PROMOTING FISCAL SUSTAINABILITY

THROUGH IMPROVED BUDGET INSTITUTIONS

ALLEN SCHICKSchool of Public PolicyUniversity of Maryland

ASIAN REGIONAL SEMINARPROMOTING FISCAL SUSTAINABILITY

KUALA LUMPUR, MALAYSIA28 FEBRUARY – 2 MARCH, 2011

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DO SOUND BUDGET INSTITUTIONS PUT GOVERNMENT ON A SUSTAINABLE FISCAL PATH?

THE GOOD NEWS

MANY NATIONAL GOVERNMENTS HAVE IMPLEMENTED MAJOR REFORMS TO IMPROVE BUDGET INSTITUTIONS

80 COUNTRIES HAVE ADOPTED FISCAL RULES THAT LIMIT DEBT, DEFICITS, OR AGGREGATE EXPENDITURE

APPROXIMATELY 100 COUNTRIES HAVE MEDIUM-TERM FRAMEWORKS THAT SET BUDGET POLICIES 3-5 YEARS AHEAD

NUMEROUS GOVERNMENTS CLAIM TO HAVE INTRODUCED A VERSION OF PERFORMANCE BUDGETING

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DO SOUND BUDGET INSTITUTIONS PUT GOVERNMENT ON A SUSTAINABLE FISCAL PATH?CONTINUED

THE NOT SO GOOD NEWS

COUNTRIES WHICH ADOPTED THESE REFORMS WERE NOT PROTECTED FROM THE GREAT RECESSION

ADVANCED COUNTRIES GENERALLY HAD GREATER DIFFICULTY COPING WITH THE GREAT RECESSION THAN EMERGING COUNTRIES

WHICH INTERPRETATION FITS?

BUDGET INSTITUTIONS DO NOT SUFFICE

BUDGET INSTITUTIONS MATTER, BUT THE ECONOMY MATTERS MORE

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HOW THEY DEAL WITH THE ECONOMY INFLUENCES THE EFFECTIVENESS OF BUDGET INSTITUTIONS

THE PROBLEM BUDGETS, LIKE ECONOMIES GO THROUGH CYCLICAL

SWINGS, WITH VARIABLE RATES OF GROWTH

BUDGETS TEND TO BE PRO-CYCLICAL, WITH EXPENDITURES INCREASING MORE WHEN THE ECONOMY IS STRONG

FISCAL RULES THAT IGNORE CYCLICAL CONDITIONS REINFORCE THIS TENDENCY

MEDIUM-TERM FRAMEWORKS THAT ASSUME HIGH, UNINTERRUPTED ECONOMIC GROWTH BUILD THIS BIAS INTO BUDGET PROJECTIONS AND OUTYEAR DECISIONS

COUNTRIES THAT BASED EXPANSIONARY BUDGETS ON THESE BIASES NOT WELL PREPARED FOR THE CRISIS

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HOW THEY DEAL WITH THE ECONOMY INFLUENCES THE EFFECTIVENESS OF BUDGET INSTITUTIONS, CONTINUED

IMPROVING BUDGET INSTITUTIONS THE CRITICAL TEST OF RULES AND FRAMEWORKS IS IN

GOOD TIMES, WHEN CURRENT AND PROJECTED FISCAL CONDITIONS ARE FAVORABLE

IN GOOD TIMES, IF GOVERNMENT “PRE-SPENDS” FUTURE FISCAL DIVIDENDS, IT MAY BE SETTING THE STAGE FOR FUTURE IMBALANCES OR CRISES

IT IS ESSENTIAL TO RE-ENGINEER RULES AND FRAMEWORKS TO PROMOTE FISCAL PRUDENCE DURING PERIODS OF STRONG ECONOMIC GROWTH

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STRENGTHENING FISCAL RULESTHE PROBLEM MOST RULES IGNORE CYCLICAL SWINGS IN THE ECONOMY MONITORING AND ENFORCEMENT TEND TO BE WEAK

