Top-down Budgeting A Tool for Central Resource Management John M. Kim Korea Inst. of Public Finance

Outline 1.What is Top-down Budgeting? 2.Historical Background 3.Issues in Implementation 4.Prerequisites 5.Conclusion

1.What is Top-down Budgeting? 2.Historical Background 3.Issues in Implementation 4.Prerequisites 5.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 Steps Ceilings (aggregate numbers) 1)Decide total spending & deficit levels (agg. ceiling) 2)Inter-sectoral allocation among major policy areas (sectoral ceilings: about 30) Intra-sectoral allocations (details) 1)Ministry/agency budgets

6 Top-down: Functionally Defined Division of Roles/Responsibilities Ceilings (aggregate numbers) 1)Final decision by PM & Finance Minister 2)Focus on Aggregate fiscal management Medium-term perspective (multi-year ceilings) Policy priorities Intra-sectoral allocations (details) 1)Ministries formulate their own budgets 2)But must follow rules

7 Benefits of Top-down Budgeting Effective for fiscal consolidation Easier to integrate with MTEF (MTBF) (ceilings are usually multi-year limits) Ensures spending is aligned with priorities Efficient in time and effort Utilizes ministries expertise

1.What is Top-down Budgeting? 2.Historical Background 3.Issues in Implementation 4.Prerequisites 5.Conclusion Outline

9 Fiscal Crises as Motivation Huge deficits ca.1990 in OECD countries Fiscal Balance (% of GDP) Australia Canada Chile Denmark Korea Netherlands Sweden UK OECD Avg 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 perspective Need to control anticipated spending growth in social welfare, etc. 2)Efficiency a.Need to focus on broader policy priorities b.Eliminate unproductive games in budget negotiations c.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 Ceilings Top-Down ApproachBottom-Up Approach Overall 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 Implementation 4.Prerequisites 5.Conclusion Outline

14 Determining Spending Ceilings Overall Ceiling 1)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 Ceiling s 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

17 Issues in Setting Ceiling s 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

18 Issues in Setting Ceiling s 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 Ceiling s Expenses Included in Ceilings? 1)Discretionary expenses usually included 2)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

20 Issues in Setting Ceiling s 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 Background 3.Issues in Implementation 4.Prerequisites 5.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 Background 3.Issues in Implementation 4.Prerequisites 5.Conclusion Outline

25 Conclusion Top-down budgeting is an effective approach to fiscal consolidation Political will comes foremost; Top-down provides effective framework/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

26 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

27 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

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