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ANALYTICAL TOOLS
VERSUS BUDGET RULES
SHOULD NEW FORMS OF DATA AND ANALYSIS
INFORM BUDGET MAKERS OR CONSTRAIN
HOW THEY ALLOCATE MONEY?
ALLEN SCHICK
International Monetary Fund
19 September 2007
PRESENTATION
International Monetary Fund
19 September 2007
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1.
TOOLS AND RULES
 Many analytic concepts can be formulated into rules that guide or
constrain budget and other policy actions of government
 Alternatively, analytic tools can be deployed solely to inform decisions,
but not to dictate how governments allocate resources
 This seminar reviews tools that have been proposed as rules and
explores criteria for determining the adoption of new rules
2.
TOOLS THAT HAVE BEEN CAST INTO DECISION RULES
 Baseline projections that estimate the future cost of current policies
 Medium-Term Expenditure Frameworks that limit future spending
 Fiscal Rules that limit key fiscal aggregates, such as the deficit
3.
TOOLS THAT HAVE NOT BEEN TRANSFORMED INTO RULES
 Herbert Stein’s proposal to allocate the budget as shares of GDP
 The Tax Expenditure Budget and the Regulatory Budget
 The Program Budget Concept to allocate money according to
government objectives rather than spending units
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4.
5.
CRITERIA FOR DETERMINING WHETHER TOOLS SHOULD BE
FORULATED AS RULES

Lessons from past successes and features

Why governments should be parsimonious in devising new
rules

Proposed Criteria

Applying the criteria to accrual budgeting and performance
budgeting
CONTEMPORARY CANDIDATES FOR NEW RULES

