Government Budgeting Coursepack PDF 2024-2025

PA 312 – GOVERNMENT BUDGETING Lesson 1 GOVERNMENT BUDGETING: ITS DEFINITION, PURPOSES, ADVANTAGES, FUNDAMENTAL PRINCIPLES AND THE COMMON KINDS OF BUDGETS Government Budgeting and Government Budget: A Definition Government Budgeting is the critical alloc...

PA 312 – GOVERNMENT BUDGETING Lesson 1 GOVERNMENT BUDGETING: ITS DEFINITION, PURPOSES, ADVANTAGES, FUNDAMENTAL PRINCIPLES AND THE COMMON KINDS OF BUDGETS Government Budgeting and Government Budget: A Definition Government Budgeting is the critical allocation of resources (usually scarce) to competing demands. A government budget is a plan for financing the activities of the government for a fiscal year prepared and submitted by responsible executive to a representative body whose approval and authorization are necessary before the plan can be executed. It is more than a mere estimate of receipts and expenditures; it is a definite proposal to be approved or rejected. As such it should take hold of the complete fiscal program for ensuing fiscal year and as an essential information document, it should present a detailed exposition of the revenues and expenditures of the government for the past and ensuing years and should provide not only definite information regarding the general character, purpose and amount of government expenditures but also detailed data regarding the cost entailed in maintaining particular units of organization and in performing particular units of organization and in performing particular activities. In general, a government budget is the financial plan of a government for a given period, usually for a fiscal year, which shows what its resources are, and how they will be generated and used over the fiscal period. The budget is the government's key instrument for promoting its socio-economic objectives. The government budget also refers to the income, expenditures and sources of borrowings of the National Government (NG) that are used to achieve national objectives, strategies and programs. Section 22, Article VII of the Constitution states that: "The President shall submit to the Congress within 30 days from the opening of every regular session, as the basis of the general appropriation bill (GAB), a budget of expenditures and sources of financing including receipts from existing and proposed revenue measures." What is referred to by the term "national government budget"? The National Government budget (also known simply as the budget) refers to the totality of the budgets of various departments of the national government including the NG support to Local Government Units (LGUs) and Government- Owned and Controlled Corporations (GOCCs). It is what the national government plans to spend for its programs and projects, and the sources of what it projects to have as funds, either from revenues or from borrowings with which to finance such expenditures. 12 | P a g e  PA 312 – GOVERNMENT BUDGETING On what is the national government budget spent? The national budget is allocated for the implementation of various government programs and projects, the operation of government offices, payment of salaries of government employees, and payment of public debts. These expenditures are classified by expense class, sector and implementing unit of government. Why does the government prepare a new budget every year? The preparation of the government's budget every year is in accordance with the provision of the Constitution which requires the President to submit a budget of expenditure and sources of financing within 30 days from the opening of every regular session of Congress. The yearly preparation of the budget is also in consonance with the principle which requires all government spending to be justified anew each year. This principle ensures that government entities continuously evaluate and review the allocation of resources to project/activities for cost efficiency and effectiveness. What is a balanced budget? What happens when the budget is not balanced? In the context of government budgeting, a budget is said to be balanced when revenues match expenditures or disbursements. When expenditures exceed revenues, the government incurs a deficit which may result in the following situations: The government borrows money either from foreign sources or from the domestic capital market which increases the debt stock of the NG and its debt servicing requirements; The government borrows money from the Bangko Sentral ng Pilipinas; or, The government withdraws funds from its cash balances in the Treasury. Why is surplus budgeting necessary? The surplus budget policy is important to encourage economic growth. The less the government borrow from the public, the lesser the pressure on interest and inflation rates and the more funds are made available in the financial market. Such funds may be used by businessmen to build factories, hire workers, buy equipment and open more employment opportunities. By keeping more funds in the hands of the private sector rather than competing for credit, the government helps make financing available for families who want to own homes, buy cars, or support their children's education. The government also needs to generate a budget surplus to repay the huge debt it has accumulated over the years. The reduction of the national budget debt will correspondingly lessen government's requirements for interest and principal payments. This becomes important particularly during periods of rising interest rates and unstable exchange rates. 