SUSTAINABLE FISCAL POLICY EXTEND THE FISCAL RULE TO COVER THE MEDIUM TERM OR

LONGER. ONE-YEAR RULES ENCOURAGE EVASION MAKE THE FISCAL RULE PART OF THE MEDIUM-TERM

FRAMEWORK USE THE FISCAL RULE TO CONSTRAIN REVENUE AND

SPENDING ACTIONS WHEN THE ECONOMY IS STRONG ESTABLISH EFFECTIVE ENFORCEMENT MECHANISMS TO

DETER BREACHES DEVISE ADJUSTMENTS OR CLAWBACKS TO CONSOLIDATE

PUBLIC FINANCE WHEN FISCAL TARGETS ARE MISSED CONSIDER SPECIAL TREATMENT FOR INVESTMENT

EXPENDITURE IN DEVELOPING COUNTRIES

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IMPROVING THE MEDIUM-TERM EXPENDITURE FRAMEWORK (MTEF)

THE PROBLEM MANY COUNTRIES REGARD THE MTEF AS A TECHNICAL

EXERCISE THAT IS SEPARATE FROM THE BUDGET, WITH ITS OWN STAFF AND PROCEDURES

GOVERNMENTS OFTEN MAKE FORWARD COMMITMENTS THAT PROVE TOO COSTLY

WHEN THE MTEF IS ROLLED FORWARD, CEILINGS SET IN THE PREVIOUS MTEF OFTEN ARE TREATED AS FLOORS

THE MEDIUM-TERM (3-5 YEARS) IS TOO SHORT TO ASSESS LONG-TERM FISCAL SUSTAINABILITY

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IMPROVING THE MEDIUM-TERM EXPENDITURE FRAMEWORK (MTEF), CONTINUED

MAKING THE MTEF AN INSTRUMENT OF SUSTAINABLE FISCAL POLICY

INTEGRATE THE BUDGET AND MTEF SO THAT THEY ARE A SINGLE PROCESS, PREPARED BY THE SAME STAFF AND USING THE SAME ECONOMIC/PROGRAM ASSUMPTIONS AND DATA SOURCES

IN CONSTRUCTING AND UPDATING THE BASELINE (FORWARD ESTIMATES) GUARD AGAINST EXPANSIONARY BIASES

MAKE THE FISCAL RULE OR TARGET PART OF THE FRAMEWORK, RATHER THAN A FREE-STANDING PROCESS

TREAT THE BUDGET CONSTRAINT AS A GENUINE LIMIT, NOT JUST AS A STARTING POINT FOR THE NEXT YEAR’S BUDGET

DISCOURAGE AD HOC EXPENDITURE DECISIONS OUTSIDE THE MTEF FRAMEWORK DURING IMPLEMENTATION OF THE BUDGET

TO THE EXTENT FEASIBLE, APPEND LONGER-TERM PROJECTIONS TO THE MTEF

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INTEGRATING MEDIUM-TERM FRAMEWORKS AND NATIONAL PLANS

THE PROBLEM MANY ASIAN COUNTRIES RELY ON NATIONAL PLANS TO

MAKE STRATEGIC POLICY DECISIONS, TYPICALLY FOR THE NEXT FIVE YEARS

NATIONAL PLANS OFTEN DISREGARD BUDGET IMPLICATIONS

ADDING AN MTEF MAY ADD COMPLICATIONS BECAUSE IT ROLLS FORWARD EVERY YEAR, BUT THE PLAN IS FOR A FIXED TERM

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INTEGRATING MEDIUM-TERM FRAMEWORKS AND NATIONAL PLANS, CONTINUED

INTEGRATE NATIONAL PLANNING INTO THE BUDGET FRAMEWORKDEVELOPING COUNTRIES BENEFIT FROM HAVING STRONG

BUDGET AND PLANNING SYSTEMSPLANNING AND BUDGETING TEND TO HAVE DIFFERENT VALUES

AND PERSPECITVES. PLANNING IS CHANGE-ORIENTED; BUDGETING FAVORS CONTINUITY. PLANNING FOCUSES ON OPPORTUNITIES; BUDGETING ON COSTS