Accrual Accounting and Accrual Budgeting

Performance-Based Budgeting for link resources and results
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ANALYTIC TOOLS VERSUS BUDGET RULES
 An analytic tool assists budget makers in deciding the purposes and
amounts to be allocated
 A decision rule is information that dictates either how decisions are made
or the types of decisions
 Medium-term projections that inform budget makers of the future fiscal
outlook are analytic tools
 Medium-term frameworks that limit future spending or other budget
elements are decision rules
 Economists often seek to convert analytic tools into decision rules
because of concern that the information will not be used in deciding the
budget
 Over the years, both analytic tools and decision rules have proliferated in
budgeting
 Not every tool of analysis is appropriate for making budget decisions:
tools expand budget choice, rules constrain choice
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PARSIMONY IN BUDGETING RULES:
EXPENDITURE CLASSIFICATION
 The classification of expenditure is one of the most important decision
rule in budgeting
 Government can have only one decision structure in budgeting
 It can have multiple supplementary classifications which serve as
analytic tools
 The traditional classification has been by organizational units and
items of expenditure (inputs)
 Efforts to replace spending units as the decision structure through
program or performance budgeting have been unsuccessful
 The organization structure has survived as the main decision structure
because it is the basis for implementing the budget, carrying out
authorized activities and maintaining accountability
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TOOLS THAT HAVE BEEN CAST INTO
RULES: BASELINE PROJECTIONS
 Baseline projections of Medium-Term or longer budget
trends under current policy have become the starting
point for budget work in many developed countries, as
well as the official benchmark for measuring the budget
impact of proposed or adopted policy changes.
 In Most countries, these projections began as internal
estimates in the finance ministry or budget office. It used
the projections to inform itself of the fiscal outlook for the
years immediately following the budget year. Over time,
projections were improved and published, and were
converted into the standard metric for budget decisions.
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BASELINE: WHY THIS TOOL WAS
FORMULATED INTO A RULE
 Baselines serve other recent innovations in budget rules, in particular
medium-term frameworks and fiscal rules. These innovations would not
be workable without authoritative baselines.
 Baselines strengthen the finance ministry in negotiations with spending
units, for it can show the downstream impacts of expenditure increases
on the government’s fiscal position.
 Baselines serve the interests of program beneficiaries and government
agencies by building price or workload changes into projections,
thereby shifting the focus of budgeting from cash to volume.
 Baselines recognize the inherently incremental character of budgeting
by focusing budget decisions on marginal changes.
 Baselines comfort with the shift in budgeting from control of inputs into
a process for deciding policy changes.
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TOOLS THAT HAVE BEEN CAST INTO
RULES: FISCAL RULES
 Fiscal Rules limit one or more fiscal aggregates, such as the
balance between revenue and expenditure, the primary or
structural deficit, or total expenditure as a share of GDP. The
rules are set in advance of submission and review of budget bids,
and typically pertain to the Medium-Term or longer.
 Fiscal Rules were introduced near the end of the 20 th century in
the form of targets that guided but did not constrain budget
decisions. Often, the targets were political statements that lacked
enforcement, but were intended to indicate that the era of rapid
expenditure growth that permitted large deficits had come to an
end. Goaded by regional treaties (particularly the Stability and
Growth Pact, IMF conditionalities, and fiscal responsibility laws,
fiscal rules have become a prominent feature of budgeting.
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FISCAL RULES: WHY THIS TOOL WAS
FORMULATED INTO A RULE
 Regional and international organizations have monitored compliance
and have occasionally intervened to enforce the rules.
 Voter and political resistance to tax increases and government
expansion, and projections from long-term fiscal imbalances due to
the ageing of the population have emboldened politicians to embrace
fiscal constraints.
 Finance ministries welcome the bargaining advantage given them by
fiscal rules in cabinet debate and bilateral negotiations with spending
ministries.
 Research on fiscal institutions by Von Hagen and others influenced
governments to accept fiscal rules.
 Financial crises (East Asia, Sweden, Latin America) persuaded
political leaders of the need for stronger fiscal discipline.
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TOOLS THAT HAVE BEEN CAST INTO RULES:
MEDIUM-TERM FRAMEWORKS (MTEF)
 MTEF extends budget decisions from the year immediately
ahead to the medium term, typically the next 3-5 years.
Decisions for each of the out-years are firm, but may be
revised as the MTEF is rolled forward each year. Although
MTEF has been introduced in many countries, only a small
number have fully integrated annual budgeting into the
Medium-Term Framework.
 MTEF began as a means of estimating the out-year impacts of
current budget decisions. With the aim of sensitizing
policymakers to the future implications of changes in revenues
or expenditures. With development of baselines and
imposition of fiscal rules, MTEF displaced annual budgeting as
the authoritative basis for budget decisions.
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MTEF: WHY THIS TOOL WAS
FORMULATED INTO A RULE
 MTEF is a critical accessory of new public management’s drive
to transform budgeting from a process that controls inputs to one
that focuses on policy changes.
 MTEF enables policymakers to do something about the medium
and long-term fiscal outlook.
 MTEF institutionalizes incrementalism, changing budgeting from
a process that purports to allocate all resources to one that
emphasizes marginal changes in revenue and expenditure policy.
 MTEF encourages spending units to make tradeoffs that enable
them to spend more on policy initiatives by cutting back on
existing programs.
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TOOLS THAT HAVE NOT BECOME RULES:
THE TAX EXPENDITURE BUDGET
 The term “ Tax Expenditures” was devised in the 1960s to
identify and measure deferrals, exemptions, deductions,
credits, and other deviations from the normal tax structure.
The term connotes that these exceptions convey financial
benefits to recipients and impose costs on government.
 Proponents of the tax expenditure concept urged that
governments adopt a “Tax Expenditure Budget” that would
limit and allocate benefits from these provisions in the
same manner as the budget allocates and limits direct
expenditures. Although many governments publish
estimates of the revenue losses from these provisions,
they do not compile a tax expenditure budget.
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THE TAX EXPENDITURE BUDGET: WHY THIS TOOL
HAS NOT BEEN FORMULATED INTO A RULE
 Because of interactions among different tax expenditures, it is
