Policy framework for budget norms implementation (Laos: June 2009)


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Policy framework for budget norms implementation (Laos: June 2009)

  1. 1. POLICY FRAMEWORK FOR THE IMPLEMENTATION OF A BUDGET NORM SYSTEM AND A SYSTEM OF UNCONDITIONAL AND CONDITIONAL INTERGOVENMENTAL TRANSFERS (Draft version to be approved by the Steering Committee)Version modified on June 18th 2009 I. Objectives of the Budget Norm SystemBased on the new Budget Law promulgated by the National Assembly on December 26th 2006 andthe Implementation Decree issued by the Prime Minister’s Office on February 14th 2008, the Ministryof Finance has undertaken the design of a Budget Norm System. This Budget Norm System is animportant component of the reform of the Central-Local fiscal system which has four broadobjectives: (1) Ensuring the rational distribution of fiscal resources across sub-national jurisdictions in an equitable manner; (2) Ensuring that fiscal resources allocated to sub-national jurisdictions are used in line with the Government development objectives with the purpose of improving Government’s service delivery; (3) Improving financial management at the local level, including planning, budget formulation, budget execution and reporting; (4) Strengthening incentives for improved service delivery performance of local administration.In order to reach these broad objectives, the Ministry of Finance has recognized that work must beundertaken in four areas: (1) The development of Budgetary Norms (2) The development of a system of unconditional transfers for provincial administration (3) The development of additional conditional grants for the provinces (4) The improvement of budget formulation at the sub-national level through a set of instructions and guide-linesThe Ministry of Finance also has recognised that work on budget norms must go in parallel with thedevelopment of the unconditional transfer system to reach the maximum level of integration. 1
  2. 2. Within that context, objectives of the Budget Norms system have been identified as follows: (1) To depart from the existing de facto provincial expenditure assignment mostly based on historical trends and to move to a system based on transparent and objective principles; (2) To base unconditional transfers to provinces on principles of equity that will reduce existing disparities in spending per capita in key sectors; (3) To base unconditional transfers to provinces on identified needs as a departure from the existing input driven system based on revenue assignments; (4) To align provincial expenditures with Government’s priorities as they have been expressed in the National Growth and Poverty Eradication Strategy (NGPES) and the sixth National Socioeconomic Development Plan (NSEDP); (5) To ensure that local recurrent budgets have sufficient funding for daily operations in key sectors such as education, health and agriculture and that the required expenditures are properly identified in local budget in accordance with the new budget classification adopted by the Ministry of Finance; (6) To ensure that local budget have sufficient funding for the maintenance of infrastructures and investments; (7) To ensure a better integration between the recurrent budget and the investment budget by taking into account the impact of new investments on the recurrent budget and by ensuring that the level of investment remains sustainable, and that such investments can be properly maintained in the future. II. General principles of the budget norm systemIn relation with the objectives identified above, the Ministry of Finance has decided that BudgetNorms and the Intergovernmental Transfer System (covering conditional and unconditional grants)will be based on the following principles: 1. Budget norms will be developed as a component of the futur intergovernmental fund transfer system of unconditional grants with the objective of moving away from the present excessively ad hoc and discretionary system of fund allocations. The budget norms system should result in rationalizing budget decisions, strengthening principles of equity in fund 2
  3. 3. allocation between provinces, and gradually correcting disparities in fund allocation among provinces.2. Budget norms will apply to six sectors that have been defined as followed: (1) Education (2) Health (3) Agriculture (4) Communication, Transport, Post & Construction (CTPC) (5) General Administration (6) Provincial Administration3. Energy and Mining will be covered by targeted grants.4. Budget norms will apply only partially to CTPC. The Post Office and large projects in telecommunication will probably be excluded from budget norms. The Sector Review and the Expenditure Need Assessment to be conducted at a later stage will identified CTPC’s sub- sectors to which budget norms will apply.5. The General Administration Sector is defined as the aggregation of provincial expenditures of the following ministries: (1) Industry & Commerce, (2) Information & Culture, (3) Justice, (4) Finance, and (5) Planning.6. Ministries and Government agencies other than those mentioned here will not be covered by the budget norm system. Another mechanism will have to found for determining the size of the intergovernmental transfer necessary to cover