Analyses on the budget processes from the aspect of risks and opportunities of added value

1. Analyses on the budget processes from the aspect of risks and opportunities of added value József Simon, audit managerState Audit Office of Hungary Istanbul, 18th-19th April 2019

2. Background information • Each EU Member States had to introduce numerical fiscal rules which effectively promote compliance with its obligations deriving from the Treaty on the Functioning of the European Union (TFEU) in the area of budgetary policy. • In order to monitorthe compliance with thefiscal rules, Independent fiscal institutions (IFIs) were sat up in almost every EU Member State. • IFI’smain concern is the reliability of the macroeconomic forecasts since a budget built on unrealistic (to optimistic) macroeconomic projections will result in a deficit exceeding the limits set by the national fiscal rules.

3. Backgroundinformation • The president of the SAO is – ex officio – one of the members of the Hungarian Fiscal Council which is a three-member body. It is the independent fiscal institution of Hungary. The main task of the Council is to ensure that the act on the central budget complies with the national fiscal rules. • The operation of the Council is supported by the analysts of the SAO who assess the budget risks other than unrealistic economic forecasts. • SAO’s analyses are primarily based on the expertise that the SAO has accumulated during its audits related to budget issues. SAO has transformed its methodology for auditing the budget bill to a methodology for the assessment of budget risks other than unrealistic macroeconomic forecasts. • This methodology might be adapted not only by independent fiscal institutions but by SAIs also which try to broaden the scope of their activities to audit or asses certain aspects of their national fiscal policy.

4. Fundamental principles ofthe methodology • Applied principles: transparency, materiality and evidence-based approach • Methods used: observation, inquiry, analytical review. • Fundamental auditing principles serve as general guidelines. • the selection of suitable assessment criteria • concept of substantiation • principle of materiality

5. Selection of suitable assessment criteria • Assessment of compliance with formal criteria, such as relevant laws, including budgetary laws. EveryMS introduced complex national legislation on the budgeting. Itprovides formal criteria for budget assessment (e.g. compliance withnational fiscal rules). • When legislation doesn’t cover all aspects of budgeting then propriety criteria (ISSAI 400) could be used. Suitable criteria of propriety will be: - generallyaccepted principles - national or international best practice. • Several recommendations of the OECD’s “Principles of Budgetary Governance” can be used as propriety criteria

6. Substantiation • Substantiation in auditing: audit reports must comprehensively documented by evidence. • Substantiation in budgeting: the organization responsible for the planning of the appropriations must proof with documents and calculations that • the revenue appropriation can be met, • the expenditure appropriations are sufficient to fulfil those public tasks which are to be funded by them. • Three conditions of substantiation: • appropriations were supported by calculations, • authentic and actual information and data were used for the calculations, • calculations were documented.

7. Concept of materiality • Concept of materiality recognises that some matters are important, either individually or in aggregate, and others are not. • Level of risk is determined by • the size of the underperformance or overspending of a certain appropriation, • the probability of them. • An appropriation is material if its value is significant within the budget, and/or it was qualified as risky in the course of the analysis. • Appropriations selected on the criteria of materiality are called key appropriations. • A budget bill is considered to be substantiated if during the risk assessment a significant percentage of the amount of the key appropriations proved to be substantiated, and fiscal rules are met.

8. Phases of the budgetary risk assessment

9. Selection of key appropriations • Theyshould be selected in such a way and amount that a sound assessment may be formed on the substantiation of the budget as a whole based on the analysis of the selected appropriations and the quantification of their risks. • In advance of the assessment a risk-threshold must be defined. • Its size depends on the amount of risk allowed by the assessor. • Coverage: the total amount of the selected expenditure appropriations. • Coverage should reach 80 percent of the expenditure total, and the most risky ones should be selected. • Higher coverage would require smaller appropriations to be included in the evaluation, so a small increase would require a large number of additional appropriations to beassessed.

10. Analysis of the selected appropriations • Assessmentcriteria:whether appropriations were supported by proper calculations. • The documentsprovided by the ministries are reviewed by the assessor to see whether the keyappropriation had been supported by proper calculations. • An appropriation is qualified as supported if all of the following conditions are satisfied: • the planning of the appropriations are sufficiently documented • the ministry responsible for the planning of the appropriation has assessed the expected attainments, • the calculations corroborate the planned budget appropriation, • the statutory background of the appropriation is ensured, • the appropriation was designed in line with macroeconomic forecasts and economic and other policy objectives.

11. Criteria for the rating of revenue appropriations

12. Assessment and quantification of risks • In the case of appropriations rated unsubstantiated or partly substantiated the related risk must be quantified. • A revenue appropriation is considered risky if based on the assessment of the submitted documents it is expected to underperform the budgeted appropriation. • The volume of the risk is calculated according to the following equation: • Methods used: Analysis of historical data, legal environment, economic and other factors. Risk = most probable attainment value of the appropriation – planned value of the appropriation

13. Verifying compliance with fiscal rules related to budget deficit Planned deficit – Total risks of additional deficit + • Reserves > Deficit allowed by the fiscal rule • Task: to collect each element of the above inequality, • to check whether the inequality is valid or not. • Negative and positive risks identified for each • appropriations should be summed up. • 2. Assessors have to collect all kinds of free reserves • built in the budget which are apt to mitigate the risks • emerging during the execution • of the budget • 3. the aggregated value of the identified risks is compared to the value • of the reserves available for risk management. • 4. If the reserves are sufficient to address the risks identified, • then the assessor affirms that the budget bill complies with the fiscal • rule related to budget deficit.

14. Addedvalue of assessment 1.

15. Addedvalue of assessment 2.

16. Addedvalue of assessment 3.

17. Conclusions • The substantiation of the budget bill is an important precondition of the actual compliance with fiscal rules. • The proper substantiation of the budget bill can be fostered by independent assessment focusing on the relevant risks of the key appropriations of the budget bill.This is a vast but feasibly task. • The presented methodology took some basic ideas from the ISSAIs. • The assessment of budgetary risks is enhancing budgetary discipline.SAIs can contribute to budgetary governance by taking part in this exercise. • SAO cancreateaddingvaluewiththismethodfordifferentactors.

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