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Top-down Budgeting. A Tool for Central Resource Management December 15, 2006. 2006 OECD Asian SBO. Korea Institute of Public Finance John M Kim, PhD [email protected] Outline. What is it? Why do it? How to do it? Caveats. What is Top-down Budgeting?. It is not: Bottom-up Budgeting

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top down budgeting

Top-down Budgeting

A Tool for Central Resource Management

December 15, 2006

2006 OECD Asian SBO

Korea Institute of Public Finance

John M Kim, PhD

[email protected]

slide2

Outline

  • What is it?
  • Why do it?
  • How to do it?
  • Caveats
what is top down budgeting
What is Top-down Budgeting?
  • It is not: Bottom-up Budgeting
    • Traditional way of budgeting
    • Sum of ministry budgets  Total budget
      • Difficult to control aggregates (total budget, deficit)
      • Difficult to control allocation among major sectors
        • Defense vs. pollution control vs. infrastructure, etc.
    • Additional Problems
      • Focus on annual numbers (myopic)
      • Inefficient process
        • Iterative negotiations (game-playing & adjusting for totals)
        • Inability to utilize ministries’ expertise
what is top down budgeting 2
What is Top-down Budgeting? (2)
  • It is:Budgeting in 2 Steps
    • Ceilings (aggregate numbers)
      • Decide total spending & deficit levels (agg. ceiling)
      • Decide allocation among major policy areas (sectoral ceilings: about 30)
        • Defense vs. pollution control vs. infrastructure, etc.
    • Intra-sectoral allocations (details)
      • Ministry/agency budgets
what is top down budgeting 3
What is Top-down Budgeting? (3)
  • It is:ADivision 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
what is top down budgeting 4
What is Top-down Budgeting? (4)
  • It is:
    • Effective for fiscal consolidation
    • A key tool for enforcing MTEF (NFMP) decisions

(ceilings are often multi-year limits)

    • Ensures spending is aligned with priorities
    • Efficient in time and effort
    • Utilizes ministries’ expertise
slide7

Outline

  • What is it?
  • Why do it?
  • How to do it?
  • Caveats
urgency of reform
Urgency of Reform?
  • Huge deficits ca.1990 in many OECD countries forced them to adopt major fiscal reforms
different motivation for korea
Different Motivation for Korea
  • Top-down adopted as key part of 4 fiscal reforms
    • Need for longer-term perspective

Anticipate need for controlling future 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
what are korea s 4 reforms
(What are Korea’s 4 Reforms?)
  • National Fiscal Management Plan
    • Medium-term (5-year) fiscal plan for 14 sectors
  • Top-Down budgeting
    • Tier 1: Fixed spending envelope for each sector/ministry
    • Tier 2: Autonomy for line ministries in own budgets
  • Performance Management
    • Assess performance of spending programs
    • Enhance link between performance and budget
  • Digital Budget and Accounting System
    • Program Budgeting
    • Accrual Accounting
    • Computerization of accounting system
why the 4 reforms
(Why the 4 Reforms?)
  • Anticipate fiscal difficulties driven by aging & other socioeconomic changes
    • Population aging and low fertility rate
      • Old population (65 and above): 7.2 (2000)  14.4(2019)
      • Total fertility rate: 6.0(1961)  2.1(1982)  1.19(2003)
      • Less workers must support welfare of more elderly people Public pensions and health care financing will suffer most
    • Society demands better quality of life (social welfare, education, culture, environment)
    • Economic growth slowing down  so will tax revenues
    • Emphasis on participation and transparency
  • Spending growth may outrun revenue increase, so try to get fiscal system in good shape before it’s too late
some background current fiscal status
(Some Background: Current Fiscal Status)
  • Up to the financial crisis, Korea’s public finances were solid, thanks to two decades of balanced budgeting
  • Some deterioration resulted from coping against crisis (national debt more than doubled), but fiscal situation remains better than most other OECD countries

What does this mean for the 4 Reforms?