13 | P a g e  PA 312 – GOVERNMENT BUDGETING What is the total resource budget concept and its significance? Total resource budgeting is a concept adopted by the present budgeting system which requires the preparation of the national government within the framework of the total impact of all government entities on the national economy. Under this concept, the National Government (NG) budget is considered as only one component of the entire public sector resources. Government-Owned and Controlled Corporations (GOCCs) and Local Government Units (LGUs) are also considered as substantial contributors to total public resources. GOCCs and LGUs are therefore required to prepare their budget consistent in form and timing with that of the NG to facilitate comprehensive evaluation of the overall budget. In total resource budgeting, the energies and capabilities of all public entities are harnessed in drawing up the optimal package of goods and services that can be sustained by available resources. What is the consolidated public sector fiscal position? The consolidated public sector fiscal position (CPSFP) refers to the net deficit or surplus calculated after summing-up the budget balances of all government entities, namely the national government, the non-financial government corporations (usually includes only the 14 major GOCCs), government financial institutions, local government units, the social security institutions, the Oil Price Stabilization Fund, the Bangko Sentral ng Pilipinas, and the Central Bank- Board of Liquidators. Through the CPSFP, the government is able to assure itself that all public resources are mobilized and used in magnitudes that are consistent with overall macroeconomic targets and the government's economic priorities What is the planning-programming-budgeting system (PPBS)? The planning-programming-budgeting system (PPBS) is a concept that stresses the importance of establishing a strong linkage between planning and budgeting. It emanates from the policy of the government to formulate and implement a national budget that is an instrument of national development, reflective of national objectives, strategies and plans. Under the PPBS concept, the budget is anchored on the degree by which the accomplishment of economic plans and the attainment of target contained in the Medium-Term Philippine Development Plan (MTPDP) and the Medium-Term Public Investment Program (MTPIP) are supported Purposes of Budgeting Budgeting is basically planning and controlling. Careful plans for the future should be laid and those who direct the affairs of business must be held strictly responsible for carrying out the plans. Thus, in budgeting, there is need for wise selection of essential activities or programs to be undertaken and for a coordinated plan of financing such activities or programs. 14 | P a g e  PA 312 – GOVERNMENT BUDGETING In business, the fundamental purpose of budgeting is to find the most profitable course through which the efforts of the business may be directed and to aid management in holding on to that course. From the business point of view, following are the three basic fundamental purposes of budgeting: 1. establish in advance the objective or end result of the budget period; 2. provides means of coordinating the activities of the various subdivisions and departments of the business; and 3. provides a period-to-period basis of comparison to show whether the plan is being realized and if not realize indicate when changes must be made to obtain current objectives. Moreover, when applied to government budgeting, another purpose may be added: to serve as basis of orderly management of public finances. Advantages of Budgeting Following are some advantages of budgeting. 1. Action is based on study. Due to the fact that executives and operating heads make the plans that they are bound to execute when approved, careful study will become a routine before any action is taken. 2. Cooperation is secured in the entire organization. Operating heads and all those who have something to do with operations are supposed to assist in the formulation of the best operating plans for the organization. As such, the results of their work represent the judgment of the entire organization. 3. Policies are established. Policies are declared in the budget such that emphasis is given on the essentiality of projects to be undertaken. A system of priorities is often established especially where there are limited resources. 4. Program or activities are related to expected or available resources and economic conditions. The economy of the nation as a whole is considered in budgeting of public expenditures. Government spending may be constricted or expanded depending on the needs of the economy. 5. Balanced Programs are developed. Again, the priority and essentiality of projects are studied to the end in view of determining how money should be spent and what is to be expected in the implementation of chosen projects or actions. 15 | P a g e  PA 312 – GOVERNMENT BUDGETING 6. Coordinated effort is attained. In budgeting, coordination of all departments is necessary for without it concerted action cannot be attained. 7. Operations are controlled. Control of expenditure and operations is provided in systematic budgeting. 8. Weaknesses in the organizations are revealed. In the execution of plans, responsibilities are delegated. One will not accept responsibility unless authority is defined. Where plans are developed and responsibilities for the accomplishment are delegated, weaknesses in the organization if any, will be revealed. 