The International Executive Program for Parliamentary Staff Public Financial Management Overview Module

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1


The International Executive
Program for

Parliamentary Staff


Public Financial Management
Overview Module



























2



Summary Contents


I
NTRODUCTION
:

W
HAT IS PUBLIC
FINANCIAL MANAGEMENT
?


A.

THE CONTEXT OF PUBLI
C FINANCIAL MANAGEME
NT


A.1


The Governance, Institutional and Global Context


A.2 The Policy, Macroeconomic and Fiscal Context



A.3 The Revenue Side


B.
PUBLIC FINANCIAL MANAGEMENT: CONCEPTS,
OBJECTIVES AND
SYSTEMS

B.1 Basic Concepts and Objectives of Public Financial Management

B.2

Main Budgeting Systems

B.3 Budget Coverage, Fiscal Risk and Fiscal Responsibility


C:
THE “UPSTREAM” STAGES: PREPARING THE BUDGET


C.1 The Process of
Budget Preparation


C.2 Medium
-
Term Expenditure Programming


C.3 Public Investment


D:
THE “DOWNSTREAM” STAGES: BUDGET EXECUTION, FINANCING
AND CONTROL


D.1 Budget execution


D.2 Financing the budget: debt and aid management



D.3
Accounting, reporting, audit and evaluation



E.

ASSESSING AND DEVELOPING PFM SYSTEMS: THE PEFA
PERFORMANCE MEASUREMENT FRAMEWORK





3

Introduction
1


What is Public Financial Management?




Public sector management (PSM) reform is concerned with improving
public sector
results by changing the way governments work. Sustainable institutional

change
often requires that thousands of public agents alter their behaviour; it is therefore a
challenging reform area and political incentives may be at odds with improv
ing
public sector performance.




A principal aspect of public sector reform is Public Financial M
a
nagement

(PFM):
the

system of institutions, rules, regulations, procedures and processes through
which
financial
decisions are made and implemented.
In other words it is the
system for raising and for controlling the use of public financial resources,
including strategic planning; budget planning, budget execution, accounting and
reporting and external audit.




The dimensions of PFM can be divided to
upstream

and
downstream

functions.
Upstream functions include strategic budgeting (including multi
-
year forecasting
and debt planning); annual budget preparation; budget analysis and approval (by
the legislature).
Upstream bodies include core ministries an
d

agencies at the centre
of government, such as the Ministry of Finance and the offices that support the
head of

government, which have functions that cut across sectors
.




Downstream functions relate to budget execution
and those aspects of the financial
system
which deal with controls and oversight of actual spending.

Downstream
bodies include both sector ministries and

agencies
which deliver and fund services
under the policy direction of

government.

They also include a diverse group of
more autonomous b
odies such as regulators and State
-
Owned

Enterprises and
corporate bodies which, in many countries, still provide the majority of
infrastructure services

despite extensive privatization.




Downstream, the public sector delivers outputs that directly matter

to citizens
and firms
.
It

provides firms and households with

services
, such as health and
education,

housing, transport, electricity or security,

through direct provision and
through

funding.
It manages infrastructure and

other public investments
which the
private sector may be unable to finance or for which the private sector may be
unwilling to bear all the risk.
It regulates social and

economic
behaviour

when
necessary, such

as food or road transport safety. Equally

importantly,
it develops
and
manages

competing policy proposals,
pro
-
actively (ideally) identifying
emerging social and

economic challenges and proposing

solutions and
it sets sector



1

This introduction is a shortened version of The World Bank (2012).
The World Bank Approach to Public
Sector Management 2011
-
2020: Better Results from Public Sector Institutions,
The
World Bank
,
http://siteresources.worldbank.org/PUBLICSECTORANDGOVERNANCE/Resources/285741
-
1287520109339/PSM
-
Approach.pdf

[September

2012].





4

policy

objectives,
such as reimbursement methods

for allocating recurrent budgets
to hospitals, or inc
entives for water use efficiency
.




The public sector is also responsible for some less tangible but equally critical
outcomes
. It must encourage both
fiscal and institutional sustainability
. It must
provide systems and processes that enable governments to
manage public revenues,
expenditures and debt
ensuring that they remain within agreed fiscal aggregates. It
must manage the allocation of fiscal, administrative and functional authorities
across levels of

government
in a way that
ensures cooperative and co
nstructive
engagement between them
. The public sector must also work with and
support
accountability and governance mechanisms
(judiciaries, legislatures and other non
-
executive state institutions such as Supreme Audit Institutions) to ensure that they
pro
vide transparency

through credible arms
-
length oversight.




How these public sector results are achieved matters.
The subjective individual,
household and firm perception of “being well
-
governed” is a desired outcome of
well
-
functioning public sector arrang
ements, not least because a trusted government
is one which generates less resistance from tax payers
. In other words, the public
sector is not only important for what it does, it is also important for how it is seen
to do it
.




The size and economic signif
icance of the public sector make it a major
contributor to growth and social welfare.
It is important to understand, and

improve, what it is achieving with its very significant

expenditures. Its
achievements emerge in

the quality and nature of the services

it provides, the

infrastructure it finances or underwrites and the quality

of its social and economic
regulation and its sector

policy objectives. How well those public sector

activities
are managed is a key development variable.




There are three main
objectives to PFM (see B.1):




maintaining aggregate fiscal discipline (preventing over
-
spending or over
-
borrowing)



allocative efficiency (allocating resources in line with strategic priorities)



operational efficiency (economy, efficiency and effectiveness

in the use of
resources).




Sound PFM supports aggregate control, prioritization, accountability and efficiency
in the management of public resources and delivery of services, which are critical
to the achievement of public policy objectives, including ach
ievement of the
Millennium Development Goals (MDGs). In addition, sound public financial
management systems are fundamental to the appropriate use and effectiveness of
donor assistance since aid is increasingly provided through modalities that rely on
well
-
functioning systems for budget development, execution and control.




The critical dimensions of performance of an open and orderly PFM system have
been identified as follows (see E.1.1):




5


1.

Credibility of the budget



The budget is realistic and is implement
ed as
intended
.

2.

Comprehensiveness and transparency



The budget and the fiscal risk
oversight are comprehensive, and fiscal and budget information is
accessible to the public.

3.

Policy
-
based budgeting



The budget is prepared with due regard to
government policy

4.

Predictability and control in budget execution



The budget is
implemented in an orderly and predictable manner and there are
arrangements for the exercise of control and stewardship in the use

of
public funds.

5.

Accountability, recording and reporting



Adequate records and
information are produced, maintained and disseminated to meet decision
-
making control, management and reporting purposes.

6.

External scrutiny and audit



Arrangements for scruti
ny of public
finances and follow up by executive are operating.




PSM
reform is
the art and scie
nce of making the public sector
machinery
work.
It is about deliberately changing the

interlocking structures and processes
within the public

sector that define
how financial and physical resources

and people
are deployed and accounted for.





PSM reforms
are often thought of as changes
to the formal (
de jure
)
institutional and managerial
arrangements in the
centre

of government and in
sector agencies,
such as new
civil service laws or budgetary

procedures, revised
funding arrangements for health care etc. Changes to formal arrangements are often
critical,

but ultimately PSM reform is about changing the informal
de facto
behaviours

of agents within the public
sector
. Changing these actual
behaviours

does not necessarily commence with legal or other formal reforms


changes in
how downstream agencies and departments function day
-
to
-
day can provide the
springboard for more

formal changes in the laws and procedures.
Yet

the political,
administrative and financial incentives for rapid PFM reform may not always exist.




