Top-down Budgeting A Tool for Central Resource

Management

John M. Kim

Korea Inst. of Public Finance

jhrv@kipf.re.kr

Outline

1. What is Top-down Budgeting?2. Historical Background3. Issues in Implementation4. Prerequisites5. Conclusion

1.What is Top-down Budgeting?

2. Historical Background3. Issues in Implementation4. Prerequisites5. Conclusion

Outline

4

Top-down vs. Bottom-up

Top-down Bottom-up Problems of Bottom-up Budgeting

• Difficult to control aggregate spending

• Sectoral allocations may not be optimal• Hard to keep multi-year perspective• Inefficient formulation process

- Game-playing between budget office and line ministries

- Ministries’ expertise under-utilized

5

Top-down: Procedurally Defined

Budgeting in 2 Steps① Ceilings (aggregate numbers)

1) Decide total spending & deficit levels (agg. ceiling)2) Inter-sectoral allocation among major policy areas

(sectoral ceilings: about 30)

② Intra-sectoral allocations (details)1) Ministry/agency budgets

6

Top-down: Functionally Defined

Division of Roles/Responsibilities① Ceilings (aggregate numbers)

1) Final decision by PM & Finance Minister2) Focus on

Aggregate fiscal management Medium-term perspective (multi-year ceilings) Policy priorities

② Intra-sectoral allocations (details)1) Ministries formulate their own budgets2) But must follow rules

7

Benefits of Top-down Budgeting

① Effective for fiscal consolidation② Easier to integrate with MTEF (MTBF)

(ceilings are usually multi-year limits)

③ Ensures spending is aligned with priorities

④ Efficient in time and effort⑤ Utilizes ministries’ expertise

1. What is Top-down Budgeting?

2.Historical Background3. Issues in Implementation4. Prerequisites5. Conclusion

Outline

9

Fiscal Crises as Motivation Huge deficits ca.1990 in OECD countries

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

• Fiscal Balance (% of GDP)

Australia -3.8 -6.0 -5.6 -4.6 -3.7 -2.2 -0.5 0.6 1.6 0.1

Canada -8.3 -9.1 -8.7 -6.7 -5.3 -2.8 0.2 0.5 1.6 3.2

Chile 1.4 2.1 1.8 1.6 2.4 2.1 1.8 0.4 -1.4 0.1

Denmark -2.4 -2.2 -2.9 -2.4 -2.3 -1.0 0.4 1.1 3.2 2.5

Korea 1.8 1.4 2.5 3.1 4.2 3.8 3.6 1.9 3.1 6.9

Netherlands

-3.2 -4.4 -3.6 -4.2 -4.2 -1.8 -1.1 -0.8 0.4 2.2

Sweden -2.0 -7.8

-11.4

-10.8

-7.7 -3.1 -1.6 2.1 1.3 3.7

UK -3.1 -6.4 -7.9 -6.7 -5.8 -4.4 -2.2 0.4 1.1 1.6

OECD Avg. -3.7 -4.6 -5.0 -4.2 -3.9 -3.2 -1.8 -1.4 -0.9 0.0

top-down introduced as tool for fiscal consolidation + prevent reoccurrence

10

A Different Motivation (Korea)

Top-down adopted as key part of 4 fiscal reforms (multi-year, top-down, performance, program budgeting)

1) Emphasis on longer-term perspectiveNeed to control anticipated spending growth in social welfare, etc.

2) Efficiencya. Need to focus on broader policy prioritiesb. Eliminate unproductive games in budget negotiationsc. Utilize ministries’ expertise

3) Need to focus on performance management, rather than controlling inputs

11

Top-down & Bottom-up Compared

• Bottom-up • Top-down - Ministry by ministry analysis that - Aggregate fiscal analysis that largely ignores economic forecasts takes into account economic forecasts

- Annual - Multi-year

- Time consuming - Delegated authority

- Ownership of proposals is more - Creates joint ownership of agency- specific proposals

- Reactive - Proactive

12

Complementary Approaches

Approaches to Determining Expenditure CeilingsTop-Down Approach Bottom-Up ApproachOverall Ceiling