  • Korea’s reforms are not driven by an immediate crisis, but this may end up somewhat undermining the momentum of the reforms
top down vs bottom up
Top-down vs. Bottom-up

Comparison of Bottom-up & Top-down Approaches

top down vs bottom up 2
Top-down vs. Bottom-up (2)
  • Top-down and bottom-up methods are complementary
    • Information for evaluating new initiatives
    • Program reviews for monitoring programs/activities

Approaches to Determining Expenditure Ceilings

○: actively used, △ : used as reference, - : not used

results
Results?
  • No more excessive budget requests
    • Increase rate of budget requests in the general account dropped significantly: 30.8%(’04)  11.7%(’05)  7.0%(’06)
  • Self-initiated restructuring of spending by line ministries
    • Restructuring of multi-year programs and introduction of new programs have nearly doubled
slide16

Outline

  • What is it?
  • Why do it?
  • How to do it?
  • Caveats
budget formulation in bottom up vs top down systems

Y+5

Y+1

Y+1

Budget Formulation in Bottom-up vs. Top-down Systems
  • Strategic resource allocation emphasized

Line Ministries

MoF

Budget Requests

( by line items)

Budget Formulation

(line item-oriented)

Before

Cabinet

Meeting

MPB

Line Ministries

MoF

Consultation

and Review

Budget

Formulation

Within Ceilings

 Total

Ceiling

 Sectoral

Ceilings

NFMP

Now

determining expenditure ceilings
Determining Expenditure Ceilings
  • Overall Ceiling
    • Prudent Economic Assumptions (Growth, etc.)
      • Sensitivity analysis
      • Independent panel or private sector forecasting
      • Built-in bias for lower growth rate
    • 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
determining expenditure ceilings 2
Determining Expenditure Ceilings (2)
  • Sectoral Ceilings
    • Must not affect overall ceiling
    • Usually overlaps with ministerial boundaries

(good program budget design)

    • New initiatives may be required to be funded from savings from existing programs
determining expenditure ceilings 3
Determining Expenditure Ceilings (3)
  • Operating/Capital Ceilings
    • Ministries tend to favor operating expenses
    • Denmark: separate ceilings for current & capital expenses
      • Sub-ceiling for salaries/wages in operating ceiling
    • UK
      • Current expenses: Golden Rule
      • Capital expenses: Sustainable Investment Rule
determining expenditure ceilings 4
Determining Expenditure Ceilings (4)
  • 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
determining expenditure ceilings 5
Determining Expenditure Ceilings (5)
  • Buffers against Contingencies
    • Built-in buffers in prudent forecasts

 Windfalls (repay debt, tax cut, 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
determining expenditure ceilings 6
Determining Expenditure Ceilings (6)
  • Expenses in or excluded from 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
determining expenditure ceilings 7
Determining Expenditure Ceilings (7)
  • 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
slide26

Outline

  • What is it?
  • Why do it?
  • How to do it?
  • Caveats
conditions for top down budgeting
Conditions for Top-down Budgeting
  • Good monitoring system to compensate for delegation of authority to ministries
    • Performance & program reviews
    • Information system to monitor execution
  • Enhanced policy capacity + Behavioral change
    • Budget Office: better forecasts & projections, must be able to defend fiscal rules, but work better “together” with line ministries
    • Ministries: need to learn internal allocation decisions
  • Strong PM & Finance Minister
  • Commitment to rule-based budgeting (Fiscal Rules)
    • Remove arbitrariness in budgeting decisions, but leave room for flexibility and judicious discretion/autonomy
  • Support from the legislature
remaining tasks korea
Remaining Tasks (Korea)
  • Areas for improvement
    • Consensus and understanding on the top-down system
    • Ex-ante consultations with line ministries when setting spending ceilings
    • Further expansion of autonomy at line ministries
    • Insufficient preparation and guidelines by MPB
  • Future plans
    • Surveys and consultations with line ministries
    • Sectoral and ministerial spending ceilings set after sufficient discussions
    • Active use of performance assessments to restructure spending programs
    • Detailed budget formulation guidelines
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