Poor public s
ector performance can be traced
to weak links within the chain
.
For example, poor

education quality can be caused both “downstream”, for

examp
le by school management arrangements that

weaken accountability, or
“upstream” by transfer

financing mechanisms that allow funds to dissipate

before
they reach schools.




“Weak links”
can be found in the formal
laws and procedures


but often the
problem is

that
these formal rules are not followed in practice.
For
example,
many countri
es have meritocratic employment
regimes
de jure


but
de facto
, these
often remain only
partially enforced and
provide insufficient protection
against
patronage or the s
ale of public posts.







6



PSM reform remains a distinctively difficult policy area

and five challenges
must be overcome:




T
here is relatively little explicit evidence about what matters most in
improving public sector performance.
The connection between
strong PSM
and social and economic

development is evident to any experienced
government official or practitioner


but hard to pin down precisely.



There is significant uncertainty about the
institutional forms
that are
suited for improving public sector pe
rformance in a given context
. For
example, there is evidence that merit

in staffing decisions matters for public
sector results; however, it is highly contestable

whether a strictly apolitical civil
service oversight body is always suited for ensuring that

there are no political

considerations engaged in staffing.



It is challenging to change the actual
behaviour

of public agents.



Even if PSM reforms are implemented in practice, they may not make the
intended difference for development outcomes.
A PSM refo
rm may be
ineffective if other weak links in the chain are more

fundamental obstacles to
improving the types of public sector outputs necessary to achieve real progress
in

growth, social development or poverty reduction.
The problem of the long
-
time

lags b
efore institutional change takes effect adds to this uncertainty.



P
olitical economy factors may not be fully evident until the reform process
plays out.

Powerful actors may block reforms to ensure that the public sector
serves their or their supporters’ in
terests,

rather than the public good.




This introductory
module
on PFM
aims to

provide a basis for better
understanding of core concepts,
objectives and issues in PFM
.

It

considers the
context of PFM as well as the "upstream" and "downstream" stages of
the
budget.

A particular focus of the course
-

both in the core material and the e
-
discussions
-

will be to examine

how PFM arrangements impact on budgetary
outcomes

and the objectives of aggregate fiscal discipline, allocative efficiency
and operational e
fficiency.

Special focus is placed on the role of the legislature.




The module contains the

following units:




Context of Public Financial Management
:

Unit 1

provides an overview
of
the major dimensions of the internal and external context of PFM as well
as

the

policy, macroeconomic and fiscal context. The unit ends

by
examining the revenue side

with focus on the basic principles of tax policy
and tax administration.





PFM: Concepts, Objectives and Systems
:
The second unit introduces
the
basic concepts and
objectives of PFM before examining budget types,
budgeting systems and classifications. It also considers budget coverage
and the impact of the government’s financial actions on the future fiscal
situation of the country.





7



The “Upstream” Stages:
Preparing the Budget:

To budget is to choose,
and the fundamental basis of a good budget preparation is thus an
“availability” approach rather than a “needs” approach. This unit explores
the process of budget preparation, including the role of the legislat
ure. It
also explains the need for a multiyear fiscal perspective, mainly in order to
assure its sustainability avoid short
-
sighted decisions and provide a
financial perspective against which to decide major changes in government
policy.




The
“Downstream” Stages:

Budget Execution, Financing and Control:

Un
it 4 outlines the
three key “downstream” stages: budget execution,
financing and control (both internal and external). The unit also describes
the main principles of debt and aid management.




Assessing and Developing PFM Systems: The PEFA Performance
Measurement Framework
.
The final
unit describes and explains Public
Expenditure and Financial Accountability (PEFA) using the PEFA
Performance Measurement Framework.




Throughout the text, core con
cepts are highlighted and explained. Each
subsequent
unit concludes with
some work assignments for private study

and
some suggestions for
further reading.

There will be opportunity to discuss each
unit through the e
-
discussions in the e
-
institute

(also lis
ted at the end of each
unit)
.



Select Bibliography


The World Bank (2012).
The World Bank Approach to Publ
ic Sector Management 2011
-
2020:
Better Results from Public Sector Institutions
, The World Bank,
http://siteresources.worldbank.org/PUBLICSECTORANDGOVERNANCE/Resources/28
5741
-
1287520109339/PSM
-
Approach.pdf

[September 2012].
















8

Unit 1:
Context of Public Financial Management


Learning Objectives

Understanding the context of Public Financial Management



After studying this unit, you should be able to:




Explain
the major dimensions of the internal and external context of
PFM;




Understand the linkages between broad policy objectives and fiscal &
expenditure management
;




Describe some of the
basic principles of tax policy.



A.1 The Governance, Institutional and Global Context


No system of taxation and public spending
sho
uld be adopted nor decisions be made
without considering their overall context. The major dimensions of the domestic context
of PFM are the quality of governance and the capability of institutions in the country.
The major dimension of the external co
ntext is the process of globalization, with its

opportunities and constraints.

A.1.1 The governance context


Governance is the
manner

in which state power is exercised

as distinct from
how state power is acquired or the purposes for which it is exercised
.
Governance is thus different from democracy, although closely related to it.




The foundation of good governance is a strong civil society, and its
four pillars

are:




accountability
: the capacity to call public officials to task for their actions,
with appropriate consequences to follow;




transparency
: the systematic provision of cost
-
effective access to relevant
information




participation:

the appropriate involvement and consultation of the main
stakeholders; and




rule of law
: laws and regulat
ions that are clear, known in advance, and
uniformly and effectively enforced.




The “supply” of and “demand” for governance.
It is said that “in a democracy
people get the government they deserve”. This is not always true, and in any
case repressive regi
mes do not give choices to the people
--
but the statement



9

highlights that good governance is neither a gift from the political leadership
nor can it be taken for granted. This realization underpins the expansion of the
governance debate from an exclusive f
ocus on the internal workings of the
executive branch to consideration of the powers of the legislature and then
more broadly to the rights and responsibilities of the media, civil society
organizations and the individual citizens

the so
-
called “demand
-
sid
e of
governance

.





Worldwide there is increasing recognition that citizen involvement is critical
for enhancing democratic governance, improving service delivery, and
fostering empowerment. "Demand for Good Governance" (DFGG) refers to the
ability of citizens, civil society
organizations and other
non
-
state

actors to hold
the state accountable and make it responsive to their needs
.




The measurement of governance


There is a variety of different surveys and measures of governance.
On the
economic and social dimensions, the
most comprehensive and widely used
measures are the Wo
rldwide Governance Indicators

(see Box 1)
.


Box 1: Worldwide Governance Indicators

Voice and Accountability (VA)



capturing perceptions of the extent to which a country's
citizens are able to participate in selecting their government, as well as freedom of expression,
freedom of association, and a free media.

Political Stability and Absence of Violence/Terrorism (P
V)



capturing perceptions of the
likelihood that the government will be destabilized or overthrown by unconstitutional or violent
means, including politically
-
motivated violence and terrorism.

Government Effectiveness (GE)



capturing perceptions of the q
uality of public services, the
quality of the civil service and the degree of its independence from political pressures, the quality
of policy formulation and implementation, and the credibility of the government's commitment to
such policies.

