Construction of expenditure ceilings

Jean-Marc Lepain

AFRITAC West 2

Resident Regional PFM Advisor

Workshop on Medium-Term Budget Frameworks

June 2nd–6th, 2014 Accra, Ghana

Construction of Expenditure Ceilings

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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


Medium-term Fiscal Framework

Principles of fiscal managementNumerical fiscal ruleDisclosure requirements

Multi-year macroeconomic forecastMulti-year fiscal forecastMedium-term fiscal target

Multi-year expenditure ceilingMulti-year spending allocationsPlanning margin

Detailed expenditure outturnReconciliation of change from BudgetExplanation 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 appropriationsOther budgetary controlsReconciliation of changes from MTBF

Fiscal Rule or Responsibility Law

Annual BudgetAuthorize

annual expenditure

I. Medium Term Expenditure Ceilings Purpose and Concepts

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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

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80

100

120

140

160

180

200

2011 2012 2013 2014 2015 2016 2017 2018

Baseline Estimates

Budget Appropriations

MTBF Allocations

Problem

Stylized example: Aged care spending

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•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

II. Methodology and Design

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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.

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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

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Education Budget / Total Budget

Education

18%Education 22%

Education 20%

Year 1 Year 3Year 2

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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?

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Issues in Medium Term Expenditure Ceilings

1. Design: time horizon, aggregation / desegregation

2. Comprehensiveness

3. Inflation Adjustment

4. Managing uncertainty

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Examples of different designs

COUNTRY

COVERAGESPECIFITY TIME

HORIZONYears

DISCIPLINE

Soc Sec

Debt Interest

Local Gov’t

% of CG spending

Fixedor Flexible

Frequency of Update

AGGREGATE EXPENDITURE CEILINGS

Sweden Yes No T’fers 96%Total Spending

27 Policy Areas3 3 -4 fixed

3rd-4th year added each

year

Finland Some No No 78%Total Spending

13 Ministries4 4 fixed Every 4 years

Netherlands Yes No T’fers 80%4 Sectors

26 Ministries4 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

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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?

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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

III. Medium Term Expenditure Ceilings: Issues

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

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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

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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

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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

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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

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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

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II. Medium Term Expenditure Ceilings: Issues Numerical Definition

^• 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+𝑛𝑇 − 𝐸𝑡+𝑛𝑂𝐶 ………(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+𝑛𝑇 : Targeted fiscal balance 𝐸𝑡+𝑛𝑂𝐶 :𝐹𝑜𝑟𝑒𝑐𝑎𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 𝑜𝑢𝑡𝑠𝑖𝑑𝑒 𝑡ℎ𝑒 𝑐𝑒𝑖𝑙𝑖𝑛𝑔

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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

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VI. Conclusions

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

Construction of expenditure ceilings

Economy & Finance