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Construction of expenditure ceilings


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Methodology for developping expenditure ceilings (aggregated and disaggregated), including integration of sector strategies, baase-line expenditure, no-policy-change basis, design, scope, time horizon, comprehensiveness, policy costing, inflation adjustment, etc.

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Construction of expenditure ceilings

  1. 1. Jean-Marc Lepain Construction of Expenditure Ceilings
  2. 2. Outline of the Presentation I. Medium Term Expenditure Ceilings: Purpose and Concepts II. Methodology and Design I. Methodology for fund allocation II. General design and time horizon III. Medium Term Expenditure Ceilings: Issues I. Scope and comprehensiveness II. Inflation Adjustments III. Managing Uncertainty IV. Conclusions 2
  3. 3. I. Medium Term Expenditure Ceilings: Purpose and Concepts
  4. 4. Medium-term Fiscal Framework Principles of fiscal management Numerical fiscal rule Disclosure requirements Multi-year macroeconomic forecast Multi-year fiscal forecast Medium-term fiscal target Multi-year expenditure ceiling Multi-year spending allocations Planning margin Detailed expenditure outturn Reconciliation of change from Budget Explanation of discrepancies Instrument Content Medium-term Budget Framework Final Accounts Objective Foundation for fiscal objectives State multi- year fiscal policy targets Set multi-year spending plans Report actual expenditure Detailed expenditure appropriations Other budgetary controls Reconciliation of changes from MTBF Fiscal Rule or Responsibility Law Annual Budget Authorize annual expenditure I. Medium Term Expenditure Ceilings Purpose and Concepts
  5. 5. I. Medium Term Expenditure Ceilings: Purpose and Concepts • Understanding of the cost of government policies over the: – budget year – medium-term – long-term • Baseline expenditures: – No-policy-change basis – Impact of new policies – Parameter versus policy changes • Ceilings versus Estimates: – Spending commitments can (and often do) exceed ceilings – Unrealistic budgeting can lead to unmet commitments or a build up of arrears 5
  6. 6. I. Medium Term Expenditure Ceilings: Purpose and Concepts 6 80 100 120 140 160 180 200 2011 2012 2013 2014 2015 2016 2017 2018 Baseline Estimates BudgetAppropriations MTBFAllocations Problem Stylized example: Aged care spending
  7. 7. I. Medium Term Expenditure Ceilings: Purpose and Concepts •Strong understanding of baseline expenditure estimates becomes very important when thinking about the medium-term. •Elements that are static year to year become fluid over the medium and long term –Population characteristics change –Behavioral responses –Greater policy discretion •Medium-term Forecasts provide policy certainty and guidance to all players •Present the full cost of policies over time –Allows for early adjustments for unsustainable policy commitments •Separation of revenues and expenditures 7
  8. 8. II. Methodology and Design
  9. 9. Why to move to expenditure ceilings • To ensure that budget request are realistic and fit a fiscal envelope; • To allocate additional fiscal space based on strategic priorities; • To ensure that the budget is fully aligned with fiscal objectives; • To shift the responsibility of detailed allocations to MDAs. 9
  10. 10. Ceilings and fiscal objectives • Macro-fiscal objectives • Revenue/GDP • Debt / GDP • Sector objectives • Education = 5% of GDP or 25% of budget; • Teacher salaries increase by 5% a year in real term • Health = 3% of GDP • Expenditure structure objectives • Wage bill no more than 45% of budget • Education operational expenditure = 25% of wages • Road maintenance = 15% of initial investment • Investment budget = 30% total budget 10
  11. 11. Education Budget / Total Budget 11 Education 18% Education 22% Education 20% Year 1 Year 3Year 2
  12. 12. Budget ceiling and sector objectives • What does it take to increase the share of education by 2% a year? • How should I allocate additional revenue? • How do I use the fiscal space available? • What is the role of development partners? • What is the role of the other fiscal constrains? 12
  13. 13. Issues in Medium Term Expenditure Ceilings 1. Design: time horizon, aggregation / desegregation 2. Comprehensiveness 3. Inflation Adjustment 4. Managing uncertainty 13
  14. 14. 14 Examples of different designs COUNTRY COVERAGE SPECIFITY TIME HORIZON Years DISCIPLINE Soc Sec Debt Interest Local Gov’t % of CG spending Fixed or Flexible Frequency of Update AGGREGATE EXPENDITURE CEILINGS Sweden Yes No T’fers 96% Total Spending 27 Policy Areas 3 3 -4 fixed 3rd-4th year added each year Finland Some No No 78% Total Spending 13 Ministries 4 4 fixed Every 4 years Netherlands Yes No T’fers 80% 4 Sectors 26 Ministries 4 4 fixed Every 4 years FIXED MINISTERIAL PLANS United Kingdom No No T’fers 59% 25 Depts 3 3 fixed Every 3 years France No Yes No 39% 35 Missions 3 2 fixed + 1 Flexible Every 2 years
  15. 15. Design issues • How much of my budget do I allocate by ceiling? • Do I include intergovernmental transfers? • How do I deal with special purpose funds ? • How do I deal with entitlement? 15