Regulatory Q
uality (RQ)



capturing perceptions of the ability of the government to formulate
and implement sound policies and regulations that permit and promote private sector
development.

Rule of Law (RL)



capturing perceptions of the extent to which agents have c
onfidence in and
abide by the rules of society, and in particular the quality of contract enforcement, property rights,
the police, and the courts, as well as the likelihood of crime and violence.

Control of Corruption (CC)



capturing perceptions of the e
xtent to which public power is
exercised for private gain, including both petty and grand forms of corruption, as well as "capture"
of the state by elites and private interests.

Source:
worldbank
.
org
/governance/
wgi





10



Links between the governance pillars and

public financial management


Good governance is critical for every aspect of organized society, but it is in
particular linked to the major objectives and functioning of PFM, in the
following major ways:




accountability: Because the executive branch of government is responsible
both for using the money and the results of spending it, both
internal

accountability of personnel to their superiors and
social

accountability vis
-
à
-
vis the broader society are nece
ssary. Such social accountability can be
“vertical”
-

where government is held to account for their spending
decisions by citizens through elections


and “horizontal”, those
counterbalancing state institutions that are charged to oversee government


incl
uding parliament and other constitutional watchdogs, such as the
Supreme Audit Institution, which report to parliament.


The role of parliament is key: a
s the representative institutions of the
people, national
legislatures are
the appropriate place to ensure
that the
budget optimally matches a nation’s needs with available resources.
Effective

legislative participation in the budget process establishes checks
and balances that are crucial for transparent and accountable governme
nt
and ensuring efficient delivery of public services.




transparency: Timely communication of relevant fiscal and financial
information is a must for good decision making at all levels of government
and to achieve accountability to parliamentarians and the

public at large
--
no
information, no accountability.
Transparency is one of the six principles of
good budgeting (World Bank 1998) because it is recognised that a
ll relevant
information required for sound budgetary decision making should be
available in an

accessible format, and in a timely and systematic fashion.


Budget information needs to be accurate, reliable and comprehensive.

However, in most countries budgetary
information is normally
generated
from the executive and the information supplied to
parliamentarians is weak.
Often the only source of narrative information is the budget speech and the
budget document itself may contain minimal narrative that outlines the
policies underlying tax and spending proposals. In many developing
countries, the c
omprehensiveness of information on donor funding may be
lacking. The lack of accurate, appropriate and timely information makes it
difficult for parliamentarians and their staff to understand the policy basis of
the budget, relate expenditures to budget
objectives, and to evaluate whether
the budget adequately reflects stated government policy.

A good resource to
assess budget transparency is the Open Budget Index (OBI)

organised by the
International Budget Partnership (IBP)
2
.







2

http://internationalbudget.org/what
-
we
-
do/open
-
budget
-
survey
.




11

Box 2
:

What types of bud
get documentation should be available?


The OECD has developed Best Practices for Budget Transparency that deal with the availability of
budget information, specific disclosure requirements, and integrity and accountability
fundamentals. The OECD
recommends the following types of budget documentation:


A comprehensive budget

includes performance data and medium term projections.


A pre
-
budget report

states explicitly the government’s long
-
term economic and fiscal policy
objectives, and its economic

assumptions and fiscal policy intentions for the medium term.


Monthly reports

show progress in implementing the budget, including explanations of any
differences between actual and forecast amounts.


A mid
-
year report

provides a comprehensive update on t
he implementation of the budget,
including an updated forecast of the budget outcome for the medium term.


A year
-
end report

should be audited by the supreme audit institution and released within six
months of the end of the fiscal year.


A pre
-
election re
port

illuminates the general state of government finances immediately before
an election.


A long
-
term report

assesses the long
-
term sustainability
of current government policies.

Source: OECD (2001),
http://www.oecd.org/dataoecd/33/13/1905258.pdf




participation: participation by government employees and other internal
stakeholders is necessary for sound budget formulation; participation by
external entities stimulates operational efficiency; feedback by service users
is necessary to monitor access t
o and quality of the services; and in general,
participation is important to build public understanding and consensus
needed for implementing the difficult decisions made through the budget.


The idea of participatory budgeting takes the idea of civil
society’s
involvement in the budget process even further as citizens are involved in
budget decisions. First introduced in Brazil in 1
989 and since expanded to
more than 300 municipalities worldwide with the goal of improving state
performance and enhancin
g the quality of democracy (Wampler 2007) with
a particular emphasis on redistribution towards poorer citizens and
neighbourhoods.
Concerns about participatory budgeting include capture by
interest groups, the focus on executive initiati
ve and the (often d
iminished)

role of legislatures.




the rule of law underpins the legitimacy of the PFM system, supports budget
implementation, facilitates planning and delivery of services, and provides
the predictability that is necessary for good budget implementation as

well
as signpost to guide the private sector in making its own investment and
production decisions.

Legislative authorization of all public spending and
taxation also ensures the rule of law in public finance.




12




Improvements in PFM can be especially effective in reducing the incidence and
extent of corruption.
Corruption is an outgrowth of malgovernance
,

not a cause of
it. Defined as “
the abuse of public office for private gain
.” (World Bank) or more
broadly as “
the
mis
use of public office, roles or resources for private benefit

(OECD), corruption is costly for the economy, damaging to development and
particularly bad for the poor.
A recent IMF study, published in "
The
Many Faces
of Corruption: Tracking Vulnerabilities in the Sectors
" (World Bank, 2007) found
that “
countries
with better
-
performing

PFM systems have lower corruption
perception indexes.”


A.1.3. The gender dimension




While gender roles and cultural norms differ in different societies, non
-
discrimination on the basis of gender is a corollary of good governance, and should
be reflected, among other things, in the PFM system.




In most low
-
income countries, poverty and g
ender are closely correlated, with
women showing consistently more
unfavourable

human development indica
tors.
Moreover, corruption in PFM

has an especially severe impact on the poor, and thus
on women. The overarching goal of poverty reduction thus calls

for systematic
consideration of gender in the budgeting process.




Moreover, efficient allocation and use of public financial resources cannot be
achieved if any large group in society is systematically excluded from appropriate
participation. In additi
on to equity, the other central issue is the potential for
enhanced economic contribution of women by expanding opportunities

including
through the PFM system.




However, consideration of gender in PFM must not be designed and implemented
in ways that risk

weakening the integrity of the budget and fragmenting its unity
(see A.2.3 and B.3.1).




Consistent with the above, certain guidelines have emerged from international
practice, especially after the 1995 Beijing Conference on Women (see Budlender
et al
, 2002):




The degree of attention and resources devoted to gender
-
specific programs will
differ in different countries, and special ministries or programs devoted to
women’s affairs can be useful. However, they are not sufficient and should not
be taken a
s a substitute for systematic consideration of the impact of the overall
budget on gender;





gender and participation are closely related
--
to engage local government,
traditional rulers and civil society in the formulation of medium
-
term budget
policy; to

appraise the impact of the annual budget on different groups; conduct
beneficiary assessments; and monitor the actual execution of the budget;




13




among the various analytical and technical tools, those affecting the “upstream”
phases of budget preparation
are likely to be more effective than those targeting
the execution of the budget;




while the ministry of finance has an important role as motivator of gender
-
responsive budgeting, the responsibility and the “action” rest mainly with the
spending ministries

and agencies, and thus with their initial budget proposals;




in principle, a full program classification (see B.2.3
) is

necessary as the basis
on which to estimate the impact of the budget on gender. However, the fact
that program budgeting is unnecessar
y and impractical in low
-
income countries
and in most middle
-
income countries does not preclude systematically asking
the question of the probable impact on gender of different major budget
decisions, and is certainly not an obstacle to fostering broader p
articipation and
consultation in the budget process.




consideration of gender in PFM does not require more money, but only explicit
attention to the issue. Indeed, if implemented properly, consideration of the
gender dimension can lead to better quality a
nd/or lower cost of government
activities. (As just one example, understanding that in most African countries
women do the bulk of agricultural work leads to greater inclusion of women in
extension training programs and thus to improved agricultural produ
ctivity.)




g
ender budget analysis
is

often carrie
d out within government as part
of the
budget preparation process (either by law or through adopted practice).
For
example, the first gender budgeting initiatives in Australia were established
within governm
ent.

