Topdown Budgeting A Tool for Central Resource Management

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

Outline 1. 2. 3. 4. 5. What is Top-down Budgeting? Historical Background Issues in Implementation Prerequisites Conclusion

Outline 1. What is Top-down Budgeting? 2. 3. 4. 5. Historical Background Issues in Implementation Prerequisites Conclusion

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 4

Top-down: Procedurally Defined § Budgeting in 2 Steps ① Ceilings (aggregate numbers) 1) Decide total spending & deficit levels (agg. ceiling) 2) Inter-sectoral allocation among major policy areas (sectoral ceilings: about 30) ② Intra-sectoral allocations (details) 1) Ministry/agency budgets 5

Top-down: Functionally Defined § Division of Roles/Responsibilities ① Ceilings (aggregate numbers) 1) Final decision by PM & Finance Minister 2) Focus on § § § Aggregate fiscal management Medium-term perspective (multi-year ceilings) Policy priorities ② Intra-sectoral allocations (details) 1) Ministries formulate their own budgets 2) But must follow rules 6

Benefits of Top-down Budgeting ① Effective for fiscal consolidation ② Easier to integrate with MTEF (MTBF) (ceilings are usually multi-year limits) ③ Ensures spending is aligned with priorities ④ Efficient in time and effort ⑤ Utilizes ministries’ expertise 7

Outline 1. What is Top-down Budgeting? 2. Historical Background 3. Issues in Implementation 4. Prerequisites 5. Conclusion

Fiscal Crises as Motivation § Huge deficits ca. 1990 in OECD countries 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 • Fiscal Balance (% of GDP) Australia -3. 8 -6. 0 -5. 6 -4. 6 -3. 7 -2. 2 -0. 5 0. 6 1. 6 0. 1 Canada -8. 3 -9. 1 -8. 7 -6. 7 -5. 3 -2. 8 0. 2 0. 5 1. 6 3. 2 1. 4 2. 1 1. 8 1. 6 2. 4 2. 1 1. 8 0. 4 -1. 4 0. 1 -2. 4 -2. 2 -2. 9 -2. 4 -2. 3 -1. 0 0. 4 1. 1 3. 2 2. 5 1. 8 1. 4 2. 5 3. 1 4. 2 3. 8 3. 6 1. 9 3. 1 6. 9 Netherlands -3. 2 -4. 4 -3. 6 -4. 2 -1. 8 -1. 1 -0. 8 0. 4 2. 2 Sweden -2. 0 -7. 8 -11. 4 -10. 8 -7. 7 -3. 1 -1. 6 2. 1 1. 3 3. 7 UK -3. 1 -6. 4 -7. 9 -6. 7 -5. 8 -4. 4 -2. 2 0. 4 1. 1 1. 6 OECD Avg. -3. 7 -4. 6 -5. 0 -4. 2 -3. 9 -3. 2 -1. 8 -1. 4 -0. 9 0. 0 Chile Denmark Korea top-down introduced as tool for fiscal consolidation + prevent reoccurrence 9

A Different Motivation (Korea) § Top-down adopted as key part of 4 fiscal reforms (multi-year, top-down, performance, program budgeting) 1) Emphasis on longer-term perspective Need to control anticipated spending growth in social welfare, etc. 2) Efficiency a. Need to focus on broader policy priorities b. Eliminate unproductive games in budget negotiations c. Utilize ministries’ expertise 3) Need to focus on performance management, rather than controlling inputs 10

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

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 Top-Down Approach Overall Sectoral Ceiling Bottom-Up Approach Overall Sectoral Program Ceiling Review Sweden ○ ○ - - △ Netherlands ○ ○ - △ ○ UK ○ ○ - △ ○ Denmark ○ ○ - △ ○ Korea ○ ○ - △ ○ Canada ○ - - ○ ○ Australia ○ - - ○ ○ Chile ○ - - ○ ○ ○ : actively used, △ : used as reference, - : not used 12

Outline 1. What is Top-down Budgeting? 2. Historical Background 3. Issues in Implementation 4. Prerequisites 5. Conclusion

Determining Spending Ceilings § Overall Ceiling 1) Prudent Economic Assumptions (Growth, etc. ) – – – Sensitivity analysis Independent panel or private sector forecasting Built-in bias toward lower growth forecast 2) 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 14

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 15

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 16

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 17

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 18

Issues in Setting Ceilings § Expenses Included in Ceilings? 1) Discretionary expenses usually included 2) Mandatory expenses (social security entitlements, etc. , mandated by law) • • Sweden, Korea, Chile, Netherlands: included Canada, Denmark: excluded 3) Interest on debt • • Sweden, Denmark: excluded Chile, Netherlands, Korea: included 19

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 20

Outline 1. What is Top-down Budgeting? 2. Historical Background 3. Issues in Implementation 4. Prerequisites 5. Conclusion

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 22

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

Outline 1. 2. 3. 4. What is Top-down Budgeting? Historical Background Issues in Implementation Prerequisites 5. Conclusion

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 25

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

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 27

End of Presentation