Public Finance and Budgeting

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Public Finance and Budgeting

• Miami ICGFM , May 11, 2006
• Richard Bartholomew
• OTA Senior Budget Advisor

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AN OVERVIEW OF PUBLIC FINANCE THE BUDGET
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Today Presentation

• A brief look at the Public Finance System
• The Budget Process
• An Emphasis on Budget Execution
• The PEFA Indicators
• The Platform Approach
• Questions and Discussion

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What Happens When The Public Finance System
Malfunctions?

• Corruption improper payments
• Inflation the worst tax
• Budget deficits and debt pile up

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What Happens When The Public Finance System
Malfunctions?

• Money gets spent but results are not seen
  damage to democracy and government credibility
• Banking System bank manipulation or bad
  regulation can create serious problems

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It is necessary to understand this system to work
effectively in it
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• The Public Finance System

MoFinance Macroeconomics, Budget, Treasury, Tax
and Debt
Executive/Council of Ministers
Taxpayers, Bondholders Lenders
Ministries/Chapters/Localities/Agencies
Supreme Audit Agency
External Partners WB, IMF, donors, peer groups
Parliament
Payments System
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A Vehicle to Achieve Objectives

• PFM can help move us from where we are to places
  we want to go
• To better benefits and education for citizens
• To economic competitiveness, growth and jobs
• To more security in the streets or at the border
• PFM is a sophisticated, powerful vehicle that
  must be professionally maintained and controlled

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PFM Task 1

• Maintain aggregate fiscal discipline by
• -Setting Spending Frameworks
• -Establishing Fiscal Rules Controls

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PFM Task 2

• Allocate resources effectively, according to
  priorities, by
• formulating the budget in a fair, stable and
  sustainable process that involves stakeholders

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PFM Task 3

• Gather, Maintain and Use resources efficiently by
• - executing the budget in a way that does not
  waste money or time. Revenue collection is in
  this task.
• Capital inventories are part of it.

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Roles

• Taxpayers,
• Fee Payers,
• Lenders and
• Asset Purchasers
• All provide the inputs, the fuel of Public
  Finance

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Roles

• Parliaments have the constitutional authority to
  provide public resources
• Councils of Ministers and subordinated agencies
  hold Executive powers and manage public funds

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Managers of Public Funds

• Ministries, led by the Finance Ministry
• Special bodies, such as procurement boards
• Local governments
• Government Sponsored Enterprises

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Managing Public Funds

• Schools and universities
• Subordinate organizations such as public
  transport
• Private vendors/contractors for state and donor
  projects (NGOs)

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Payments Systems

• Help collect revenues
• Make payments during budget execution
• Interact with other systems, especially banking

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External Partners

• International Financial Institutions (IFIs)
• World Bank development loans/grants
• IMF monetary stabilization and planning
• Development Banks project financing
• OECD shares advanced practices
• Networks (ICGFM, SBOs)
• Bi-lateral donors such as Japan, EU, The
  Netherlands, Britain and America

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The Verification Role

• Supreme Audit Agencies and Internal Auditors
  report on the ultimate use of resources can you
  define this in a more precise way?
• Budgeters needs auditors!
• Audits determine credibility

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Program Budgets Need Auditors

• Program budget systems
• Require performance audits using non-financial
  data
• Must validate indicators that measure results
• Use continuing flows of audit information to
  analyze results and make allocation decisions
• Rely on the expectation of audits to encourage
  spending organizations to submit truthful budget
  execution data

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The Fiscal Facts of Life

• Countries can only spend what they can collect
  through revenues and borrowing
• They must manage these funds successfully

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Finance of Ministry Functions

• Revenue
• Public Finance Policy
• Budgeting
• Macroeconomic Estimates
• Internal Audit/Control

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Finance Ministry Functions

• Treasury management of accounts and payments
• Debt Operations
• Financial Institutions Regulation

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Finance Ministry Budget Tasks

• Budget Formulation - ensuring allocation of funds
  according to priorities enacted in Parliament
  based on Executive preparation
• Budget Execution - conforming the use of
  resources to the enacted plan and making changes
• Systemic controls and accountability
• Analysis monitoring and internal challenge
• Information and Reporting for transparency and
  management

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Budgeting

• Focuses on PROCESS, as does Internal Audit
• This is different from Debt Instruments and
  Treasury payments, which involve transactions

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The Budget

• The device that allocates the shortage of public
  money
• There is never enough money to do all the things
  people want done.

