top-down budgeting a tool for central resource management december 15, 2006 korea institute of...
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Top-down Budgeting
A Tool for Central Resource Management
December 15, 2006
Korea Institute of Public Finance
John M Kim, PhD
jhrv@kipf.re.kr
2006 OECD Asian SBO
2
1.What is it?
2.Why do it?
3.How to do it?
4.Caveats
Outline
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What is Top-down What is Top-down Budgeting?Budgeting?
It is not:It is not: Bottom-up Budgeting Bottom-up Budgeting– Traditional way of budgetingTraditional way of budgeting– Sum of ministry budgets Sum of ministry budgets Total budget Total budget
• Difficult to control aggregates (total budget, deficit)Difficult to control aggregates (total budget, deficit)• Difficult to control allocation among major sectorsDifficult to control allocation among major sectors
– Defense vs. pollution control vs. infrastructure, etc.– Additional ProblemsAdditional Problems
• Focus on annual numbers (myopic)Focus on annual numbers (myopic)• Inefficient processInefficient process
– Iterative negotiations (game-playing & adjusting for totals)
– Inability to utilize ministries’ expertise
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What is Top-down What is Top-down Budgeting? (2)Budgeting? (2)
It is:It is: Budgeting in 2 StepsBudgeting in 2 Steps
①① Ceilings (aggregate numbers)Ceilings (aggregate numbers)1)1) Decide total spending & deficit levels (agg. ceiling)Decide total spending & deficit levels (agg. ceiling)2)2) Decide allocation among major policy areas (sectoral ceilings: aDecide allocation among major policy areas (sectoral ceilings: a
bout 30)bout 30)– Defense vs. pollution control vs. infrastructure, etc.
②② Intra-sectoral allocations (details)Intra-sectoral allocations (details)1)1) Ministry/agency budgetsMinistry/agency budgets
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What is Top-down What is Top-down Budgeting? (3)Budgeting? (3)
It is:It is: AA Division of Roles/ResponsibilitiesDivision of Roles/Responsibilities
①① Ceilings (aggregate numbers)Ceilings (aggregate numbers)1)1) Final decision by PM & Finance MinisterFinal decision by PM & Finance Minister2)2) Focus on Focus on
Aggregate fiscal management Medium-term perspective (multi-year ceilings) Policy priorities
②② Intra-sectoral allocations (details)Intra-sectoral allocations (details)1)1) Ministries formulate their own budgetsMinistries formulate their own budgets2)2) But must follow rulesBut must follow rules
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What is Top-down What is Top-down Budgeting? (4)Budgeting? (4)
It is:It is:①① Effective for fiscal consolidationEffective for fiscal consolidation
②② A key tool for enforcing MTEF (NFMP) decisionsA key tool for enforcing MTEF (NFMP) decisions
(ceilings are often multi-year limits)(ceilings are often multi-year limits)
③③ Ensures spending is aligned with prioritiesEnsures spending is aligned with priorities
④④ Efficient in time and effortEfficient in time and effort
⑤⑤ Utilizes ministries’ expertiseUtilizes ministries’ expertise
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1.What is it?
2.Why do it?
3.How to do it?
4.Caveats
Outline
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Urgency of Reform?Urgency of Reform?