In Tanzania, a checklist developed by an NGO with the
Ministry of Finance assists planners and budget officers to consider general
issues in the medium
-
term budget strategy.




L
inking such analysis (whether gender or youth) to the budget preparation
pr
ocess, may
result in
reduce
d

legislative involvement because budget drafting
is usually treated as an executive
-
led activity

(
there is
, of course,

the further
challenge of increasing the number of women elected to national parliaments)
.





However,
developing a gender
-
sensitive

analysis can help to focus and
strengthen
parliamentary oversight and scrutiny more generally (European
Commission 2010).
South Africa is an example of a country which has been
successful in ensuring legislative involvement wi
th gender budgeting.

The
Finance Committee works alongside two NGOs through the Women’s Budget
Initiative which analyses the gender impact of government spending. A gender
committee has also been established in the Gauteng province for this end.







14

A.1.3.

The institutional context and the critical issue of capacity




Even the best formal mechanisms for good governance must be translated into
practice through good management of the public sector. To translate
improvements in governance into state effectiveness of the state and inclusive
economic growth thus requires a
strengthening of the capacity of the government.




“Capacity” is often and wrongly identified with human resources, and capacity
-
building is reduced simply to training. But new skills atrophy if not actually used,
and the training is wasted if the instit
utional and organizational environment is not
conducive to their use.




The
components of capacity

are:




institutional capacity: institutions are the “rules of the game”, i.e., the basic
processes and incentive frameworks that motivate people and influenc
e their
behaviour
;




organizational capacity: clarity of mandate and the internal structures
appropriate to administer the rules of the game;




information capacity, including both provisions for the flow of information and
the information systems that are a
ppropriate to the actual needs of the
organization and the broader context;




resources capacity, including financial, material
and

human resources

individuals with the skills commensurate with their actual roles and functions.




Adequate capacity is important for state effectiveness in general, but in particular
for
PFM


which requires clear rules, efficient structures, easy information flows,
and the economic, financial and accounting skills necessary for good budget
formulation

and implementation.
The choice of public financial management
systems and practices must therefore be guided by the realities of capacity in all
these four dimensions.




One should
distinguish formal institutions from the informal rules and customs

that
ma
y be even more important to determine behaviour and thus budgetary outcomes,
and be aware of the possibility of a discrepancy between formal and effective
power, laws and actual practices in government and society.




This point, too, applies also to the l
egislature, which in some countries is
essentially a rubberstamp for the executive despite the existence on paper of
substantial legal and formal powers.
Conversely, a legislature with limited formal
powers may prove effective at influencing the budgetary
process.

In such case,
persistently confronting the discrepancy between form and substance may, over
time, lead to strengthening the legislature.
The National Democratic Institute (NDI)
has produced a very useful Standards
-
Based Questionnaire which measures the
perception gap between the real powers of the legislature and the powers



15

legislators exercise in practice (NDI 2010). The difficulty between

‘having’ and
‘using’ power has been revealed in legislative assessment exercises in Rwanda,
Colombia and within Central and Easter Europe.




Capacity building is as important for the legislature as it is for the executive.
A
sound PFM system requires capa
bility in both branches of government. Indeed,
developing capacity within the executive branc
h alone is likely to lead to or
reinforce an imbalance of power in
favour

of the executive. Ideally, all capacity
-
building initiatives ought to be designed in an

integrated manner to strengthen the
regulatory and organizational framework, information flows, and skills in both the
executive branch and the parliament. In practice, the much weaker position of the
legislature in many low
-
income countries suggests a s
pecial effort to strengthen the
ability of legislators to understand the basic PFM issues and build the technical
infrastructure and staff of the main parliamentary committees dealing with
economic and budgeting issues.



Table 1

Is there a specialized
budget research organization attached to the
legislature that conducts analyses of the budget?



Number of countries

Percentage of total

Yes, with less than ten professional staff

7

18%

Yes, with ten to 25 professional staff

1

2%

Yes, with 26 or more
professional staff.

3

8%

No

28

72%

Total

39

100%

Source: OECD (2003),
http://ocde.dyndns.org/





Many of the more active legislatures, in budgetary terms, have substantial budget
research capacity. The
Congressional Budget Office in the United States has about
230 highly trained staff. Some legislatures have smaller research units that
specialize in budget analysis, and yet others have general research units that can
deliver some budget analysis when nee
ded. However, in many legislatures’ budget
research capacity is negligible or nonexistent. Building such capacity should be a
component of efforts to strengthen the role of the legislature in budgeting.
Parliamentary budget research capacity can be complem
ented with analyses by
independent think tanks, private sector economists and academics. In some
countries, individual parliamentarians or political parties represented in the
legislature employ specialized budget researchers.











16

Table 2

What is the
total number of special professional staff serving political
parties and dealing largely with budget issues?



Number of countries

Percentage of total

None

8

25%

Less than 10

19

59%

Between 10 and 25

4

13%

Over 25

1

3%

Total

31

100%

Source: OECD (2003),
http://ocde.dyndns.org/





The importance of capacity building support for parliaments is increasingly being
recognised. One fundamental reason for this trend if that strengthening the ability
of parliaments to review budgets and government policy relating to aid contributes
to coun
try ownership, rather than government or ruling party ownership. In
addition, the shift towards direct budget support as a primary vehicle for
democratic assistance
has increased the need for effective democratic oversight;
and representative institutions
are therefore essential.




One recent trend has been the establishment of legislative or parliamentary budget
offices (PBO).
A PBO is an independent, objective unit
that specializes in high
quality research and analysis on fiscal policy for the Parliament.

It provides
independent, non
-
partisan and policy neutral analysis on the full budget cycle,
fiscal policy and the financial implications of proposals
.




Four core functions have been identified for such independent analytic units.
These are independent, ob
jective economic forecasts; baseline estimates
(projections, not predictions); analysis of the Executive’s budget proposals; and
medium
-
term analysis for all the core functions mentioned. Some of the
suggested wider functions of independent budgetary units

include the Analysis
of Proposals; Options for Spending Cuts; Analysis of Mandates; Economic
Analyses; Tax Analyses; Long
-
Term Analysis and Policy Briefs

(Anderson
2008).




While there are some examples of PBOs issuing recommendations (
Californian
Legislative Analyst Office)
, their basic function is to provide technical and
objective information to the legislature and they are normally very careful
not
to become too associated with policy development for fear of drawing the
office into political deb
ate, and compromising its independence and
impartiality.




