. Year 2000 Survey. Country Report:Hungary. (Paris: OECD, 2000).

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OECD: Managing Public Expenditures. A Reference Book for Transition Countries (editedby Allen, Richard and Daniel Tommasi). (Paris: OECD, 2001).

Schaeffer, Michael: Municipal Budgeting. Urban and Local Development BackgroundSeries No. 4., (Washington DC: World Bank, 2000).

Ter-Minassian, Teressa: Decentralization and Macro-economic Management. (IMFWorking Papers, 1997), WP/87/155.

Documents

Local Government Budgeting: Hungary - United …unpan1.un.org/intradoc/groups/public/documents/untc/unpan013818.pdf · 335 LOCAL GOVERNMENT BUDGETING—HUNGARY this viewpoint, the