Huge deficits ca.1990 in many OECD countries forced them to adopt major Huge deficits ca.1990 in many OECD countries forced them to adopt major fiscal reformsfiscal reforms
19919911199199
22199199
33199199
44199199
55199199
66199199
77199199
88199199
99200200
00
• • Fiscal Balance (% GDP)Fiscal Balance (% GDP)
AustraliaAustralia -3.8-3.8 -6.0-6.0 -5.6-5.6 -4.6-4.6 -3.7-3.7 -2.2-2.2 -0.5-0.5 0.60.6 1.61.6 0.10.1
CanadaCanada -8.3-8.3 -9.1-9.1 -8.7-8.7 -6.7-6.7 -5.3-5.3 -2.8-2.8 0.20.2 0.50.5 1.61.6 3.23.2
DenmarkDenmark -2.4-2.4 -2.2-2.2 -2.9-2.9 -2.4-2.4 -2.3-2.3 -1.0-1.0 0.40.4 1.11.1 3.23.2 2.52.5
KoreaKorea 1.81.8 1.41.4 2.52.5 3.13.1 4.24.2 3.83.8 3.63.6 1.91.9 3.13.1 6.96.9
NetherlNetherlandsands
-3.2-3.2 -4.4-4.4 -3.6-3.6 -4.2-4.2 -4.2-4.2 -1.8-1.8 -1.1-1.1 -0.8-0.8 0.40.4 2.22.2
SwedenSweden -2.0-2.0 -7.8-7.8
--1111..44
--1100..88
-7.7-7.7 -3.1-3.1 -1.6-1.6 2.12.1 1.31.3 3.73.7
Utd. Utd. KingdoKingdomm
-3.1-3.1 -6.4-6.4 -7.9-7.9 -6.7-6.7 -5.8-5.8 -4.4-4.4 -2.2-2.2 0.40.4 1.11.1 1.61.6
OECD OECD -3.7-3.7 -4.6-4.6 -5.0-5.0 -4.2-4.2 -3.9-3.9 -3.2-3.2 -1.8-1.8 -1.4-1.4 -0.9-0.9 0.00.0
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Different Motivation for Different Motivation for KoreaKorea
Top-down adopted as key part of 4 fiscal Top-down adopted as key part of 4 fiscal reformsreforms
1)1) Need for longer-term perspectiveNeed for longer-term perspective
Anticipate need for controlling future spending Anticipate need for controlling future spending growth in social welfare, etc.growth in social welfare, etc.
2)2) EfficiencyEfficiency
a.a. Need to focus on broader policy prioritiesNeed to focus on broader policy priorities
b.b. Eliminate unproductive games in budget Eliminate unproductive games in budget negotiationsnegotiations
c.c. Utilize ministries’ expertiseUtilize ministries’ expertise
3)3) Need to focus on performance Need to focus on performance management, rather than controlling inputsmanagement, rather than controlling inputs
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(What are Korea’s 4 (What are Korea’s 4 Reforms?)Reforms?)
1.1. National Fiscal Management PlanNational Fiscal Management Plan– Medium-term (5-year) fiscal plan for 14 sectorsMedium-term (5-year) fiscal plan for 14 sectors
2.2. Top-Down budgetingTop-Down budgeting– Tier 1: Fixed spending envelope for each sector/ministryTier 1: Fixed spending envelope for each sector/ministry– Tier 2: Autonomy for line ministries in own budgetsTier 2: Autonomy for line ministries in own budgets
3.3. Performance ManagementPerformance Management– Assess performance of spending programsAssess performance of spending programs– Enhance link between performance and budgetEnhance link between performance and budget
4.4. Digital Budget and Accounting SystemDigital Budget and Accounting System– Program BudgetingProgram Budgeting– Accrual AccountingAccrual Accounting– Computerization of accounting systemComputerization of accounting system
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(Why the 4 Reforms?)(Why the 4 Reforms?)
Anticipate fiscal difficulties driven by aging & other Anticipate fiscal difficulties driven by aging & other socioeconomic changes socioeconomic changes
– Population aging and low fertility ratePopulation aging and low fertility rate• Old population (65 and above): 7.2 (2000) Old population (65 and above): 7.2 (2000) 14.4(2019) 14.4(2019)• Total fertility rate: 6.0(1961) Total fertility rate: 6.0(1961) 2.1(1982) 2.1(1982) 1.19(2003) 1.19(2003) Less workers must support welfare of more elderly people Less workers must support welfare of more elderly people
Public pensions and health care financing will suffer mostPublic pensions and health care financing will suffer most
– Society demands better quality of life (social welfare, education, Society demands better quality of life (social welfare, education, culture, environment)culture, environment)
– Economic growth slowing down Economic growth slowing down so will tax revenues so will tax revenues