  16. 16. II. Medium Term Expenditure Ceilings: Issues Time horizon • Fixed-term/multiyear ceiling: – Depends (partly) on political set-up of the government – Can this government restrict the next government’s spending decisions? – Political commitment is the key 16
  17. 17. III. Medium Term Expenditure Ceilings: Issues
  18. 18. II. Medium Term Expenditure Ceilings: Comprehensiveness • Special issues when considering exclusions: – Items financed by donations or foreign grants – Cyclically sensitive expenditures – balance between allowing for countercyclical expenditure policies against long-term fiscal sustainability. – Interest payments
  19. 19. Aggregation vs. Disaggregation • Aggregate ceilings is what textbooks recommend. • Benefit of aggregation: managerial flexibility • Obstacle to aggregation: laws regulating civil service employment, procurement law, PFM laws and regulation 19
  20. 20. II. Medium Term Expenditure Ceilings: Comprehensiveness • Which items to be restricted by the expenditure ceiling? – Completeness, with clearly motivated and unambiguously defined exceptions; but high number of exceptions makes monitoring complex – Simplicity and transparency important 20
  21. 21. II. Medium Term Expenditure Ceilings: Inflation Adjustments • Ceilings can be expressed in nominal or real terms • Issues to be considered: – Real: • flexible: changes in expenditure items caused by price changes do not require other expenditure items to be cut for the spending limits to be upheld. On the other hand, if prices fall, this does not create a surplus usable for increasing other expenditure. • But poorer transparency in comparison with the nominal spending limits; difficult for external parties to monitor whether the spending limits are being adhered to • Lead more easily to a pro-cyclical fiscal policy, since when inflation is boosted by economic growth, expenditure increases in nominal terms, and vice versa – Nominal: • Unambiguous and transparent: no cost adjustments need to be made during the spending limits period • Have a counter-cyclical effect in that if inflation were to increase beyond that which was predicted, expenditure would automatically be restricted during the spending limits period (and vice versa) • On the other hand nominal limits allow the increasing of expenditure if inflation is lower than predicted. This could lead to a permanently higher level of expenditure. Higher inflation than predicted can lead to expenditure reductions or cost-cutting which could be difficult to accept and might lead to the exceeding the spending limits 21
  22. 22. II. Medium Term Expenditure Ceilings: Issues Managing Uncertainty • Integrity of the framework requires that overall commitments are not revised • Uncertainty grows with the time-horizon • New policy initiatives are part of the political reality • Margins are needed – Contingency margins – Planning margins • Avoid practices such as substituting expenditure for tax expenditure, net budgeting and accounting, and deferral of payments from one fiscal year to the next 22
  23. 23. II. Medium Term Expenditure Ceilings: Issues Managing Uncertainty • How much and what type of flexibility? Depends on the construction of the ceiling: – A comprehensive ceiling needs some mechanisms for dealing with an unfavorable developments – Nominal ceilings require more flexibility than real ceilings in order to absorb unforeseen increases in inflation. – The uncertainty in forecasts increases with the time horizon, – The further in advance the expenditure ceiling is established, the larger the expected variations in expenditure that must be accommodated. • Uncertainty in medium-term expenditure development requires that planned expenditure generally be set at a lower level than the expenditure ceiling to ensure that the outcome complies with the ceiling 23
  24. 24. II. Medium Term Expenditure Ceilings: Issues Numerical Definition 24 • E.g. sustainability: – Explicitly establish the relationship between expenditure under the ceiling, revenue, and the targeted fiscal balance or debt: 𝐸𝑡+𝑛 = 𝑅𝑡+𝑛 + ∆𝑇𝑡+𝑛 − 𝐵𝑡+𝑛 𝑇 − 𝐸𝑡+𝑛 𝑂𝐶 … … … (1) Where: 𝐸𝑡+𝑛: Expenditure ceiling for the year t+n 𝑅𝑡+𝑛: Total revenue ∆𝑇𝑡+𝑛: Efffect of tax reforms not included in revenue foreca𝑠𝑡 𝐵𝑡+𝑛 𝑇 : Targeted fiscal balance 𝐸𝑡+𝑛 𝑂𝐶 : 𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 𝑜𝑢𝑡𝑠𝑖𝑑𝑒 𝑡ℎ𝑒 𝑐𝑒𝑖𝑙𝑖𝑛𝑔
  25. 25. II. Medium Term Expenditure Ceilings: Issues Accountability elements Legislative endorsement Promotes parliamentary buy-in … … and elevates the status of medium-term ceilings and estimates … …but can make the framework rigid Example: Austria, Australia, Sweden Information only Exposes the fiscal impact of the government’s budget … … and increases the government’s accountability … … but risks being treated lightly if no formal approval Example: UK, Finland No legislative role The medium-term framework is an internal instrument for the government … … high risk of becoming a technical exercise with little impact on decision-making 25
  26. 26. VI. Conclusions 26 1. Crucial to understand the difference btw ceilings and baselines 2. Puts a lot of demands on both line ministries and MoF 3. Ceilings can be designed in a number of different ways 4. Not (only) a technical exercise: political commitment is the key