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The Budget
We use budgets to decide what is most important
and who gets what proportion, or share, of public
resources
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Therefore
A budget should a priority list of
government actions and policies
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The Formulation Chart

• This illustrates a complete, mature process
• OTA suggests that you use it as a template to see
  how your system measures up
• A detailed explanation can be found in the UST
  100 course found on our website

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A Good Formulation Process

• Starts with real macroeconomic and budget
  execution data
• Operates within politically accepted limits
• Relies extensively on analyses of financial and
  non-financial data
• Has an established calendar and clear
  instructions/manuals/handbooks
• Incorporates internal challenges, appeals and
  final decisions

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Formulation

• You can badly execute a well formulated budget
• You cannot execute a badly formulated budget well

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Budgeting for Results

• OTA recommends program, or results based budgets
• This is how we tell people what we are doing with
  their money

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Program Budgets Take Time

• Get political buy in do not waste the effort
• Put the data/accounting fundamentals in place
  early
• Start with outputs while you work on outcomes
• Migrate from organization/economic classification
  to measurable objectives that drive real programs

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Budget Execution
Formulation
Year end accounting
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The Rail Track Analogy

• Budgeting ALWAYS follows two tracks
• Budget Formulation
• and
• Budget Execution

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The Rail Track Analogy

• Ties of budget law and policy, help execution to
  follow budget formulation.
• Execution data ties guide formulation.

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Destination SAI Report

• The last stop on every budgets journey down
  these twin tracks is a final statement, the
  reconciliation of what was authorized to what has
  been spent and accomplished.

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Budget Execution Stakeholders

• Finance ministry unitsCentral Treasury
  ManagementBudget Internal controls and auditing

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Finance Ministry Execution Stakeholders

• Cash and Debt Managers
• Revenue Units
• Capital Investment Programmers
• Grant Management Unit

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Spending Ministry Execution Stakeholders

• Departments or sections which perform the
  following functions
• Treasury transactionsBudgetingRevenue
  collectionCapital Programs and Projects

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Spending Ministry Stakeholders

• Human resources/payroll
• Procurement officers
• Internal audit and other controls
• Grant Management

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Other Budget Execution Stakeholders

• Citizens, companies and organizations
• Audit Institutions
• The Council or Cabinet of Ministers
• Parliament
• Planning and analysis units

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Other Budget Execution Stakeholders

• The Central Bank
• The banking community
• Credit rating organizations
• International Financial Institutions (IFIs-
  World Bank and International Monetary Fund) and
  Donors

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Budget Execution Duties

• a. carefully managing daily financial
  operationsb. accounting under clear rules and
  controls

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Budget Execution Duties

• c. maintaining a record of historical and
  comparative data and
• d. auditing, analyzing and evaluating the
  financial performance and results of government
  policies, spending and programs

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Major Treasury Unit Duties

• Cash management.
• Management of bank accounts.
• Accounting and reporting.
• Planning and forecasting of cash flows.

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Treasury Unit Duties

• Management of debt and guarantees.
• Administration of grants and counterpart funds
  from international aid.
• Financial assets management.

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Cash Management

• NOT cash rationing! Does not pay bills on an ad
  hoc, day to day decision basis.
• Relies on continuous communication, good data and
  established rules
• Uses multiple tools
• Experience-based scheduling
• Short term borrowing
• Commitment System

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Cash Management Activities

• a. controlling aggregate spending b.
  effectively implementing the budget by insuring
  that adequate cash is available to pay
  liabilities and prevent arrears c.
  concentrating available funds to earn interest
  and, therefore d. minimizing costs of public
  borrowing.

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More Treasury Responsibilities

• Maintaining the Chart of Accounts
• Setting budget accounting standards
• Developing budget accounting laws, regulations,
  policies, and procedures

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More Treasury Responsibilities

• Reporting on results of the governments budget
  execution and
• Preparing statutorily or contractually required
  financial and non-financial reports (e.g. for
  donor funds)
• Others you could suggest?

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Chart of Accounts

• The General Ledger Those accounts representing
  the highest level of summarization for assets,
  liabilities, equity, revenues, and expenditures
  of the state. These are the accounts that will be
  the basis for the annual financial statements.
• Functional Classification The broad area of
  government activity, often defined by the
  international GFS system endorsed by the
  International Monetary Fund. GFS compatible
  functional classifications are used for
  international reports.

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Chart of Accounts 2

• Economic Classification Shows what is being
  acquired/paid for with budget resources. Examples
  include Employee pay, Employer Benefit/Social
  Insurance costs, Goods and Services such as
  travel, and interest payments.