9. Waste is prevented. Because budgeting analyzes the reasons for proposed expenditures in advance, waste is prevented. Fundamental Principles of Fiscal Operations Budget activities are governed by legal provisions/fundamental principles relating to financial transactions and operations of the government. The principles as provided by law are: 1. No money shall be paid out of any public treasury except in the pursuance of an appropriation law or other specific statutory activity; 2. Government funds or property shall be spent or used exclusively for public purposes; 3. Trust funds shall be available and may be spent only for the specific purpose for which the trust was created; 4. Fiscal responsibility shall to the greatest extent, be shared by all those exercising authority over the financial affairs, transactions, and operations of the government agency; 5. Disbursement or disposition of government funds or property shall consistently bear the approval of the proper officials; 6. Claims against government funds shall be supported with complete documentation; 7. All laws and regulations applicable to financial transactions shall be faithfully adhered to; 8. Generally accepted principles and practices of accounting as well as of sound management and fiscal administration shall be observed, provided they do not break existing laws and regulations. 16 | P a g e  PA 312 – GOVERNMENT BUDGETING Linkage between Government Budgeting and State Accounting A close linkage exists between government budgeting and accounting. The accounting system provides essential information needed to make resource allocation decisions, monitor budgetary performance, and assess the effectiveness of operations. The budget provides the framework within which transactions should be recorded, classified, and summarized in the accounting system to permit comparison of actual results with budgeted standards. A substantial of the accounting system pertains to accountability reports needed to monitor performance in the execution and accountability phases of the budgetary process. The Department of Budget and Management prescribe the content, form and other requirements of such reports. The Commission on Audit issues rules and regulations that may be applicable when the reporting requirements affect accounting functions. Kinds of Budget 1. As to Nature a. Annual Budget – a budget that covers a period of one year. It is the basis of an annual appropriation. b. Supplemental Budget – a budget that contends to supplement or adjust a previous budget, which is deemed inadequate for the purpose for which it is intended. This is the basis for a supplemental appropriation. c. Special Budget – a budget of special nature and generally submitted in special forms on account of the fact that itemizations are not adequately provided in the Appropriation Act or that amounts are not all included in the Appropriation Act. 2. As to Basis a. Performance Budget – A budget emphasizing the programs or services conducted and based on functions, activities, and projects which focus attention upon the general character and nature of the work to be done, or upon the services to be rendered, rather than upon the things to be acquired, such as personal services, supplies and equipment. It is a management-oriented measures actual or estimated results in the basis, terms of benefits accruing to the public and their costs. b. Line-Item Budget – a budget that is based on the objects of expenditures such as salaries and wages, traveling expenses, freight, supplies, materials, equipment, etc. 17 | P a g e  PA 312 – GOVERNMENT BUDGETING 3. As to Approach and Technique a. Zero-Based Budgeting - a process that requires systematic considerations of all programs, projects, and activities with the use of defined ranking procedures. In ZBB activities are analyzed and presented in “decision packages” or key budgetary inclusions. b. Incremental Approach – a budget where only additional requirements need justification. It focuses analysis on incremental changes in the budget and may be done within the context of performance and program budgeting. 4. Other forms of Budget a. Regional Budgeting – is a budget prepared consistent with the regional organization of the national government, wherein the Department of Budget and Management identifies by region the expenditures of government agencies and releases funds also on a regional basis. b. Long-Term Budget – is a budget prepared for a four or five year period or longer; longer range estimate of revenue and expenditures requirements. c. Key Budgetary Inclusions – refer to the financial commitments of agencies pertaining to a budget year. KBIs are maintained for the purpose of: § controlling major financial commitments so that funds are not misappropriated or to prevent juggling of funds; § to disclose the funds and have a clear picture of the expenditures; § to track down a mandatory obligations and insure funding of priority projects. 18 | P a g e  PA 312 – GOVERNMENT BUDGETING Name: ________________________________ EXERCISE NO. 1 Instruction: Comprehensively discuss the following. 1. What is government budgeting and why is it very important in managing the affairs of the public sector? 2. What are the benefits or advantages of budgeting? 3. What are the different kinds of budget? Briefly explain each of these. 