Development agencies have reported that even nascent budget offices have
already improved legislators’ ability to interpret, review and make sound
judgments related to the budget (Hubli and Schmidt,

2005; Wehner 2007) and
recent experience suggests that the opportunity for parliament to oversee the
national budget has been dramatically enhanced even if broad use of PBO



17

reports by MPs may still be modest (Straussman & Renoni 2009). Given that
many of
the independent budgetary units are new, there has been very little
empirical cross
-
country evidence as to the extent of their influence on
economic and fiscal performance.



A.1.4 Globalization and PFM




Interdependence has always been a reality of economic activity and international
trade. “Globalization” entails a
particularly rapid

reduction in economic distance
and increase in interdependence, and thus special difficulties in managing the
process and
its implications.





The current wave of globalization has been especially uneven, with large benefits
but also significant costs, and the distribution of benefits among countries and
groups within countries has differed from the distribution of costs. M
oreover,
globalization is a two
-
way channel, making it easier to transmit both positive and
negative changes, including “contagion” from financial crises.





With reference to PFM, globalization entails a “positive” restraint on the ability of
governments

to sustain persistent and structural fiscal deficits, and a “negative”
constraint on the implementation of their independent social policies and
redistributive objectives.




Globalization also carries major implications for PFM:




owing to the constraint on

raising tax rates and increasing expenditure, tax
administration efficiency, good expenditure management and more rigorous public
investment programming become particularly important;




given the importance of transparency and accountability for transbound
ary
activities, it is critical to adopt and credibly implement standard norms of
budgeting, accounting, reporting and audit.




f
iscal risks
have been
increasing

owing to t
he integration of
international
financial
markets
, which

generate
larger

and volatile

cross
-
border flows,
and may oblige
governments

to intervene to support their financial system.




some argue these trends have reduced the importance of political ideology with
elections increasingly being decided over an incumbent government’s economic
competence and a country’s successful integration into global market structures.




Globalization is also having a huge impact on legislators and legislatures. All
politics may be local, but it is now imperative for parliamentarians to consider
global issues. Globalization is also changing the links between citizens and their
representati
ves with citizens generally more informed through the spread of
information
-
sharing which in turn is increasing the demands on elected
representatives.




18


A.2 The Policy, Macroeconomic and Fiscal Context

As instruments of a well
-
governed state, tax admin
istration and public
expenditure management should never be considered in isolation, but aim to
implement government policies and fit into a coherent framework of decisions
affecting the economy as a whole.



A.2.1 Linkages between broad policy objecti
ves and fiscal & expenditure
management




PFM

is not the same as
public financial

policy.

The latter focuses on ‘what’ is
to be done (e.g. w
hat
should be the

level of government expenditure?
) and the
latter focuses
on ‘how’ it is to be done

(e.g.
ho
w
to
realise the desired level of
government

expenditure?
)

PFM can therefore be analysed separately
regardless
of the country’s policy

choices, but is also instrumental in achieving public
finance policy objectives.




The three main
policy objectives

are economi
c growth, financial stability, and
equity

sometimes

merged into the aim of “sustainable and inclusive growth”.
In pursuit of these goals, several types of policies

exchange and trade
policies, monetary policy, fiscal policy and various sector policies

nee
d to be
brought together into a coherent policy package consistent with both the goals
and the available resources.




In particular, to
link public financial management with the policy objectives

calls for:




consistency, between the budget and the government policies


the
budget is the government’s principal policy document


government
“priorities” should be backed up with budget allocations.




realism, with expenditure programs both affordable and implementa
ble




stability, from a vision and sense of direction for the medium term




openness and clarity, of criteria and processes of expenditure choices




selectivity, from an appropriate institutional mechanism to filter out
minor issues and focus policymakers’ attention on the major revenue
and expenditure issues; and




communications, to assure a good understanding of the budget and the
policies it pursue
s in order to underpin its approval and subsequent
implementation.





19



A long
-
term vision of development

m
ust underpin government policy,
particularly in low
-
income countries needing to escape a low
-
equilibrium trap.
Stagnation is different from stability
.

Such a policy must be shared and agreed
between the executive and legislative branches of government; communicated
effectively to the population at large; and articulated in strategies for the main
sectors (including both the government and the private ro
les in each sector) that
can guide investment and budgeting decisions coherent with the overall vision.


A.2.2 Planning and macroeconomic programming




A long
-
term vision is necessary for development, but needs to be articulated
into realistic
medium
-
term and annual macroeconomic programs that embody
the above
-
mentioned coherent policy package. The main building blocks of
such programs are:




“external”

covering international trade, exchange rate and financial flows;




monetary

covering interest
rates, credit, banking, and the quantity of
money;




“real sector”

covering production in the various economic and social
sectors and the macroeconomic aggregates of GDP, national savings, etc.;




government finance

covering forecasts and policies on revenu
e and public
expenditure.




Each of the four components must be
analysed

in light, among other things, of
the interaction with the other three components, because changes in any of the
components necessarily affect projections in the others.




The basic model underlying macroeconomic programming remains that
elaborated in the 1970s by Jacques Polak of the IMF. However, the model
provides only the starting point and assures internal consistency and precludes
contradictions. The process of macroe
conomic programming is inherently
iterative, with judgment and deliberate decisions intervening at various points
to eventually produce a framework that embodies both the policy priorities and
the economic and financial realities.




In low
-
income countries

subject to particular uncertainties, such as fragile
states and others, it may be necessary to produce several macroeconomic
scenarios instead of a single framework and in any event to make frequent
adjustments as and when unforeseen changes occur. (This

is especially the
case of aid
-
dependent countries, when disburse
ments are less than predictable
.)








20

A.2.3 Fiscal programming and adjustment




With government finance one of the four main components, projections and
decisions on government revenue and

expenditure are a central part of
macroeconomic programming (and public sector management as a whole).
Moreover, fiscal programming has acquired increasing importance during this
century as a result of three main trends:





exchange rates have become le
ss flexible (e.g., with the introduction of the
euro in 2002) and

partly related to the demands of globalization
--
a
tendency has emerged to leave exchange rates unchanged except in response
to major and permanent shocks;




some convergence of interest rat
es among countries has occurred;




a tendency has risen to reduce the role of the state and shed many of the
functions it had taken on in earlier years

a tendency that was reinforced by
the global f
inancial crisis of 2008
-
2011.




Correspondingly, the
challenge of economic adjustment has shifted more to the
domestic side, and in the domestic side primarily on the public finances. To
remain consistent with the broad goals of growth, stability and equity, efficient
fiscal adjustment
must meet the following
conditions:




put everything on the table
. Because the fiscal balance results from both
revenue and expenditure (which affect different population groups in
different ways), fiscal programming should normally include an appropriate
m
ix of both revenue and expenditure measures.




similarly,
examine the totality of expenditure
, to allow comparison of
relative costs and advantages of changing one or another type of
expenditure;




do not allow any category of expenditure to be define
d as a residual
, and
avoid focusing expenditure cuts only in those categories where they are
politically or administratively easier;




conversely,
avoid across
-
the
-
board proportional cuts
, which would
preclude consideration of a more efficient allocation of

expenditure among
different uses.




provide an
appropriate balance between current and capital expenditure

(see C.3.1)
, to prevent shortchanging essential operations and maintenance
or, on the other hand, cutting public investment needed to complement
private activity and for growth; and





21



assure the
fullest measure of consultation

of the service users and the public
at large.




