Top-down Budgeting A Tool for Central Resource Management

1. Top-down BudgetingA Tool for Central Resource Management John M. Kim Korea Inst. of Public Finance jhrv@kipf.re.kr

2. Outline • What is Top-down Budgeting? • Historical Background • Issues in Implementation • Prerequisites • Conclusion

3. Outline • What is Top-down Budgeting? • Historical Background • Issues in Implementation • Prerequisites • Conclusion

4. Top-down vs. Bottom-up • Top-down Bottom-up • Problems of Bottom-up Budgeting • Difficult to control aggregate spending • Sectoral allocations may not be optimal • Hard to keep multi-year perspective • Inefficient formulation process • Game-playing between budget office and line ministries • Ministries’ expertise under-utilized

5. Top-down: Procedurally Defined • Budgeting in 2 Steps • Ceilings (aggregate numbers) • Decide total spending & deficit levels (agg. ceiling) • Inter-sectoral allocation among major policy areas (sectoral ceilings: about 30) • Intra-sectoral allocations (details) • Ministry/agency budgets

6. Top-down: Functionally Defined • Division of Roles/Responsibilities • Ceilings (aggregate numbers) • Final decision by PM & Finance Minister • Focus on • Aggregate fiscal management • Medium-term perspective (multi-year ceilings) • Policy priorities • Intra-sectoral allocations (details) • Ministries formulate their own budgets • But must follow rules

7. Benefits of Top-down Budgeting • Effective for fiscal consolidation • Easier to integrate with MTEF (MTBF) (ceilings are usually multi-year limits) • Ensures spending is aligned with priorities • Efficient in time and effort • Utilizes ministries’ expertise

8. Outline • What is Top-down Budgeting? • Historical Background • Issues in Implementation • Prerequisites • Conclusion

9. Fiscal Crises as Motivation • Huge deficits ca.1990 in OECD countries top-down introduced as tool for fiscal consolidation + prevent reoccurrence

10. A Different Motivation (Korea) • Top-down adopted as key part of 4 fiscal reforms (multi-year, top-down, performance, program budgeting) • Emphasis on longer-term perspective Need to control anticipated spending growth in social welfare, etc. • Efficiency • Need to focus on broader policy priorities • Eliminate unproductive games in budget negotiations • Utilize ministries’ expertise • Need to focus on performance management, rather than controlling inputs

11. Top-down & Bottom-up Compared • Bottom-up • Top-down - Ministry by ministry analysis that - Aggregate fiscal analysis that largely ignores economic forecasts takesinto account economic forecasts - Annual - Multi-year - Time consuming - Delegated authority - Ownership of proposals is more - Creates joint ownership of agency- specific proposals - Reactive - Proactive

12. Complementary Approaches • Top-down approach should be complemented by bottom-up methods: • Information for evaluating new initiatives • Program reviews for monitoring programs/activities Approaches to Determining Expenditure Ceilings ○ : actively used, △ : used as reference, - : not used

13. Outline • What is Top-down Budgeting? • Historical Background • Issues in Implementation • Prerequisites • Conclusion

14. Determining Spending Ceilings • Overall Ceiling • Prudent Economic Assumptions (Growth, etc.) • Sensitivity analysis • Independent panel or private sector forecasting • Built-in bias toward lower growth forecast • Fiscal Rules for Good Discipline • Sweden: structural surplus of 2% GDP • Chile: Structural surplus of 1% GDP • UK: Balance current budget over econ. cycle • Surplus automatically goes to repaying debt

15. Determining Spending Ceilings • Sectoral Ceilings • Must not affect overall ceiling • Usually overlap with ministerial boundaries (good program budget design) • New initiatives may be required to be funded by savings from existing programs

16. Issues in Setting Ceilings • Operating vs. Capital Ceilings • Ministries tend to favor operating expenses • Denmark: separate ceilings for current & capital expenses • Sub-ceiling for salaries within operating ceiling • UK • Current expenses: Golden Rule • Capital expenses: Sustainable Investment Rule

17. Issues in Setting Ceilings • Number of Ceilings • Korea (200+) vs. Sweden (27) • Optimal number is around 30 • More ceilings make budgeting decisions politically difficult • Need to give ministries room to exercise autonomy to ensure their proactive participation • This means Budget Office needs better tools: • Performance management • Information system to monitor execution • Enhanced analytical capacity for policy assessment

18. Issues in Setting Ceilings • Buffers against Contingencies • Built-in buffers in prudent forecasts  Windfalls (repay debt, tax cuts, etc.) • Budget Margin • Overall Ceiling = Sect. Ceilings + Budget Margin • Covers unexpected changes (forecasts errors, etc.) and institutional reforms after ceilings were fixed • Usually does not cover new policy initiatives

19. Issues in Setting Ceilings • Expenses Included in Ceilings? • Discretionary expenses usually included • Mandatory expenses (social security entitlements, etc., mandated by law) • Sweden, Korea, Chile, Netherlands: included • Canada, Denmark: excluded • Interest on debt • Sweden, Denmark: excluded • Chile, Netherlands, Korea: included

20. Issues in Setting Ceilings • Funding for New Policy Initiatives • Sweden: must come from existing ceilings • Most countries have review process to judge new initiatives  adjust ceilings • Australia, Canada: Cabinet committees • Netherlands, Denmark: simply verify fit with coalition agreement • Chile: pooled “Bidding Fund” from savings on obsolete or poorly performing programs

21. Outline • What is Top-down Budgeting? • Historical Background • Issues in Implementation • Prerequisites • Conclusion

22. Prerequisites for Success • Good monitoring system to compensate for delegation of authority to ministries • Performance & program reviews • Information system to monitor execution • Policy capacity + Behavioral change • Budget Office: better forecasts & projections, need to defend fiscal rules aggressively, but work better together with line ministries • Ministries: need to learn internal allocation decision-making

23. Prerequisites for Success • Strong PM & Finance Minister • Must be able to enforce ceilings • Commitment to rule-based budgeting • Remove arbitrariness in budgeting decisions, but leave room for flexibility and judicious discretion/autonomy • Support from the legislature

24. Outline • What is Top-down Budgeting? • Historical Background • Issues in Implementation • Prerequisites • Conclusion

25. Conclusion • Top-down budgeting is an effective approach to fiscal consolidation • Political will comes foremost; Top-down provides effective framework/tools • Framework fits well with multi-year fiscal discipline & rules-based budgeting • But, discipline tends to slacken as public finances improve • Many countries find it useful to have: • About 30 sub-ceilings for optimal inter-sectoral allocations • Separate ceilings for operating and capital expenditures • Budget margins as buffers against contingencies • Some flexibility in adjusting ceilings for new policy initiatives • Exclusion of mandatory spending differs by country

26. Conclusion • Prerequisites for Success • From the Budget Office • Willingness to defend fiscal rules aggressively • Good monitoring + evaluation of spending programs • Better analytical capacity & ability to work together with ministries • From Line Ministries • Ability to prioritize and make own budgeting decisions • From PM & Finance Minister • Commitment to rule-based budgeting • Willingness/ability to enforce ceilings • From the Legislature • Support for rules and ceilings

27. Conclusion • Despite common features & principles, practices differ by country. Some balance needs to be struck between strict discipline and flexibility, especially at initial stage. • Top-down system by itself does not guarantee good results • Political willingness to honor rules & principles is essential • Capacity of budget office (staff + systems) is also a major factor • Behavioral change must follow • But, overall, has delivered desired results in countries that have adopted it

28. End of Presentation