– Emphasis on participation and transparencyEmphasis on participation and transparency
Spending growth may outrun revenue increase, so try to get Spending growth may outrun revenue increase, so try to get fiscal system in good shape before it’s too late fiscal system in good shape before it’s too late
Increase rate of national tax revenues(annual average)
1980~1990 1991~1997 1998~2003 2004~2008(Proj.) 17.0% 14.7% 8.6% About 8%
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(Some Background: Current (Some Background: Current Fiscal Status)Fiscal Status)
Up to the financial crisis, Korea’s public finances were solid, thanks to Up to the financial crisis, Korea’s public finances were solid, thanks to two decades of balanced budgeting two decades of balanced budgeting
Some deterioration resulted from coping against crisis (Some deterioration resulted from coping against crisis (national debt national debt more than doubled), but fiscal situation remains better than most other more than doubled), but fiscal situation remains better than most other OECD countriesOECD countries
What does this mean for the 4 Reforms?What does this mean for the 4 Reforms? Korea’s reforms are not driven by an immediate crisis, but this may Korea’s reforms are not driven by an immediate crisis, but this may
end up somewhat undermining the momentum of the reformsend up somewhat undermining the momentum of the reforms
<General Government Debt in OECD Countries, 2003>
Korea USA Japan OECD Total Debt (% of GDP) 23.0 62.8 157.3 76.0
<Korea’s National Debt>
1997 2000 2001 2002 2003 2004 Total Debt (in tn. won) 60 111 122 134 166 204 % of GDP 12.3 19.2 19.6 19.5 23.0 26.2
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Top-down vs. Bottom-upTop-down vs. Bottom-up
Comparison of Bottom-up & Top-down ApproachesComparison of Bottom-up & Top-down Approaches
Bottom-up Top-down
Ministry-by-ministry analysis that ignores economic forecasts
Macro-oriented fiscal analysis based on economic forecasts
Annual, myopic time horizon Multi-year perspective, especially for investments
Time-consuming negotiations Delegated authority
Ownership of proposals is more agency-specific Creates joint ownership of proposals
Reactive Proactive
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Top-down vs. Bottom-up (2)Top-down vs. Bottom-up (2)
Approaches to Determining Expenditure CeilingsTop-Down ApproachTop-Down Approach Bottom-Up ApproachBottom-Up Approach
Overall Overall CeilingCeiling
Sectoral Sectoral CeilingCeiling
Overall Overall CeilingCeiling
Sectoral Sectoral CeilingCeiling
Program Program ReviewReview
SwedenSweden ○○ ○○ -- -- △△
NetherlandsNetherlands ○○ ○○ -- △△ ○○
Utd. KingdomUtd. Kingdom ○○ ○○ -- △△ ○○
DenmarkDenmark ○○ ○○ -- △△ ○○
KoreaKorea ○○ ○○ -- △△ ○○
CanadaCanada ○○ -- -- ○○ ○○
AustraliaAustralia ○○ -- -- ○○ ○○
ChileChile ○○ -- -- ○○ ○○
○ : actively used, △ : used as reference, - : not used
• Top-down and bottom-up methods are complementary− Information for evaluating new initiatives− Program reviews for monitoring programs/activities
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Results?Results?
No more excessive budget requestsNo more excessive budget requests– Increase rate of budget requests in the general account Increase rate of budget requests in the general account
dropped significantly: 30.8%(’04) dropped significantly: 30.8%(’04) 11.7%(’05) 11.7%(’05) 7.0%(’06) 7.0%(’06)
Self-initiated restructuring of spending by line Self-initiated restructuring of spending by line ministriesministries
– Restructuring of multi-year programs and introduction of new Restructuring of multi-year programs and introduction of new programs have nearly doubledprograms have nearly doubled
<Comparison of FY 2004 and FY 2005 budget requests>
’04 Budget ’05 Budget Change
Programs 308 416 134 Restructuring
multi-year programs Amount (trillion won)
-1.6 -2.7 -1.1
Programs 351 459 108 Introduction of new programs Amount
(trillion won) 1.5 3.0 1.5
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1.What is it?
2.Why do it?
3.How to do it?