For the purpose of formulating the macroeconomic and fiscal framework, and
conducting all related studies and analyses, it is im
portant for any government to
have a dedicated unit (in the ministry of finance or the office of the head of
government).

This in turn should be overseen by a dedicated parliamentary
committee.


A.2.4 The meaning and limits of fiscal responsibility




The

broad aim of fiscal programming is not to achieve a particular fiscal surplus or
deficit, taken in isolation, but to achieve a fiscal target that is consistent with the
other components of the economy and with government policies.




Nor does fiscal resp
onsibility mean to either raise taxes as needed to finance all
deserving expenditure goals or cut expenditures in order to reduce the size of
government. The appropriate size of government is a legitimate subject for
political debate. However,
the meanin
g of fiscal responsibility is to aim for an
overall fiscal situation that is sustainable and appropriately financed.




As fiscal sustainability uses a much longer time horizon, it is different from
economic effectiveness (which is normally related to
profits and losses).

Fiscal
Cou
ncils or
PBOs can act as a watchdog for fiscal sustainability by assisting the
executive and legislature lengthen its planning and budgeting horizons. For this
reason the Californian L
AO

prepares a long
-
term fiscal forecast t
hat also examines
demographic trends that have a direct bearing on the state budget, such as the
number of Californians in their peak earning years and the number of children who
will be attending school.

The
Medicare

programme in the United States is anot
her
useful example of an
issue that has generated
much political debate about fiscal
sustainability.


Box 4
: The Golden Rule


1.
Deficits should be a temporary phenomenon balancing out the economic cycle.

2.
Consequently, debt should remain stable over the

economic cycle.

3.
Except if the asset is backed by an asset of at least equal value as a collateral.


Source: Bergmann 2009




Binding rules on specific fiscal outcomes have been included in legislation in some
countries. (E.g., the “golden rule” in
Germany prohibits borrowing in excess of
investment, thus precluding a current account deficit.) Other countries choose to
set out numerical fiscal targets in the budget and limit the fiscal rules to general
criteria
.
(e.g., in New Zealand prudent levels o
f debt, maintaining adequate net
worth to guard against fiscal shocks, prudently managing fiscal risks, achieving
reasonable predictability and stability of taxation rates)
.
Other examples include:




22



Chile aims for a fiscal surplus when copper prices are strong and permits a
fiscal deficit if they are weak.




In Indonesia, safeguards are in place which set the maximum deficit at 3
percent GDP and the maximum cumulative deficit at 60 percent o
f GDP
.



Special fiscal requirements in Mongolia stipulate that the total budget
expenditure growth rate shall not be more than the greatest of the non
-
mineral GDP growth rate and the average of non
-
mineral GDP growth rate
for 12 consecutive years
prece
d
ing

the par
ticular year (Article 6.1.3 of the
Law of Mongolia on Fiscal Stability). These special requirements may be
suspended temporarily if the GDP growth of a particular year compared to a
previous year equals to 0% or below or in the event of a disaster and
emer
gency situation (Article 8).




Laws or regulations mandating specific fiscal outcomes


sometimes referred to as
“fiscal responsibility rules” have the following problems and possible advantages:




they may
favour

“creative accounting” and hamper fiscal transparency by
leading the executive branch to “play games”;




Without rules limiting expenditure, extra revenues may be automatically spent
by governments seeking re
-
election.




on the other hand, if strictly appli
ed, they can prevent governments from
adjusting their budget to the economic cycle, thus worsening both recessions
and inflationary pressures (e.g., the reason why the limits set in Europe by the
Maastricht treaty on deficit
-
GDP and debt
-
GDP ratio were de
facto
abandoned);




they are in effect a government’s contract with itself, lacking an effective
external enforcement mechanism, and thus become dead letter as soon as the
government decides to violate them.

However, there may be a political sanction
if they fail to meet the fiscal target.




however, binding fiscal outcomes can work in countries where a vibrant civil
society and active political system exact a swift price for broken economic
promises;




in coun
tries with fragile coalition governments and fragmented decision
-
making setting binding targets may serve to limit political bargaining;




binding rules may be effective in subnational government entities, where the
enforcement mechanism is provided by the
national government.









23

Box 4
: A note on fiscal d
ecentralization


Decentralization of central functions to lower level government units has become an important
element of public sector reform in recent years. It is hoped that decentralization can promote local
innovation, match services with local preferences, and that g
reater accountability to local
communities can achieve more efficient provision of essential services where central government
has not been able to deliver. However, in the initial stages of decentralization, there are often
capacity bottlenecks at the sub
national level. For this reason, fiscal decentralization should be
complemented with adequate oversight and accountability mechanisms to ensure that the process
of decentralization is managed optimally and to guarantee equitable access to services. For
ins
tance, the legislature should have access to detailed spending information across levels of
government, and it should scrutinize the underpinning revenue sharing arrangements.


Source: World Bank (2012)

http://parliamentarystrengthening.org/budgetmodule/p
df/budgetall.pdf



A.3 The Revenue Side


Because decisions on public expenditure must be viewed in the context of the
overall economy, and be consistent with realism and affordability as well as
policy goals, sound management of government
expenditure

begins with reliable
forecasts of government
revenue,
which is a function of both tax policy and tax
administration.


A.3.1 Basic principles of tax policy




Taxes have been defined as
the price we pay for a civilized society”.

It has become
an important feature of democratic governance that the executive cannot
arbitrarily
impose taxes, and that parliament must pass legislation permitting taxation of the
population.
Accordingly, the basic principles of taxation are:




legitimacy
: no moneys taken from the people without explicit approval of the
people, through their legislative representatives;




efficiency
: maximize revenue relative to collection cost;




equity
: equalize the burden of taxation
as a whole

across individuals, group
s
and regions;




Direct taxes are levied on income or capital, for example income tax. Such taxes
are called direct because it is normally assumed that the real burden of payment
falls directly on the person or firm that is immediately responsible for payin
g
them. By contrast,
indirect taxes

such as sales taxes or excise taxes on alcohol
and tobacco are so called because it is assumed that the real burden of paying
the tax will not fall on the firm immediately responsible for paying it but rather
that it will be passed on to the customer.






24

Box 5
:
Main Types of Taxes


property

taxes (real estate, land use, wealth, and inheritance taxes)


highly equitable in principle,
difficult to administer in low
-
capacity countries;


income

taxes (on individuals and corporations)


both equitable and efficient, but require strong
enforcement to prevent evasion;


transactions

(sales taxes, value added taxes, customs duties)


least equitable, but simplest to
administer and thus a main revenue

source in low
-
capacity countries.





The relative burden of taxation depends on the degree of tax “progressivity”:




in a progressive tax, the tax
rate

increases as taxpayer income increases; in a
proportional tax, the rate is constant; a regressive tax takes a higher percentage
of income from lower
-
income taxpayers. Income taxes are generally
progressive; transaction taxes are generally regressive;




p
rogressive income taxation is justified mainly by: (i) the disproportionately
greater benefit received by the richer citizens from the protections of organized
society; (ii) their presumed lower subjective “pain” when paying a higher tax;
and (iii) the nee
d to offset the regressivity of the other forms of taxation.




however, assessing the impact of
overall

government activity on different
individuals, groups and regions requires taking into account not only the
distribution of the tax burden but also the di
stribution of the benefits from
public expenditure.
W
here the formal economy is small, excessive taxation of
a few high income individuals can undercut investment, which hampers growth
and employment creation. Over time, this might erode the tax base and
reduce
the ability of government to raise revenues. Raising an adequate amount of
revenues, while at the same time preserving equity and stimulating economic
growth, can be a difficult balancing act.