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Chart of Accounts 3

• Revenues Taxes, fees, and other receipts that
  finance the governments operations.
• Organizations shows what governmental entity is
  responsible for expenditures or revenue items.
  Examples might be the education ministry or a
  special investigations office.

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The PFM System Should Use ANY Desired
Classifications

• Location
• New spending vs. existing
• Beneficiary groups (retirees, students)
• Combinations of other classifications, such as
  sectoral classification
• Source of funds (internal, donor)
• Level of Government
• Your suggestions?

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More Classifications

• One-time or ongoing (projects or programs)
• Capital or recurrent
• Risk (high, medium, low danger of failure)
• Government Priority Items
• Decision options (grouping by variables)

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The Power to Classify

• Determines how we think about Public Finance
• Defines Transparency
• Enables Reform
• Intergovernmental equity needs jurisdictional
  data
• Manipulates debate
• Do I argue for money by organization or function?
• Limits concepts
• Example without program classification, we
  cannot see results. All other classifications
  show inputs.

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Classification and the Useful IFMIS

• Can the system accommodate current
  classifications for budget formulation and
  execution?
• Can the system add classifications when desired
  by the users?
• Can the system manipulate all classifications for
  analysis?
• Example ability to compare and modify
  classifications at various time points

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Execution Manuals (Policies and Procedures) 1

• Accounting
• Reporting
• Chart of Accounts
• Capital Assets
• Procurement

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Execution Manuals (Policies and Procedures) 2

• Donor funds
• Payroll
• Internal controls and audit
• Glossary of terms

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Internal Control Objectives

• It is every stakeholders duty to follow
  procedures to assure
• Effectiveness and efficiency of operation (e.g.
  payment processing time)
• Reduction of Risk (e.g. securing assets)

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Internal Control Objectives

• Prevention of Corruption (e.g. dual signatures)
• Reliability of financial reporting (e.g.
  professional verification techniques)
• Compliance with applicable laws and regulations
  (e.g. release of funds requirements observed)

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Execution Sequencing

• Allocation Plans
• Commitments for contracted goods or services
• Authorization to spend
• Disbursements and Procurement
• Reconciliation and Accounting
• Reporting and Analyzing

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Accounting

• Cash
• Accrual
• What do you prefer?
• GFS 2001 Compatibility but not an accounting
  system
• IPSAS Compliance

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Sample Cash Controls

• Segregation of duties in the handling of cash is
  one of the most effective ways to gain control
  over this asset. No one individual is to have
  complete control over cash.
• Incoming cash must be made a matter of record as
  soon as possible. Two persons should open the
  mail when they expect cash or checks in the mail.
  
• One copy of the listing is forwarded to the
  cashier. The other copy forms the basis for
  accounting controls through ledger posting. A
  third person periodically compares the listing
  with the deposit.

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Payroll Controls

• Census of Employees (remove phantoms)
• Position controls to prevent unauthorized hiring
• Signed Time sheets

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Payroll Controls

• Responsible, accountable supervisors
• Full Time Equivalent or Head Count?
• Cash payments or bank deposits?

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PEFA

• The Public Expenditure and Financial
  Accountability project of the major donors

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Applying PEFA Indicators

• The Performance Measurement Framework -PMF

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The OECD-DAC Task Force on Donor Practices
provided guidance on diagnostic reviews and
performance measurement and suggested

• Reducing duplication in assessments and high
  transaction costs on partner countries
• Establishing a performance measurement framework
  to monitor progress over time in PFM systems

A Public Expenditure Working Group was set up in
July 2003, chaired by the World Bank, with Fund
and PEFA Secretariat representation, reporting to
the PEFA Steering Committee
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• Greater country ownership, and alignment of donor
  work around country priorities
• Reduced transaction costs from streamlining
  diagnostics
• Enhanced collaboration between donors,
  governments, and stakeholders
• Better meeting of both development and fiduciary
  concerns

Improved impact on the reform of country systems
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The PFM High-Level Performance Indicator Set 1
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The PFM High-Level Performance Indicator Set 2
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The PFM High-Level Performance Indicator Set 3
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The PFM High-Level Performance Indicator Set 4
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Todays PEFA Discussion

• Consider possible applications
• Explore pitfalls
• Relate to reform programs
• Note the Platform Approach

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Indicators Are For Country Use

• Straightforward and credible
• Good job for a special assistant
• But ratings must be reviewed/discussed
• Provides immediate insights
• Auditors are suited to this task

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PMF For Country Use

• A measure of change over
• time milestones marks
• A tool for interaction with donors
• that can prove progress
• The basis for a Platform Approach

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The platform approach is currently being
implemented in a number of countries, supported
by development agencies. In Cambodia, for
example, this approach is led by government and
supported by a joint donor group. There is an 8
year plan to move through the platforms.
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Why Platforms?