Sectoral Ceiling

Overall Ceiling

Sectoral Ceiling

Program Review

Sweden ○ ○ - - △

Netherlands ○ ○ - △ ○

UK ○ ○ - △ ○

Denmark ○ ○ - △ ○

Korea ○ ○ - △ ○

Canada ○ - - ○ ○

Australia ○ - - ○ ○

Chile ○ - - ○ ○○ : actively used, △ : used as reference, - : not used

•Top-down approach should be complemented by bottom-up methods:

- Information for evaluating new initiatives- Program reviews for monitoring programs/activities

1.What is Top-down Budgeting?2. Historical Background

3.Issues in Implementation4. Prerequisites5. Conclusion

Outline

14

Determining Spending Ceilings

Overall Ceiling1) Prudent Economic Assumptions (Growth, etc.)

– Sensitivity analysis– Independent panel or private sector forecasting – Built-in bias toward lower growth forecast

2) 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

15

Determining Spending Ceilings

Sectoral Ceilings• Must not affect overall ceiling• Usually overlap with ministerial boundaries

(good program budget design)

• New initiatives may be required to be funded by savings from existing programs

16

Issues in Setting Ceilings

Operating vs. Capital Ceilings• Ministries tend to favor operating expenses• Denmark: separate ceilings for current &

capital expenses- Sub-ceiling for salaries within operating ceiling

• UK- Current expenses: Golden Rule- Capital expenses: Sustainable Investment Rule

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Issues in Setting Ceilings

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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Issues in Setting Ceilings

Buffers against Contingencies• Built-in buffers in prudent forecasts Windfalls (repay debt, tax cuts, 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

19

Issues in Setting Ceilings

Expenses Included in Ceilings?1) Discretionary expenses usually

included2) Mandatory expenses (social security

entitlements, etc., mandated by law)• Sweden, Korea, Chile, Netherlands:

included• Canada, Denmark: excluded

3) Interest on debt• Sweden, Denmark: excluded• Chile, Netherlands, Korea: included

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Issues in Setting Ceilings

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

1. What is Top-down Budgeting?2. Historical Background3. Issues in Implementation

4.Prerequisites5. Conclusion

Outline

22

Prerequisites for Success

Good monitoring system to compensate for delegation of authority to ministries

• Performance & program reviews• Information system to monitor execution

Policy capacity + Behavioral change• Budget Office: better forecasts &

projections, need to defend fiscal rules aggressively, but work better together with line ministries

• Ministries: need to learn internal allocation decision-making

23

Prerequisites for Success

Strong PM & Finance Minister• Must be able to enforce ceilings

Commitment to rule-based budgeting• Remove arbitrariness in budgeting

decisions, but leave room for flexibility and judicious discretion/autonomy

Support from the legislature

1. What is Top-down Budgeting?2. Historical Background3. Issues in Implementation4. Prerequisites

5.Conclusion

Outline

25

Conclusion Top-down budgeting is an effective approach to fiscal co

nsolidation• Political will comes foremost; Top-down provides effective frame

work/tools• Framework fits well with multi-year fiscal discipline & rules-based

budgeting• But, discipline tends to slacken as public finances improve

Many countries find it useful to have:• About 30 sub-ceilings for optimal inter-sectoral allocations• Separate ceilings for operating and capital expenditures• Budget margins as buffers against contingencies• Some flexibility in adjusting ceilings for new policy initiatives• Exclusion of mandatory spending differs by country

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Conclusion

Prerequisites for Success• From the Budget Office

- Willingness to defend fiscal rules aggressively- Good monitoring + evaluation of spending programs- Better analytical capacity & ability to work together with

ministries

• From Line Ministries- Ability to prioritize and make own budgeting decisions

• From PM & Finance Minister- Commitment to rule-based budgeting- Willingness/ability to enforce ceilings

• From the Legislature- Support for rules and ceilings

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Conclusion

Despite common features & principles, practices differ by country. Some balance needs to be struck between strict discipline and flexibility, especially at initial stage.

Top-down system by itself does not guarantee good results

• Political willingness to honor rules & principles is essential• Capacity of budget office (staff + systems) is also a major

factor• Behavioral change must follow

But, overall, has delivered desired results in countries that have adopted it

End of Presentation