Tax policies must be coordinated among the central, reg
ional and local levels of
government
based on clear rules.
The assignment of tax revenues among levels of
government (“fiscal federalism”) is intended primarily to avoid tax gaps, double
taxation, or “migration” of tax bases that would lead the regions

to

compete in
providing

lower and lower tax rates.





Accordingly,
taxes appropriate to the central government

are those that:





cover mobile tax bases (e.g., corporate income);




are sensitive to changes in income and thus useful for macroeconomic
stabilization;




cover unevenly distributed tax bases (e.g., natural resources); and




25




customs duties (which are the easiest to administer owing to the existence of
national boundaries).




Estimates of tax revenues often cause controversy because underestim
ated
revenue estimates may enable governments to exercise greater discretion over
the allocation of nonbudgeted revenues. This has been a problem in Latin
America. Similarly, parliament in many cases can only increase the budget if it
identifies sources o
f additional finance and changing the forecasted collection
of tax revenues is a tempting device which can undermine the integrity and
reliability of fiscal information. An independent analytic budget unit providing
budgetary, economic and tax analyses wi
ll help prevent this.




Further good practice takes place in Jamaica where the

Public Administration
and Appropriations Committee (PAAC)
of Parliament
examine
s

a midyear
report on the country’s fiscal performance and advise
s

the Tax Measures
Committee of P
arliament as to the revenue raising requirement for the ensuing
fiscal year.


A.3.2 Tax administration





The best tax structure is worth little in the absence of effective

administration and
enforcement.





The effectiveness of tax administration
depends among other things on the extent of
state capacity: in low
-
capacity countries, the most important requirements are
simplicity of the tax system, and high
-
level political support for robust and fair tax
collection.




The main
objectives of tax admini
stration

are:




facilitate compliance
--
because voluntary compliance is key to effective
implementation of the rules
--
through making it as easy and inexpensive as
possible for taxpayers to register, report, and pay their taxes;




enforce compliance

by streamlining the tax rules in order to reduce the
opportunities for tax
avoidance

(which is legal), and by aggressive pursuit of
illegal tax
evasion

but through a coherent enforcement strategy rather that by
isolated actions to catch individual cheater
s;




assure integrity and combat corruption

so prevalent in tax collections

mainly by providing adequate compensation to tax collectors, swift and
predictable punishment for violators, and limiting as much as possible direct
contacts between taxpayers and t
ax collectors and the
extent of discretion left to
tax officials.






26

Private Study

Assess your country’s PFM system using the Worldwide Governance Indicators.


E
-
Discussions


To what extent do gender budget analyses in your country take place within and
outside government? What policy benefits have such analyses delivered in practice?


To what extent do the taxes set in your country meet the basic principles of tax
policy?


Fu
rther Reading:


On governance: World Bank,
Governance and Development,
1992.


On governance indicators: Hazel M.McFerson, “Measuring
Governance: By
Attributes or By
Results?”,
Journal of Developing Societies
,
June 2009.


On gender in the budgeting system: D. Budlender et al,
Gender Budgets Make
Cents:
Understanding Gender
-
Responsive Budgeting.
London: Commonwealth
Secretariat, 2002.


On the nature of institutions: Douglass North, "Institutions,"
Journal of Economic
Persp
ectives
, 1991; Fred W. Riggs,
The Ecology of Public Administration
. New
Delhi: APH, 1961.



On corruption: OECD,
Public Sector Corruption, an International Survey of
Prevention Measures,

1999;

Ledivina Carino (ed.),
Bureaucratic Corruption in
Asia: Causes, Consequences and Controls,
1986;

World Bank,

Helping Countries
Combat Corruption
, 1997.


On state capacity: World Bank,
Building Effective States, Forging Engaged
Societies,
2005.


On parliamentary budget offices:
B. Anderson
. (2008) ‘The Value of a Nonpartisan,
Independent, Objective Analytic Unit to the Legislative Role in Budget
Preparation’ in
Legislative Oversight and Government Accountability: A World
Perspective

by R.
Stapenhu
rst, R
.
Pelizzo, D
.
Olson and L
.

Von Trapp.
World Bank
Publications
.


On macroeconomic programming: Jacques Polak, “The IMF Monetary Model: A
Hardy Perennial”,
Finance and Development
, December1997.


On tax policy:
Jonathan Gruber,
Public Finance and Publ
ic Policy.
Cambridge:

Worth, 2004.


On tax administration:
Richard Bird, “Smart Tax Administration”,
Economic
Premise,
No.36,
World Bank, October 2010.




27

Unit 2
:

PUBLIC FINANCIAL MANAGEMENT:
CONCEPTS, OBJECTIVES AND SYSTEMS



Learning Objectives

What
are the basic concepts, objectives and systems in PFM?



After studying this unit, you should be able to:




Understand the meaning and relevance of the three main objectives of PFM
and how they are linked
;




Distinguish the three main types of budget: cash, commitment and accrual.




Discuss the advantages and difficulties associated with the concept of
performance budgeting
;




Appraise the system of budget classification used in your country; and




Summarise the

key issues relating to budget coverage, fiscal risk and fiscal
responsibility



B.1 Basic concepts and objectives of public financial management


The basic unifying concept is that the government budget should be a financial
mirror of society’s
economic and social choices. Thus, the bedrock of PFM
legitimacy is that the executive branch of government can take no money from
the people nor spend it on behalf of the people without the express agreement
of the people
--
through their elected legislatur
e. As the heart of public financial
governance, the budget must be approved by the legislature. However, if it is
to be technically sound and consistent with economic realities as well as policy
objectives, the budget should be prepared, and implemented, b
y the executive
branch

with input from key stakeholders
. Clarity of roles and responsibilities
between and within each branch of government is also critical.




As a central instrument of policy, public financial management must pursue all
three policy goal
s of stability, growth and equity. This translates into the
following three
objectives
:




fiscal discipline
, through expenditure control;




efficient allocation of resources

to the various sectors, consistent with policy
priorities;




efficient use of
resources
, by enabling good operational management to deliver
quality public services.




28



Table 3

Basic elements of public expenditure management

Objective

Requirements

Aggregate
fiscal discipline

Budget totals should be the result of explicit, enforced
decisions; they
should not merely accommodate spending demands. These totals should
be set before individual spending decisions are made, and should be
sustainable over the medium term and beyond.

Allocative
efficiency

Expenditures should be based on gove
rnment priorities and on
effectiveness of public programs. The budget system should spur
reallocation from lesser to higher priorities and from less to more effective
programs.

Operational
efficiency

Agencies should produce goods and services at a cost
that achieves
ongoing efficiency gains and (to the extent appropriate) is competitive
with market prices.

Source: Schick (1998).





Aggregate
fiscal discipline

refers to the control of the key measures of fiscal
performance, including total spending, total revenue, the financial balance and
the public debt. Fiscal discipline requires that budget totals are the result of
explicit and enforced decisions
. Many fact
ors are important for determining the
appropriate total level of aggregate spending, including available revenues,
access to borrowing and the acceptable level of the deficit. Given these
constraints,
fiscal discipline calls for affordability of total spending, including in
the medium to long term.




