TOP DOWN BUDGETING & ITS RELATIONSHIP TO FISCAL RULES & DELEGATION OF AUTHORITY Barry Anderson Organization for Economic Cooperation & Development Meeting of Senior Budget Officials from Latin American Countries Santiago, Chile January 25, 2006 1
OECD Working Party of Senior Budget Officials Special Session on Top-Down Budgeting Selected Observations from the Special Session Overview of the Top-Down Process Background Comparisons of Bottom Up with Top Down Need for a Medium-Term Perspective Determining Expenditure Ceilings Economic Assumptions Composition of Expenditure Ceilings Role of Ministers Flexibility Changing Behavior Conclusions 2
Selected Observations from the November Session There is nothing easier than spending someone else s money. Each minister can be his own Finance Minister. Trust but verify. The expenditure ceilings produced by a top-down system are not an objective in and of themselves. They are a method to encourage fiscal policies that promote economic growth. If you are on the brink of a fiscal disaster, you really don t need any system. But if not, you really need a good system most during the good times, not the bad. In sum, bottom up: disaster; top down: success. 3
Overview of the Top-Down Process Background: a shift in the early 90 s to address deficits Primary Initial Goal: Fiscal discipline Primary Operating Method: Delegation of authority Hoped for Results: Promote economic growth and better reflect political priorities (and even staff savings) 4
Comparison of Bottom Up with Top Down Bottom Up Ministry by ministry analysis that largely ignores economic forecasts Annual Time consuming Ownership of proposals is more agency-specific REACTIVE Top Down Aggregate fiscal analysis that attempts to take into account economic forecasts Multi-year Delegated authority Creates joint ownership of proposals PROACTIVE 5
Top-Down Budgeting Requires A Medium-Term Framework Medium-term (and long-term) planning is consistent with delegated authority Prevents playing games between years Encourages objective economic assumptions 6
Length of Budget Framework Two Years Three Years Four Years More Than Four Years Italy Canada Australia Denmark United Kingdom France Netherlands Korea Germany United States Spain Sweden 7
Potential Problems with Medium-Term Budget Framework A tendency to overestimate economic growth Ministries view future resource allocations as an entitlement, even when circumstances (to include evaluations) change Some allocations were made in real terms rather than in nominal terms and inflation projections were inaccurate 8
Determining Expenditure Ceilings: Economic Assumptions The benefits of cautious economic assumptions include: It is much easier to reprogram a windfall than find new cuts required by less-than-assumed growth They do not create unrealistic expectations The nature of economic assumptions appears to be a function of who does them: Political source: invariably optimistic Technical source: usually objective, frequently cautious Sensitivity analysis can help politicians, the bureaucracy, the media, and the public understand the basis behind the assumptions 9
Steps in Deriving Expenditure Ceilings 1. Determine economic assumptions for forecast period 2. Set fiscal targets (such as, a balanced budget by the end of the period; or a deficit not to exceed 3% of forecasted GDP; or debt as a % of GDP that does not grow) 3. Determine the size of a budget margin, if any 4. Apply expenditure limits to selected sub ceilings 10
Fiscal Targets: Fixed or Flexible Are Fixed Targets (set in nominal terms) pro or counter cyclical? Impact of targets on automatic stabilizer programs Should targets be adjusted for productivity increases? Can Flexible Targets (set in real terms and/or adjusted for the business cycle) really be adjusted accurately? One measure of the success of a target is how well it works in the good times. 11
Budget Margin Choices Cautious economic assumptions Explicit buffer for forecasting errors and unpredictable events (but not policy actions). Examples, Canada: 2.5-3 billion Canadian dollars; Sweden: 2% of total expenditures. None 12
Sub Ceiling Issues Composition By sector or ministry (example, Sweden: 27) By category of spending: Operational (including wages)/capital/transfers (examples, Denmark, UK) Discretionary/Entitlement (examples, Canada, US) Automatic Stabilizers/Other Number (examples, some have 30 or more but most have under 10) Note the positive impacts of a top-down system decrease as the number of sub ceiling categories increase 13
Role of Ministers Prime Minister: use cabinet meetings to: Explain economic assumptions; Explain reason behind fiscal targets and sub ceiling allocations, and how those allocations fit into the government s overall fiscal policy; Discuss complicated budget issues; Obtain buy-in from entire cabinet Minister of Finance: as the person most responsible for setting and enforcing the rules and keeping the accounts, the Minister of Finance needs to go out of his way to be as fair and transparent as he can, and conduct program reviews in an open manner (see next slide). Sectoral Ministers need to be honest and open about their goals and priorities and not withhold important information. 14
Sample Criteria for Finance Minister s Program Review 1. Does the program serve a public interest? 2. Is this an appropriate role for the government? 3. Could this be done better by another level of government (provincial, municipal)? 4. Could this be left to the private sector or volunteers? 5. Could the program be delivered more efficiently? 6. Is it affordable? 15
Flexibility Issues Should the top down rules be in law or not? What are the rules for offsets for supplemental budgets? What are the rules for using budget margins: Cautious economic assumptions; Buffers or reserves (both aggregate and sectoral)? How much carryover of unspent funds should be allowed? Should Ministries be allowed to borrow against future appropriations? 16
Issues in Changing Behavior Delegation! Delegation! Delegation! The Finance Minister should not second-guess previously approved ministry budgets. A requirement for offsets for new, expanded, or unexpected programs is ok if this rule is known in advance and not applied in an ad hoc manner. The goal is a better relationship between the Finance Ministry and the Agencies. The goal should not be staff savings. 17
Conclusions: Five Criteria for Top- Down Budgeting to be Successful 1. Fiscal discipline needs to be a shared goal 2. Cautious economic assumptions are important 3. Flexibility matters, especially not too many sub ceilings and within the agreed-on budget levels 4. Behavior needs to change: more openness and trust 5. Despite the importance of delegation, a strong Finance Minister and Ministry of Finance is required 18