sectors outside of the budget norm system (Security, Social Organizations, Army) through specific grants.7. The system wil be developped into different phases. The first phase will cover only non-wage expenditure. Including other economic categories (wages and investment) will depend on progress made in putting consultative mechanism between all institutions involved; namely MoF, MPI and PACSA.8. The system will use three types of norms: (a) Sector budget norm(s) used for the calculation of each sector budget for each province and determining the size of the equalization grant to meet the expenditure need of a given province as part of the Intergovernmental Transfer System of unconditional grants, (b) Economic norms that provinces will use for allocating funds by economic categories based on the current budget classification. (c) Economic norms that will apply to line-ministries at the central level and that will not be part of the Intergovernmental Transfer System. 3
  4. 4. 9. In order to avoid any drastic restructuring of provincial budgets, budget norms will be introduced gradually according to a multi-year implementation plan. This plan would reduce disparities in provincial allocation by increasing the allocation for the previously under- allocated provinces at a faster rate than the others provinces and would avoid the case that any province would see its allocation reduced.10. No province will have its budget reduced as a consequence of the introduction of norms.III. Implementation Strategy of the budget norm system 1. During the first phase of development of the system MoF will put in place two types of budgets norms: a non-wage aggregated expenditure norm for the local recurrent butgets, and non-wage expenditure norms by sector to be applied by provinces. 2. During the first year of implementation, MoF will conduct consultations with other stakeholders such as MPI, PACSA , line-ministries and provinces to determine the best approach for expending the budget norm system to cover all economic categories and all key sectors. 3. Discussion on the budget norm system will consider needs for each sector and projects of line-ministries such as block-grant for schools and health financing formulae. Specific implementation strategies might have to be developed for each sector. 4. As a result of those consultations, and in a second phase, either the aggregated non- wage norm will be integrated into an intergovernmental transfer formula for general purpose unconditional grant or the intergovernmental transfer formula will result from the addition of all sectoral norms.IV. Transfer System General Outlook 1. The Transfer System will be made of the following components: (a) One single unconditional transfer (unconditional general purpose grant) that will cover the recurrent budget; (b) Conditional grants for covering additional recurrent expenditure for a limited number of provinces such as: (i)Provinces having sector with structural expenditure needs above the level of funding provided by the unconditional grant; (ii) Provinces facing temporary revenue shortfall; 4
  5. 5. (iii) Provinces having unexpected expenditure needs due for example to natural calamities (c) Conditional grants for financing large investments 2. The calculation of the unconditional grant will be based on budget norms reflecting general expenditure needs. 3. Conditional transfers for investments will be based on a list of projects by sector prepared by the Ministry of Planning. 4. Unconditional transfers for investments will either cover very small investments that can be decided only at the local level, or an investment envelope based on budget norms prepared by the Ministry of Planning. These last two points will need further discussions with the ministry of planning.V. Unconditional Transfer 1. The Unconditional transfer will be made of two components: (i) the shared revenue transfer and (ii) the General Purpose Grant. 2. The General Purpose Grant will be given by the following formula: Equalization Grant = Provincial Fiscal Envelope – Targeted Local Revenues – Shared Revenue TransferVI. The Provincial Fiscal Envelope 1. The Provincial Fiscal Envelope will be calculated on the basis of expenditures needs measured by sectoral budget norms or by predefined expenditure norm per capita modified to take into account cost factors (mountainous regions, accessibility, and special and ordinary needs such as specific project, coverage of Government service, poverty, presence of ethnic minorities, etc. . 2. Size of the Provincial Envelope will be based on f a minimum spending per capita with some adjustments for taking into account the poverty level of the province or other factors relevant to a sector such population density, number of students, urbanization rate, kilometres of roads to be maintained, etc. 5