4.Caveats
Outline
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Example of Linking Multi-year Plans to the AnnuExample of Linking Multi-year Plans to the Annual Budget (Sweden)al Budget (Sweden)
Current Current YearYear(n)(n)
Plans for Future YearsPlans for Future Years
n+1n+1 n+2n+2 n+3n+3
20042004
FY 2005FY 2005•Total Ceiling FixedTotal Ceiling Fixed•Finalize 27 sect. ceilingFinalize 27 sect. ceilings and annual budgets and annual budget
FY 2006FY 2006•Total Ceiling FixedTotal Ceiling Fixed•Adjust 27 sect. ceilings usiAdjust 27 sect. ceilings using budget marginng budget margin
FY 2007FY 2007•Total Ceiling FixedTotal Ceiling Fixed•Set 27 Sect. CeilingsSet 27 Sect. Ceilings
+ budget margin+ budget margin
20052005
FY 2006FY 2006•Total Ceiling FixedTotal Ceiling Fixed•Finalize 27 sect. ceilingFinalize 27 sect. ceilings and annual budgets and annual budget
FY 2007FY 2007•Total Ceiling FixedTotal Ceiling Fixed•Adjust 27 sect. ceilings usiAdjust 27 sect. ceilings using budget marginng budget margin
FY 2008FY 2008•Total Ceiling FixedTotal Ceiling Fixed•Set 27 Sect. CeilingsSet 27 Sect. Ceilings
+ budget margin+ budget margin
20062006
FY 2007FY 2007•Total Ceiling FixedTotal Ceiling Fixed•Finalize 27 sect. ceilingFinalize 27 sect. ceilings and annual budgets and annual budget
FY 2008FY 2008•Total Ceiling FixedTotal Ceiling Fixed•Adjust 27 sect. ceilings usiAdjust 27 sect. ceilings using budget marginng budget margin
FY 2009FY 2009•Total Ceiling FixedTotal Ceiling Fixed•Set 27 Sect. CeilingsSet 27 Sect. Ceilings
+ budget margin+ budget margin
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Budget Formulation in Bottom-up Budget Formulation in Bottom-up vs. Top-down Systemsvs. Top-down Systems
Budget Requests
( by line items)
Budget Requests
( by line items)
Budget Formulation
(line item-oriented)
Budget Formulation
(line item-oriented)Y+1Y+1Y+1Y+1
NFMPNFMP
Total Ceiling Sectoral Ceilings
Total Ceiling Sectoral Ceilings
Budget Formulation Within Ceilings
Budget Formulation Within Ceilings
Consultation and Review Consultation and Review
Y+1Y+1Y+1Y+1
Y+5Y+5Y+5Y+5
Strategic resource allocation emphasizedStrategic resource allocation emphasized
Line Ministries MoF
MoFCabinet Meeting Line Ministries MPB
NowNowNowNow
BeforeBeforeBeforeBefore
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Determining Expenditure CeilingsDetermining Expenditure Ceilings
Overall CeilingOverall Ceiling①① Prudent Economic Assumptions (Growth, etc.)Prudent Economic Assumptions (Growth, etc.)
– Sensitivity analysisSensitivity analysis– Independent panel or private sector forecasting Independent panel or private sector forecasting – Built-in bias for lower growth rateBuilt-in bias for lower growth rate
②② Fiscal Rules for Good DisciplineFiscal Rules for Good Discipline– Sweden: structural surplus of 2% GDPSweden: structural surplus of 2% GDP– Chile: Structural surplus of 1% GDPChile: Structural surplus of 1% GDP– UK: Balance current budget over econ. cycleUK: Balance current budget over econ. cycle– Surplus automatically goes to repaying debtSurplus automatically goes to repaying debt
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Determining Expenditure Ceilings (2)Determining Expenditure Ceilings (2)
Sectoral CeilingsSectoral Ceilings– Must Must notnot affect overall ceiling affect overall ceiling– Usually overlaps with ministerial boundariesUsually overlaps with ministerial boundaries
(good program budget design)(good program budget design)− New initiatives may be required to be funded from savings from exiNew initiatives may be required to be funded from savings from exi
sting programssting programs
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Determining Expenditure Ceilings (3)Determining Expenditure Ceilings (3)
Operating/Capital CeilingsOperating/Capital Ceilings– Ministries tend to favor operating expensesMinistries tend to favor operating expenses
– Denmark: separate ceilings for current & capital Denmark: separate ceilings for current & capital expensesexpenses
• Sub-ceiling for salaries/wages in operating ceilingSub-ceiling for salaries/wages in operating ceiling
− UKUK
• Current expenses: Golden RuleCurrent expenses: Golden Rule
• Capital expenses: Sustainable Investment RuleCapital expenses: Sustainable Investment Rule
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Determining Expenditure Ceilings (4)Determining Expenditure Ceilings (4)
Number of CeilingsNumber of Ceilings– Korea (200+) vs. Sweden (27)Korea (200+) vs. Sweden (27)− Optimal number is around 30Optimal number is around 30
• More ceilings make budgeting decisions politically More ceilings make budgeting decisions politically difficultdifficult
• Need to give ministries room to exercise autonomy Need to give ministries room to exercise autonomy to ensure their proactive participationto ensure their proactive participation
• This means Budget Office needs better tools:This means Budget Office needs better tools:• Performance management• Information system to monitor execution• Enhanced analytical capacity for policy
assessment
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Determining Expenditure Ceilings (5)Determining Expenditure Ceilings (5)
Buffers against ContingenciesBuffers against Contingencies– Built-in buffers in prudent forecasts Built-in buffers in prudent forecasts
Windfalls (repay debt, tax cut, etc.)Windfalls (repay debt, tax cut, etc.)