Some countries have adopted formal rules to ensure fiscal discipline, for
example by allowing borrowing for capital purposes only (the so
-
called
‘golden ru
le’



see A.2.4
). A strong treasury or finance ministry can check
that spending departments do not make exaggerated claims on the budget
and that they stick to their budgets once they have been approved. A hard
budget constraint on departmental spending ex
ists when the treasury is
successful in enforcing approved budgets. This requires comprehensive and
reliable information to monitor compliance of government departments
with spending plans. To safeguard fiscal discipline, parliament has to resist
the tempt
ation to add new spending without commensurate cutbacks
elsewhere in the budget.




Because resources are limited, budgeting forces us to consider the merit of
competing
claims on the public purse and to negotiate tradeoffs between them.
The achievement of
allocative efficiency

or strategic prioritization requires
government capacity to allocate resources and select programs and projects in
conformity with its objectives. This process is supported

where the policy basis
of the budget is stated clearly on the

basis of a medium term strategy.




Allocative efficiency is threatened where spending departments are bailed
out when they overspend, because

poor budget execution can introduce



29

substantial ad hoc realignments that distort stated priorities. Such
distorti
ons often divert resources away from the poorest and most
vulnerable groups in society to cater for the interests of bureaucracies and
strong interest groups. Parliament can provide an important platform for
public debate on the nation’s priorities.




Once
funds have been allocated they should be spent so as to deliver maximum
results.
Operational efficiency

is the ratio of the resources expended by
government agencies to the outputs produced or purchased by them. Spending
departments should strive to
elimin
ate waste and produce goods and services at
a cost that achieves ongoing efficiency gains.
To provide managerial incentives
for operational efficiency

high level civil servants

can be given
performance
contracts that spell out clear objectives and targets.




E
ffective parliamentary scrutiny and accountability for results can support a
mind shift in spending departments from a mentality of compliance to one
of achievement.

Parliaments increasi
ngly consider not only the allocation of
money, but also what is delivered with that money.
To facilitate legislative
review of departmental performance the format of the budget needs to go
beyond the traditional focus on cost and inputs. Also needed is in
formation
on strategic objectives, output targets (the amounts of goods and services to
be delivered) and outcomes (the effects or impact of the activities carried
out on the community). Parliamentary scrutiny of audit findings also
strengthens accountabil
ity for performance.


Box 6
: Examples of Output Targets


Volume:
The agency will process 652,400 claims during the fiscal year.

Timeliness:
97 per cent of claims will be processed within three days of receipt; 99
per cent within five days.

Quality:
The
error rate on determination of eligibility shall not exceed 2 per cent. The
error rate on amount paid per claim shall not exceed 3 per cent.

Service quality:
At least 60 per cent of recipients are very satisfied with the service.
At least 80 per cent are s
atisfied with the service.

Unit costs
: The average cost per claim processed will be $4.62.


Source: Alan Schick (1999)
The PFM handbook: a contemporary approach to public
expenditure management





For the public financial management system to be both legitimate and sustainable,
all three objectives must be pursued in full respect of proper norms and
due
process.





Although separable, the PFM objectives are complementary

mainly because good
budgetary

outcomes at the aggregate government level should emerge from sound
expenditure control and good operational management in each ministry and agency.





30



Some
argue that
fiscal discipline comes first. For example, politicians often
promise improving macroeco
nomic conditions such as higher growth, less
unemployment and lower inflation, all of which impact on the amount of revenues
government expects to collect. Overly optimistic revenue forecasts are politically
tempting because they create an imaginary space
for promises of more money on
services. The inevitable revenue ‘shortfalls’ result in higher deficits or necessitate
expenditure cuts that distort spending priorities so that allocative efficiency is
undermined. In
-
year spending cuts also undermine predict
ability, which is an
important prerequisite for operational efficiency in departments.




To be transparent government should publish the macroeconomic assumptions and
projections upon which the budget is predicated. It is a good test of government’s
budget
ary foundation to consider whether its growth forecasts are substantially
more optimistic than those produced by the private sector and international
organizations. If this is the case, it is rather likely that the budget is unsound.
Unrealistic assumption
s about improvements in revenue collection are another
symptom of escapist fiscal planning. Such tactics threaten to undermine the
objectives of budgeting.


B.2 Budget types, budgeting systems and budget classifications



Budget types and budgeting systems are essentially determined by the form and
purpose of the authorization given by the legislature to the executive branch of
government. Each budget system has advantages and disadvantages

which
must be examined in light
of the specific circumstances of the country, and
particularly the quality of governance, the nature of institutions and the extent of
state capacity. Also, each budget system requires a uniform classification and
complementary provisions to address its li
mitations and improve the chances of
positive budgetary outcomes.


B.2.1 Types of budgets




Types of budgets depend on the
form of the authorization

by the legislature
. The
three

main forms are as follows.




In a
cash budget
, the legislature authorizes the executive to
make payments

for
the approved purposes up to specified amounts within the fiscal year. These
cash limits cannot be exceeded, but there is no legal limit on commitments (i.e.,
contracts). Thus, in a cash budge
t, there is a risk of accumulation of payments
arrears in the absence of provisions to prevent it.




In a
commitment budget
,
the legislature authorizes the executive to
enter into
commitments

for the approved purposes up to specified amounts within the
fisc
al year. The amount of commitments cannot be exceeded, but there is no
legal limit on cash payments. Thus, in a commitment budget, the consistency
between the fiscal, monetary, real sector and balance of payments accounts that



31

is required for macroeconomi
c programming cannot be assured in the absence
of provisions to that purpose.




In an
accrual

budget, the focus is on revenues earned and liabilities incurred
rather than cash flows (money received and payments made). Many
governments report finances in the
accrual basis (ex
-
post), but few countries
have adopted accrual budgets (ex
-
ante).





A ca
sh budget is preferable for most countries
, as it fits more easily with the
monetary dimension of the macroeconomic framework, and is best suited to the
circumstances of low
-
income countries and most middle
-
income countries, owing
to its greater transparen
cy and ease of control.




Adoption of the same basis for budgeting and accounting will add complexity to
political budget debates, but may well lead to greater coherence in the budget
system over time

(see
D.3.1)
.


B.2.2. Budgeting systems




Budgeting systems can be classified according to the
purpose of the authorization

by the legislature: to purchase inputs for government activity
; to produce specific
outputs;
or to achieve certain results
.


Box
7
:
Outputs and Outcomes


Output

Output is the

amount of goods or services produced and delivered. It is measured in
absolute numbers quantities.


Outcome

Outcome is the result of the delivery of goods or services to the public. It provides the
rationale behind the supply of goods and services and is
measured by set objectives.
However, it is often difficult to link the outcome

directly to a specific output.


Source: Bergmann 2009




In
line
-
item budgeting
, the money is authorized for the purchase of “objects” (the
various goods and services required for government activity
--
e.g., purchase of
vaccines for child immunizations). The executive branch is therefore accountable
for the total expenditure as well a
s for assuring that the money is spent to purchase
the items for which it was allocated. The executive branch is not directly
accountable for the efficiency of use of resources and the achievement of certain
goals

in the absence of complementary provision
s to those purposes. Line
-
item
budgeting remains the most widespread budgeting system.




Performance
-
based budgets shift budgets away from decisions on inputs to
decisions on outputs or outcomes. The term has no standard definition, and can be
applied to