Topdown Budgeting

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Top-down Budgeting
2006 OECD Asian SBO

• A Tool for Central Resource Management
• December 15, 2006

Korea Institute of Public Finance John M Kim,
PhD jhrv_at_kipf.re.kr
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Outline

• What is it?
• Why do it?
• How to do it?
• Caveats

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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

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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

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What is Top-down Budgeting? (3)

• It is A Division 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

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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

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Outline

• What is it?
• Why do it?
• How to do it?
• Caveats

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Urgency of Reform?

• Huge deficits ca.1990 in many OECD countries
  forced them to adopt major fiscal reforms

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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

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(What are Koreas 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

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(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
  its too late

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(Some Background Current Fiscal Status)

• Up to the financial crisis, Koreas 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?
• Koreas reforms are not driven by an immediate
  crisis, but this may end up somewhat undermining
  the momentum of the reforms

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Top-down vs. Bottom-up

• Comparison of Bottom-up Top-down Approaches

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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
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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

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Outline

• What is it?
• Why do it?
• How to do it?
• Caveats

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Example of Linking Multi-year Plans to the Annual
Budget (Sweden)
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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
NFMP
? Total Ceiling ? Sectoral
Ceilings
Now
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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

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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

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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

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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

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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

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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

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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

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Outline

• What is it?
• Why do it?
• How to do it?
• Caveats

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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

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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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• This ends the presentation
• Thank You!