PROMOTING FISCAL SUSTAINABILITY THROUGH IMPROVED BUDGET INSTITUTIONS

1. PROMOTING FISCAL SUSTAINABILITY THROUGH IMPROVED BUDGET INSTITUTIONS ALLEN SCHICKSchool of Public PolicyUniversity of Maryland ASIAN REGIONAL SEMINARPROMOTING FISCAL SUSTAINABILITY KUALA LUMPUR, MALAYSIA 28 FEBRUARY – 2 MARCH, 2011

2. 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

3. 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

4. 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

5. 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

6. STRENGTHENING FISCAL RULES THE 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

7. 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

8. 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

9. 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

10. INTEGRATING MEDIUM-TERM FRAMEWORKS AND NATIONAL PLANS, CONTINUED INTEGRATE NATIONAL PLANNING INTO THE BUDGET FRAMEWORK • DEVELOPING COUNTRIES BENEFIT FROM HAVING STRONG BUDGET AND PLANNING SYSTEMS • PLANNING 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 CONSISTENT • WHEN THE PLAN IS STRUCTURED BY PROGRAMS OR SECTORS, CROSS-WALK IT TO BUDGET CLASSIFICATIONS • BRAZIL 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

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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