MAKE PLANNING MORE REALISTIC BY IMPOSING A BUDGET CONSTRAINT

ASSURE THAT THE PLAN AND THE BUDGET ARE CONSISTENTWHEN THE PLAN IS STRUCTURED BY PROGRAMS OR SECTORS,

CROSS-WALK IT TO BUDGET CLASSIFICATIONSBRAZIL HAS SOUGHT TO INTEGRATE PLANNING, MTEF, AND THE

ANNUAL BUDGET. THE PLAN COVERS ALL PROGRAMS: THE MTEF MUST BE CONSISTENT WITH IT, AND THE BUDGET MUST CONFORM TO THE MTEF

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USING THE BUDGET PROCESS TO ALLOCATE FISCAL SPACE

THE PROBLEM

BUDGETING IS INCREMENTAL; MOST ALLOCATIONS ARE BASED ON PAST DECISIONS

BUILT-IN SPENDING DUE TO AGEING, RISING HEALTH COSTS SHRINK AVAILABLE SPACE

POLITICAL RESISTANCE TO TAX INCREASES

THE GROWING TENDENCY OF GOVERNMENTS TO MAKE AD HOC SPENDING DECISIONS THROUGHOUT THE YEAR

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USING THE BUDGET PROCESS TO ALLOCATE FISCAL SPACE, CONTINUED

PROTECTING AND ENLARGING FISCAL SPACE MTEFS POTENTIALLY ENLARGE SPACE BY ENABLING GOVERNMENT TO

ALLOCATE FOR 3-5 YEARS

FUNDAMENTAL (OR STRATEGIC) SPENDING REVIEWS MAY EXPAND SPACE THROUGH CUTBACKS IN LOW PRIORITY PROGRAMS

ACROSS THE BOARD CUTS EXPAND SPACE THAT CAN BE REALLOCATED THROUGH THE BUDGET

SETTING ASIDE MONEY IN BIDDING FUNDS INCREASES COMPETITION AMONG PROPOSED PROGRAM INITIATIVES

ADJUSTING ENTITLEMENTS BEFORE CRISIS CAN SIGNIFICANTLY ENLARGE FUTURE FISCAL SPACE

WHEN IT IS EFFECTIVELY IMPLEMENTED, PERFORMANCE BUDGETING CAN INTELLIGENTLY ALLOCATE AVAILABLE FISCAL SPACE

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DEALING WITH LONG-TERM FISCAL SUSTAINABILITY

THE PROBLEM

MTEF TYPICALLY COVERS 3-5 YEARS, NOT LONG TERM PROSPECTS

COUNTRIES THAT HAVE SUSTAINABLE MEDIUM-TERM CONDITIONS MAY STILL FACE UNSUSTAINABLE FISCAL FUTURES

BOTH ADVANCED AND EMERGING COUNTRIES NEED TO BE CONCERNED ABOUT THEIR FISCAL FUTURE

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DEALING WITH LONG-TERM FISCAL SUSTAINABILITY, CONTINUED

INCORPORATING THE LONGER-TERM INTO BUDGET WORK FEW COUNTRIES HAVE SUFFICIENT DATA AND TECHNICAL CAPACITY TO

MAKE RELIABLE LONG-TERM PROJECTIONS

HOWEVER, COUNTRIES CAN DEVELOP THE SKILLS AND DATA TO EXTEND THE TIME HORIZON OF THEIR PROJECTIONS

ALL COUNTRIES CAN REFLECT ON LONG-TERM IMPLICATIONS WHEN THEY TAKE POLICY INITIATIVES

EMERGING COUNTRIES WHICH MAY FACE PRESSURE TO EXPAND INCOME SUPPORTS SCHEMES SHOULD BE ESPECIALLY MINDFUL OF LONG-RUN FISCAL IMPLICATIONS OF PROPOSED ENTITLEMENTS