difficult to tally aggregate changes in revenues, which is the
core component of the tax expenditure budget.
 Inasmuch as the value of tax expenditures is a function of tax
rates, changes in rates, change in value of tax expenditures,
leading to the perverse result that raising the liability of
taxpayers boosts the subsidies they receive.
 Powerful interests do not favor a concept that would limit the
benefits they receive through the tax code.
 Trading off between tax and direct expenditures (reductions in
tax would allow increases in direct expenditure) could open the
door to significant enlargement of government.
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TOOLS THAT HAVE NOT BECOME RULES:
THE REGULATORY BUDGET
 The regulatory budget is a measure of the full cost of
compliance with government regulations. It includes the
direct cost of operating government regulatory programs
(principally expenditures of regulatory bodies) as well as
the cost to households and firms for complying with the
regulations.
 During the drive to deregulate governments in the late 20th
century, strong proposals were made to adopt a regulatory
budget that would limit the total cost of regulation,
including compliance costs. The proposal has not been
adopted in any country, though analysts do estimate costs.
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THE REGULATORY BUDGET: WHY THIS TOOL
HAS NOT BEEN FORMULATED INTO A RULE
 Estimates of compliance costs may be unreliable, and
different analysts can produce widely different
estimates.
 This concept is a fundamental break with conventional
budget practices, which measure the costs of
expenditure to government, not social costs.
 Opponents of the concepts feared it would be used as a
frontal attack against social and environmental
regulation.
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TOOLS THAT HAVE NOT BECOME RULES:
BUDGETING SHARES OF GDP
 Analysis routinely measure aggregate and sectoral
spending as shares of GDP to facilitate comparisons
among countries and to analyze changes in the
composition of government expenditure. In 1989, Herbert
Stein, an influential American economist published a book
that strongly urged the United States to allocate resources
as shares of GDP. Doing so, he argued, would enable
government to see the full cost of policies. Stein’s proposal
has not been adopted, though the analytical tool is still
widely used.
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BUDGETING SHARES OF GDP: WHY THIS TOOL
HAS NOT BEEN FORMULATED INTO A RULE
 It is difficult to estimate or control the full social cost of a
policy. Moreover, actual costs are likely to vary
significantly from budgeted costs.
 In contrast to conventional budgeting, this concept
includes costs to firms and households, not only those
borne by government.
 Critics of Stein’s proposal feared that it would open the
door to central planning.
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CRITERIA FOR DECISION RULES
 Every decision rule biases budget decisions
 Will the rule impair government’s ability to complete its
budget work?
 Is the information required for implementing the rule
readily available?
 Do budget makers regard the rule as sensible and
relevant to their work?
 Does government have adequate means to enforce the
rule?
 What happened to past efforts to introduce similar rules?
 How does a proposed rule relate to other ongoing budget
rules?
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SHOULD PERFORMANCE BUDGETING BE
A TOOL OR A RULE?
 Shifts budgeting from decisions on inputs to decisions on
outputs or outcomes
 No standard definition of performance budgeting
 Some governments define performance budgets as
budgets that contain information on actual or estimated
results
 Others define performance budgeting as budgets in which
increments in resources are linked to increments in
results
 In the broad definition, performance budgeting is only an
analytic tool
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SHOULD PERFORMANCE BUDGETING BE
A TOOL OR A RULE? continued
 In the strict definition, performance budgeting serves as a
decision rule
 Others define performance budgeting as budgets in which
increments in resources are linked to increments in results
 In the broad definition, performance budgeting is only an
analytic tool
 In the strict definition, performance budgeting serves as a
decision rule
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PERFORMANCE BUDGETING
 No standard definition or application of performance
budgeting
 Strict version increments of resources and results hard to
implement: few countries have succeeded
 Allocating on the basis of results ignores other salient
considerations; pressure to finance ongoing activities,
political promises and interest group demands
 Systems that require agreement on objectives and
results increase conflict and jeopardize timely completion
of budget work
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PERFORMANCE BUDGETING, continued
 Performance budgeting is dependent on performance
management and commitment of public employees to
produce good results
 Hard to use performance as a decisional rule for outcomes
 Basing allocations on the volume of outputs requires cost
accounting systems that distinguish between fixed and
variable costs
 Measuring performance has received most attention in
performance budgeting, but not enough consideration of
how and whether the measurements are used
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SHOULD ACCRUAL BUDGETING BE A
TOOL OR A RULE?
 Shifts budgeting from cash flows (money received and
payments made) to revenues earned and liabilities
incurred
 The accrual basis would align budgeting and financial
reporting: both would be on the same accounting basis
 It is feasible to report in terms of accruals and to budget on
a cash basis
 If budgeting were continued on the cash basis, financial
reports would be analytic tools
 If budgeting were shifted to the accruals, accounting
principles would become decision rules in budgeting
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ACCRUAL BUDGETING
 Many governments report finances (ex post) on the accrual basis:
few governments budget (ex ante) on the accrual basis
 It is not inconsistent to report and budget differently and to reconcile
the two types of financial statements
 Financial reports are subject to audit; budgets are not
 Although cash-based budgeting is subject to manipulation of the
timing and recognition of transactions, accrual budgeting is
vulnerable to manipulation of key assumptions
 Shifting the budget to the accrual basis weakens the capacity of
political leaders to comprehend and take responsibility for accrued
expenditures
 There may be an “accruals anomaly” in government similar to the
anomaly in public firms
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ACCRUAL BUDGETING, continued
 The accrual basis provides a more reliable statement of
fiscal condition, but in well-run countries, differences
between cash and accruals tend to be small
 Accruals do not provide an adequate assessment of long-
term fiscal sustainability because they exclude liabilities
for general benefits such as social security and health
care
 Accruals enable managers to better manage cost only
when they have broad operating discretion
 There are many unresolved issues in accrual budgeting
pertaining to the recognition and valuation of assets and
liabilities
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