• Reforms are often led by different agencies and
  donors, with insufficient attention provided to
  the co-ordination and sequencing.
• This has typically led to a fragmented and
  partial approach, characterized by
• an undermining of government-led reform
• less trust between governments and donors
• administrative burdens on government

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Fragmented Approaches

• too much focus on technical developments (e.g.
  complex IFMIS)
• a tendency to promote parallel systems
• implementation of reforms frequently fails to
  complement each other
• an inconsistent approach to PFM reform between
  line ministries and the Ministry of Finance and
  the SAI

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Cambodia Platform 1 A credible budget delivering
reliable and predictable resources to
budgetmanagers

• Broad Activities
• Integration of budget (recurrent capital
  budgets)
• Strengthen macro and revenue forecasting
• Streamline spending processes

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Enables a basis for accountability
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Cambodia Platform 2 Improved internal control to
hold managers accountable

• Broad Activities
• Re-design budgeting classification system
• Initial design of FMIS for core business
  processes
• Define the internal audit function

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Enables focus on what is done with money
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Cambodia Platform 3 Improved linkage of
priorities and service targets to budget planning
and execution

• Broad Activities
• Re-design the budget cycle (e.g. MTEF)
• Pilot program-based budgeting budget analysis
• Further fiscal decentralization

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Enables more accountability for performance
management
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Cambodia Platform 4 Integration of
accountability and review processes for both
finance and performance management

• Broad Activities
• Full design of FMIS
• Develop IT management strategy
• Initial design of asset register

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Do Not Wait For Donors

• Learn the PEFA system now
• Identify strengths/weaknesses
• Create plans to raise ratings
• Divide TA among donors based on sequenced action
  plans

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Target Selected Indicators

• Decide what is critical AND doable
• Set practical steps
• and timeframes

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Good Target Indicators

• 1 3 Aggregate out-turn vs. enacted- 1st step in
  deficit control
• 2 Composition of out-turn vs. enacted ---can
  highlight budget execution quality and policy
  strategies
• 4 Arrears often elusive, always important to
  budget credibility

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Good Targets

• 7 Off Budget spending an issue in most
  countries can be a political power indicator
• 10 Public access can be done with websites,
  publications and public activities. Good for an
  early win.

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Good Targets

• 11 Annual budget process
• 18 Payroll controls one place to start the
  fight against corruption

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Good Targets

• 16 Availability of funds a key budget execution
  improvement opportunity
• 21 Effectiveness of internal audit
• 24 Budget reporting a practical test for the
  IFMIS, or existing systems

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Example

• PI-21. Effectiveness of internal audit
• Dimensions to be assessed
• (i) Coverage and quality of the internal audit
  function.
• (ii) Frequency and distribution of reports.
• (iii) Extent of management response to internal
  audit findings.

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Internal Audit Rate Your System
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Internal Audit Effectiveness

• Grade D
• (i) There is little or no internal audit focused
  on systems monitoring.
• (ii) Reports are either non-existent or very
  irregular.
• (iii) Internal audit recommendations are usually
  ignored (with few exceptions).

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Effectiveness

• Grade C
• (i) The function is operational for at least the
  most important central government entities and
  undertakes some systems review (at least 20 of
  staff time), but may not meet recognized
  professional standards.
• (ii) Reports are issued regularly for most
  government entities, but may not be submitted to
  the ministry of finance and the SAI.
• (iii) A fair degree of action taken by many
  managers on major issues but often with delay

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Internal Audit Effectiveness

• Grade B
• (i) Internal audit is operational for the
  majority of central government entities (measured
  by value of revenue/expenditure), and
  substantially meet professional standards. It is
  focused on systemic issues (at least 50 of staff
  time).
• (ii) Reports are issued regularly for most
  audited entities are distributed to the audited
  entity, the ministry of finance and the SAI.
• (iii) Prompt and comprehensive action is taken by
  many (but not all) managers.

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Internal Audit

• Grade A
• (i) Internal audit is operational for all central
  government entities, and generally meet
  professional standards, It is focused on systemic
  issues (at least 50 of staff time)..
• (ii) Reports adhere to a fixed schedule and are
  distributed to the audited entity, ministry of
  finance and the SAI.
• (iii) Action by management on audit findings is
  prompt and comprehensive across government
  entities.