SMALL DIFFERENCES IN THE DETAILS OF INCOME SUPPORT PROGRAMS CAN COMPOUND TO ENORMOUS LONG-TERM DIFFERENCES

GOVERNMENT SHOULD BE MINDFUL OF HOW THEY ALLOCATE FINANCIAL RESPONSIBILITY FOR RISKS, FOR EXAMPLE, THE RISK OF LENGTHENED LIFE EXPECTANCY

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BUILDING FISCAL RISKS INTO BUDGET INSTITUTIONS

THE PROBLEM WHEN THEY BUDGET, GOVERNMENTS OFTEN DISREGARD

FISCAL RISKS

RISKS OCCUR BECAUSE THE FUTURE COURSE OF THE ECONOMY IS UNCERTAIN

RISKS OCCUR BECAUSE THE GOVERNMENT IS EXPOSED TO CONTINGENT LIABILITIES SUCH AS GUARANTEES

CONTINGENT LIABILITIES ALSO OCCUR WHEN CITIZENS OR ENTERPRISES EXPECT GOVERNMENT ASSISTANCE WHEN THINGS GO BAD

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BUILDING FISCAL RISKS INTO BUDGET INSTITUTIONS, CONTINUED

IMPROVING BUDGET INSTITUTIONS RELY ON RANGES RATHER THAN POINT ESTIMATES TO

PROJECT MEDIUM-TERM FISCAL SPACE

RESERVE MONEY WITHIN THAT SPACE FOR FUTURE UNCERTAINTIES AND CONTINGENCIES

CONSIDER BASING THE BUDGET ON INDEPENDENT ECONOMIC FORECASTS

COMPILE AN INVENTORY OF EXPLICIT CONTINGENT LIABILITIES

TO THE EXTENT FEASIBLE, USE VALUE-AT-RISK OR OTHER METHODS TO ESTIMATE THE GOVERNMENT’S EXPOSURE

IMPROVE RISK-SHARING AND RISK-MONITORING PROCEDURES

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MAKING PERFORMANCE BUDGETING AN INSTRUMENT OF GOOD FISCAL MANAGEMENT

THE PROBLEM

IN MANY COUNTRIES, PERFORMANCE BUDGETING (PB) IS LITTLE MORE THAN A MEANS OF CLASSIFYING OR DISPLAYING EXPENDITURES

IT IS NOT A SIGNIFICANT DETERMINANT OF HOW RESOURCES ARE ALLOCATED

IT IS NOT A SIGNIFICANT INFLUENCE ON HOW SPENDING UNITS MANAGE RESOURCES AND OPERATE

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MAKING PERFORMANCE BUDGETING AN INSTRUMENT OF GOOD FISCAL MANAGEMENT, CONTINUED

ORIENTING PERFORMANCE BUDGETING TO RESULTS PERFORMANCE IS ONLY ONE CONSIDERATION IN ALLOCATING RESOURCES;

POLITICAL AND INCREMENTAL PRESSURES ARE OFTEN MORE INFLUENTIAL

HOWEVER, GOVERNMENTS CAN TAKE STEPS TO ENLARGE PB’S EFFECTIVENESS

IDEALLY, GOVERNMENTS SHOULD SYSTEMATICALLY CONSIDER THE CHANGES IN RESULTS EXPECTED TO ENSUE FROM CHANGES IN EXPENDITURES

SOME GOVERNMENTS EMPLOY A “BENDING THE CURVE” METHOD TO ANALYZE RESULTS EXPECTED FROM POLICY CHANGES

IN THIS METHOD, THE BUDGET ESTIMATES THE RESULTS EXPECTED IF POLICY IS NOT CHANGED, PROPOSED CHANGES AND ESTIMATED IMPACTS, AND FINANCIAL RESOURCES TO IMPLEMENT THE CHANGES