  6. 6. 3. Each year the minimum level of investment will be adjusted to take into account inflation, changes in policy and other fiscal considerations. 4. During a transition period of a minimum of five years, the local fiscal envelope will be adjusted to reflect different factors such the absorption capacity of the province and internal fiscal and administrative constrains. Major adjustments will be spread over a period of several years.VII. Fiscal Sustainability of the System 1. The system design and its implementation plan will be prepared in consideration of the overall fiscal sustainability of the system. 2. The implementation plan will be prepared in a way that will avoid any drastic change in the budget structure. 3. Based on a macro-fiscal model developed by the Fiscal Policy Department, the total adjustment of any given year required for fiscal equalization will not result in any increase of more than 1.5% of the general budget of the state with an average of 0.8% per year. 4. The Department of Fiscal Policy with consult with the Department of Taxes and Revenue and the Department of Budget to introduce incentives for increasing collection of local revenue such as the possibility to keep in reserve a portion of local revenue collected in excess of the revenue target. 5. In case in a shortfall in local revenue collection compared to targeted revenue, the Ministry of Finance will have the discretion to cover or not the local revenue shortfall or to make his assistance conditional on an improvement of the local tax collection system.VIII. Fiscal Implementation strategy 1. The system will be implemented in three phases: Phase 1: Health + Education Phase 2: Agriculture + CTPC + Provincial Administration Phase 3: General Administration 6
  7. 7. Phase 1 will start with the preparation of FY 2010/11 budget. It will last four years for the recurrent budget and three years for the investment budget. Phase 2 will start with the preparation of FY 2011/12 budget. Phase 3 will start with the preparation of FY 2012/13 budget. 2. Each implementation phase will last three to four years. These four years will constitute a transition period to which specific rule will apply in order to avoid large budget adjustment. 3. Although all phases have maximum implementation duration of four years, the majority of provinces are expected to make the transition in two years, except for provincial administration which is facing deep structural problems. 4. In the event that due to equalizations needs some provinces experience important budget gap, budget adjustments will be made over several years. 5. In the event that some provinces have structural sectoral expenditures well above the theoretical notional budget determined by budget norm, the provinces will incur no budget reduction. The shortfall in resources will be covered by a conditional grant.IX. Transition Period 1. The preparatory survey has identified several administrative, economic and fiscal constraints that will affect implementation of budget norms and of the Intergovernmental Transfer System of conditional and unconditional grants. Among those constraints are the practice of dual budgeting (separation between recurrent and investment budget), the lack of clarity of the expenditure assignment that will need important revision, the absence of programme budgeting, ceiling on the number of civil servants employed in the provinces, absence of multi year budgeting at the provincial level, limited capacity absorption of the poorest provinces which might not be able to use additional funding necessary to bring them to the same level of service delivery than other provinces. The necessity to accommodate those constraints explains the length of the transition period. 2. The implementation of the budget norm system is expected to represent a budget adjustment equal to 5% of the general budget for equalization needs. Spread over a period of six years the required adjustments remain sustainable. However, some 7
  8. 8. provinces will have adjustment to make that might represent up to 30% or more of the budget of a specific sector. Budget increase above inflation and the general average will have to be limited by specific rules, such as no budget in such sector will increase more than 15% of the national average. 3. Other budget increase will be linked to revision of the expenditure assignment, introduction of block grants, improvements in service delivery. 4. Effective use of increased recurrent budget might not be possible without additional investments. In such case, provinces will have to present a multi-year plan approved by the Ministry of Planning to justify an increase in the recurrent and investments budgets. 5. All arrangements for the transition period will be presented with the implementation plan for each of the three implementation phases.X. Cooperation with the Ministry of Planning A joint committee with the Ministry of Planning, or any other consultative mechanism, will be put in place with the objective of defining common objectives for the implementation of budget norms. The committee will be responsible for: -ensuring that the level of investment is sustainable and compatible with the level of spending in the recurrent budget; - ensuring a better prioritization of investments between sectors at the provincial level -developing common budget norms for investmentXI. Integration with macro-economic policy and multi-year fiscal planning Integration of the budget norm system with multi-year budgeting is essential for the management of the transition period and for long term sustainability. The equalization model used to determine the minimum level of spending per capita and per sector will be fully integrated with the MTFF/MTEF model under development. 8