− Budget MarginBudget Margin
• Overall Ceiling = Sect. Ceilings + Budget MarginOverall Ceiling = Sect. Ceilings + Budget Margin
• Covers unexpected changes (forecasts errors, etc.) Covers unexpected changes (forecasts errors, etc.) and institutional reforms after ceilings were fixedand institutional reforms after ceilings were fixed
• Usually does not cover new policy initiativesUsually does not cover new policy initiatives
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Determining Expenditure Ceilings (6)Determining Expenditure Ceilings (6)
Expenses in or excluded from ceilings?Expenses in or excluded from ceilings?1)1) Discretionary expenses usually includedDiscretionary expenses usually included
2)2) Mandatory expenses (social security Mandatory expenses (social security entitlements, etc., mandated by law)entitlements, etc., mandated by law)
• Sweden, Korea, Chile, Netherlands: includedSweden, Korea, Chile, Netherlands: included
• Canada, Denmark: excludedCanada, Denmark: excluded
3)3) Interest on debtInterest on debt
• Sweden, Denmark: excludedSweden, Denmark: excluded
• Chile, Netherlands, Korea: includedChile, Netherlands, Korea: included
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Determining Expenditure Ceilings (7)Determining Expenditure Ceilings (7)
Funding for new policy initiativesFunding for new policy initiatives• Sweden: must come from existing ceilingsSweden: must come from existing ceilings
• Most countries have review process to judge Most countries have review process to judge new initiatives new initiatives adjust ceilings adjust ceilings
• Australia, Canada: Cabinet committeesAustralia, Canada: Cabinet committees
• Netherlands, Denmark: simply verify fit with Netherlands, Denmark: simply verify fit with coalition agreementcoalition agreement
• Chile: pooled “Bidding Fund” from savings on Chile: pooled “Bidding Fund” from savings on obsolete or poorly performing programsobsolete or poorly performing programs
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1.What is it?
2.Why do it?
3.How to do it?
4.Caveats
Outline
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Conditions for Top-down BudgetingConditions for Top-down Budgeting
Good monitoring system to compensate for Good monitoring system to compensate for delegation of authority to ministriesdelegation of authority to ministries
– Performance & program reviewsPerformance & program reviews– Information system to monitor executionInformation system to monitor execution
Enhanced policy capacity + Behavioral changeEnhanced policy capacity + Behavioral change– Budget Office: better forecasts & projections, must be Budget Office: better forecasts & projections, must be
able to defend fiscal rules, but work better “together” able to defend fiscal rules, but work better “together” with line ministrieswith line ministries
– Ministries: need to learn internal allocation decisionsMinistries: need to learn internal allocation decisions Strong PM & Finance MinisterStrong PM & Finance Minister Commitment to rule-based budgeting (Fiscal Rules)Commitment to rule-based budgeting (Fiscal Rules)
– Remove arbitrariness in budgeting decisions, but Remove arbitrariness in budgeting decisions, but leave room for flexibility and judicious leave room for flexibility and judicious discretion/autonomydiscretion/autonomy
Support from the legislatureSupport from the legislature
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Remaining Tasks (Korea)Remaining Tasks (Korea)
Areas for improvementAreas for improvement– Consensus and understanding on the top-down systemConsensus and understanding on the top-down system– Ex-ante consultations with line ministries when setting spending ceilingEx-ante consultations with line ministries when setting spending ceiling
ss– Further expansion of autonomy at line ministriesFurther expansion of autonomy at line ministries– Insufficient preparation and guidelines by MPBInsufficient preparation and guidelines by MPB
Future plansFuture plans– Surveys and consultations with line ministriesSurveys and consultations with line ministries– Sectoral and ministerial spending ceilings set after sufficient discussioSectoral and ministerial spending ceilings set after sufficient discussio
nsns– Active use of performance assessments to restructure spending prograActive use of performance assessments to restructure spending progra
msms– Detailed budget formulation guidelinesDetailed budget formulation guidelines
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This ends the presentationThis ends the presentation
Thank You!Thank You!
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