HOWEVER, GOVERNMENTS CAN CHOOSE AMONG MANY VERSIONS IN IMPLEMENTING PROGRAM BUDGETING

AT THE OPERATIONAL LEVEL, PB IS EFFECTIVE WHEN MANAGERS HAVE DISCRETION IN SPENDING APPROPRIATED FUNDS FOR AUTHORIZED PURPOSES

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INCLUDING “COST” MAY STRENGTHEN FISCAL SUSTAINABILITY

THE PROBLEM ALMOST ALL COUNTRIES BUDGET ON A CASH BASIS, AND

ARE LIKELY TO CONTINUE DOING SO IN THE FUTURE

THEY DO NOT INCLUDE “COST” (RESOURCES CONSUMED OR LIABILITIES INCURRED) IN REPORTING THEIR FISCAL POSITION, IN MEASURING THE EFFICIENCY OF OPERATIONS OR IN COMPARING POLICY ALTERNATIVES

ACCRUAL-BASED BUDGETING IS NOT APPROPRIATE FOR MOST COUNTRIES. MOREOVER, IT DOES NOT RECOGNIZE THE GOVERNMENT’S GREATEST LIABILITY: MOST FUTURE PENSIONS AND OTHER ENTITLEMENTS

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INCLUDING “COST” MAY STRENGTHEN FISCAL SUSTAINABILITY, CONTINUED

INCLUDE COST IN BUDGET WORK CONTINUE TO BUDGET ON THE CASH BASIS,

SUPPLEMENTED WITH COST INFORMATION

FOR FISCAL AGGREGATES, ESTIMATE THE PRESENT OR NOMINAL VALUE OF FUTURE PENSIONS AND OTHER MAJOR ENTITLEMEMENTS, BUT DISREGARD OTHER RESOURCES CONSUMED

TO ASSESS POLICY ALTERNATIVES INCLUDE PROJECTED FUTURE COSTS TO PREPARE ALTERNATIVES SUCH AS LEASE-BUY AND PPPs

FOR OPERATIONAL EFFICIENCY, INCLUDE ONLY COSTS OVER WHICH MANAGERS HAVE EFFECTIVE DISCRETION

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ORIENTING THE CENTRAL BUDGET OFFICE TO SUSTAINABILITY AND RESULTS

THE PROBLEM THE TRADITIONAL BUDGET OFFICE FOCUSES ON

DETAILED EXPENDITURE CONTROL

IN MANY DEVELOPING COUNTRIES IT CLOSELY MONITORS AND REGULATES BUDGET EXECUTION THROUGH SHORT-TERM (MONTHLY, BIMONTHLY, OR QUARTERLY) ALLOTMENTS

WHEN THIS OCCURS, THE REAL BUDGET IS KNOWN AFTER THE FINANCIAL YEAR IS OVER AND THE OFFICIAL BUDGET DOES NOT SERVE AS A STRATEGIC POLICY STATEMENT

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ORIENTING THE CENTRAL BUDGET OFFICE TO SUSTAINABILITY AND RESULTS, CONTINUED

REORIENTING THE BUDGET OFFICE IN COUNTRIES THAT HAVE EFFECTIVE MTEFS AND PERFORMANCE

BUDGETS, THE BUDGET OFFICE HAS DIVESTED MANY CONTROLS IT BECOMES RESPONSIBLE FOR MANAGING THE BASELINE,

MONITORING AND SCORING PROPOSED TRADEOFFS, AND PROMOTING OR CONDUCTING PROGRAM AND STRATEGIC REVIEWS

A KEY ROLE OF THE BUDGET OFFICE IS TO ADVISE GOVERNMENT ON THE RESULTS ACHIEVED OR EXPECTED THROUGH CHANGES IN EXPENDITURES