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Problems with PEFA

• Consultants with opinions
• Differences in scoring or data- weaknesses can
  cause problems of appearance substance
• Extra work required
• Inadequate for major anti-corruption efforts
• Donor add-on requirements

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PEFA-based Reform Plans

• Specify indicator (s) for improvement
• Set a timetable for change
• Report monthly on milestones and manage setbacks

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Example

• Goal Improve the stability of the budget process
  through improved procedures/circulars
• Objective
• Improve the BY07 Circular to raise Indicator 11
  (policy based budget orderliness and
  participation)

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11 Budget Circular

• Dimension (i) the Calendar (no change targeted)
• Score B
• A clear annual budget calendar exists, but some
  delays are often experienced in its
  implementation.
• The calendar allows units reasonable time (at
  least four weeks from receipt of the budget
  circular) so that most of them are able to
  meaningfully complete their detailed estimates on
  time
• .

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11 Example

• (iii) Timely approval by the legislature (no
  change needed)
• Score A The legislature has, during the last
  three years, approved the budget before the start
  of the fiscal year.

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Improvement Plan Target

• Dimension (ii) preparation of budget submissions
  
• Current Score D
• the quality of the budget circular
  (instructions) is poor, causing confusion about
  requirements and late submissions of requests

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Target

• Desired Score B
• A comprehensive and clear budget circular is
  issued which reflects ceilings approved by
  Cabinet (or equivalent).
• Ceiling approval takes place after the circular
  distribution to units, but before they have
  completed their submission.

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Plan Milestones

• Agree on concept Nov, 06
• Inform spending units - Nov, 06
• Draft the changes-Dec-Jan, 06-7
• Gain cabinet approval for draft- Jan, 07
• Training as needed- Feb, 07
• Distribute Final Circular- March 15, 2007
• Cabinet sets ceilings- April 15, 2007
• Requests submitted June 2007

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What do you think?

• At what point might the plan schedule most likely
  break down?
• Drafting and Training time adequate?
• Reasonable target score?
• Unrealistic time frame for this change?

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Other Potential Complications

• Possible disagreement with donors on the quality
  of a new or old budget circular
• Failure of Cabinet to give timely ceilings
  (results in a C rating)
• Your observations?

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Rating Change

• Country score for 11 goes from ADB B rating
• to ABB B
• According to the PMF, policy based budgeting has
  advanced

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Advances Country PFM Goals

• 1.     Transparency
• 2.     Accountability and Credibility
• 3.     Stability and Sustainability

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Recommendation

• Do your own PEFA Review
• Set a PEFA focus for your planned changes/reforms
• Get measurable results

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Further Information

• Websites www.ustreasury.hu/budget/frm.shtml
• www.ustreasury.hu
• Email bartholomewr_at_gmail.com

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Remember

• Public Finance Management impacts every citizen
  and public organization
• PFM requires collaboration
• PFM Change occurs through personal, technical
  and political processes

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Two Sides to the PFM Reform Coin

• The design, training and technical assistance
  face
• The management of people face
• These two aspects must be considered for any
  reform activity to succeed.

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Change Management

• Leaders want change but people and organizations
  resist it.
• Why? We are not sure how it will affect us and
  what our work will be like after the change is
  made. Uncertainty breeds resistance.
• Systems do not work or fail people make
  them work or allow them to fail

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Reactions Anger Fear

• Those who are corrupt are angry that someone is
  trying to expose them.
• Those who are honest worry that someone intends
  to take away their work and security.

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The Faces of Change
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Responses to Change 1

• Denial
• This cannot work in our country because
• This only works in other countries.
• We cannot get political support for such an idea
  because.

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Denial

• We do not have the technical expertise/staff
  capacity/etc. to do this
• There are many other things that we must do that
  are more important
• We agree that this is a good idea and we intend
  to begin, but only when the time is right

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Response 2

• Bargaining
• Ok, we will do it, but lets move slowly
• It would be better to do it this way than that
  way
• Lets study this thoroughly before taking the
  next steps. Appoint a study committee!

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Response 3

• Depression
• It has happened.
• There is no going back.
• We could not stop it.
• BUT, this shows that the leaders of change are
  succeeding.

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Response 4

• Acceptance
• The change becomes the new old way and develops
  many defenders

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Are you trying to change PFM?

• Economic Forecasting?
• Budget Formulation?
• Accounting Standards?
• Procurement?
• Information Systems?
• How do you plan to deal with the human side of
  change?