THE BUDGET OFFICE ALSO PROMOTES GOOD PRACTICE IN MEASURING AND REPORTING OUTPUTS AND OUTCOMES

IT MAY BE APPROPRIATE TO RETAIN CENTRAL EXENDITURE CONTROLS IN COUNTRIES WITH UNSTABLE REVENUE SOURCES

COUNTRIES WHERE BASIC BUDGET PRACTICES ARE NOT YET WELL EMBEDDED SHOULD MOVE CAUTIOUSLY IN ADOPTING ADVANCED PRACTICES

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DEALING WITH FISCAL SHOCKS

THE PROBLEM

FISCAL SHOCKS, WHICH OFTEN ARE UNPREDICTABLE, DESTABILIZE PUBLIC FINANCE

FISCAL RULES AND THE MTEF ARE BRUSHED ASIDE, BY AUTOMATIC OR DISCRETIONARY RESPONSES TO THE SHOCKS

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DEALING WITH FISCAL SHOCKS, CONTINUED

RESPONDING TO FISCAL SHOCKS THE BEST WAY TO AVOID SHOCKS IS TO HAVE PRUDENT

POLICIES IN PLACE BEFORE THE CRISIS SOME COUNTRIES CAME OUT OF THE GREAT RECESSION

WITH LITTLE DIFFICULTY; OTHERS ARE STILL STRUGGLING TO RECOVER

DEPENDING ON POLITICAL AND OTHER CONDITIONS, SHOCKS MAY BE RIPE OCCASIONS FOR FUNDAMENTAL EXPENDITURE REVIEWS AND RIGHT-SIZING THE PUBLIC SECTOR

THE EFFECTS OF SHOCKS ARE MAGNIFIED WHEN GOVERNMENT IS THE HOLDER OF LAST RESORT FOR ECONOMIC AND SOCIAL RISKS

IN THE AFTERMATH OF THE FISCAL CRISIS, IT MAY BE APPROPRIATE TO CONSIDER STRONGER STANDBY FACILITIES FOR CUSHIONING SHOCKS

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CONCLUSION: INTEGRATE BUDGET INSTITUTIONS TO PROMOTE SUCCESSFUL REFORM

THE PROBLEM MAJOR INSTITUTIONAL REFORMS TEND TO BE

DISCONNECTED FROM ONE ANOTHER

FISCAL RULES, MTEF, AND PERFORMANCE BUDGETING TEND TO BE SEPARATE REFORMS, EACH WITH ITS OWN ORGANIZATIONAL CHAMPION

WHEN THIS OCCURS, GOVERNMENT’S CAPACITY TO SUCCESSFULLY INNOVATE MAY BE IMPAIRED

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CONCLUSION: INTEGRATE BUDGET INSTITUTIONS TO PROMOTE SUCCESSFUL REFORM CONTINUED

INTEGRATE BUDGET INSTITUTIONS RULES, MTEF, AND PB ARE ALL ELEMENTS OF MODERN BUDGET

INSTITUTIONS TO PROMOTE EFFICIENT AND SUSTAINABLE POLICIES

MTEF IS THE APPROPRIATE VEHICLE FOR INTEGRATING THE REFORMS, WHEN IT IS IMPLEMENTED IN THE MANNER DISCUSSED EARLIER

THE FISCAL RULE WOULD PROVIDE THE BUDGET CONSTRAINT IN MTEF, AND PERFORMANCE BUDGETING WOULD SUPPLY A BASIS FOR DECIDING POLICY CHANGES

IT IS IMPORTANT THAT THEIR DATA BASES ALSO BE INTEGRATED

WHEN REFORMING BUDGET INSTITUTIONS A KEY CONSIDERATION SHOULD BE WHICH EXISTING DATA AND PROCEDURAL REQUIREMENTS MAY BE REDUCED

A COUNTRY’S SOCIAL-ECONOMIC DEVELOPMENT AND ADMINISTRATIVE CAPACITY ARE HIGHLY RELEVANT IN DETERMINING WHETHER AND HOW TO INTEGRATE BUDGET INSTITUTIONS