19 | P a g e  PA 312 – GOVERNMENT BUDGETING Lesson 2 OVERVIEW OF EXPENDITURE MANAGEMENT An effective Public Expenditure Management (PEM) highlights the importance of outcomes and sees expenditures as a means to produce outputs which are needed to achieve desired outcomes. Hence, PEM focuses on desired outputs and outcomes and the right processes, rules and incentives to achieve them. The right balance between autonomy/flexibility and accountability should be provided to enable agencies to deliver the outputs and achieve outcomes. The three (3) objectives of PEM include: 1. Macro-fiscal discipline and stability support economic growth and stability (and reduce poverty) avoid public finance crises 2. Strategic allocation of resources match government policy with programs, objectives, and assure social safety nets, and promote growth 3. Technical efficiency getting the most from each zloty spent; and just delivery of core services In the Philippine setting, PEM includes the tools of Medium-Term Expenditure Framework (MTEF); Performance-Informed Budgeting (PIB) and its associated Organizational Performance Indicator Framework (OPIF); Zero-Based Budgeting (ZBB); Program or Convergence Budgeting (P/CB); Bottom-up Budgeting (BUB); Public-Private Partnership (PPP) or Build-Operate-Transfer (BOT); and Transparency. PEM aims to achieve the following objectives: "Spending within means", or aggregate fiscal discipline - resources should be used in a planned and deliberate medium-term strategy within the aggregate resource constraints. "Spending on the right priorities", or allocative efficiency - spending should be aligned with socio-economic priorities, as spelled out in the Philippine Development Plan (PDP). "Spending with value-far-money", or operational efficiency - all public goods and services must be provided at the most reasonable cost and considers the absorptive capacity of the agency given the thrust to maximize government's contribution to economic growth. 20 | P a g e  PA 312 – GOVERNMENT BUDGETING Spending for the empowerment of citizens, or participatory budgeting through citizen's participation in governance, by allowing citizens to play a key role in identifying, discussing, and prioritizing public spending projects. Box1 The Philippine PEM Tools MTEF - the planning-budgeting framework used by the government to provide a three-year forward perspective to the decision making process during budget preparation. The framework facilitates the determination of the fiscal space (uncommitted funds) available for allocation for needed new and expended programs taking into account the future cost of approved and ongoing programs under the forward estimates (FE) process and the fiscal consolidation targets of the National Government. PIB - a budgeting approach that uses performance information to inform Congress and the public about the outputs and outcomes an agency/GOCC is committing to deliver in exchange for the approval of its budget. The performance information is presented alongside the budget in the NEP and includes: a) the organizational outcomes for which the funds are required; b) the major final outputs (goods or services) that would be produced or that would be rendered to external clients; and c) the quantity, quality and timeliness targets for the outputs and/or services. The PIB focuses more on outputs and outcomes of the agency/GOCC and places less emphasis on its input needs. It links funding to results, and provides a framework for more informed resource allocation and management. An agency/GOCC outcome-based PIB was adopted in the FY 2017 to provide the agency/GOCC the following benefits: (1) clearer statement of the results being aimed for to prioritize its programs/activities/projects; (2) the outcome target to guide the conduct of monitoring and evaluation activities to adjust program strategies during the year to improve program performance; and (3) a clearer outcome accountability framework to base the grant of Performance Based Incentive System (PBIS). Zero-Based Budgeting - program evaluation approach through which major agency programs and projects are assessed/evaluated primarily by third party entities to: (1) assess the continuing relevance of these programs and projects; (2) explore alternatives and better ways to achieve their objectives; (3) determine whether the resources for a program/project should be kept at the present level, increased, reduced or discontinued; and (4) guide departments/agencies/GOCCs in eliminating funding for activities which are not aligned with priorities or which are inefficient, ineffective and fraught with leakages. Program or Convergence Budgeting - is a budgeting approach to facilitate and incentivize inter-agency collaboration along the Key Results Areas of the Social Contract to ensure that priority interagency programs are planned, budgeted and implemented in a coordinated manner. Bottom-up Budgeting - is a budgeting approach which ensures that the prioritized list of programs and projects required by poor cities/municipalities are incorporated into the 2017 budget levels of participating agencies. It promotes the responsiveness of agencies and ensures convergence of services of departments/agencies/GOCCs to the needs of the poorest LGUs and communities. It also strengthens the capacity of the LGUs to identify, plan, budget and execute urgent antipoverty programs with the assistance of CSOs. Pursuit of Public-Private Partnership (PPP) or BOT projects with the private sector financing/constructing and/or operating projects which traditionally would be within the ambit of the public sector and minimizing the risks associated with these projects by building the environment for solicited bids and the capacity to identify and monitor contingent liabilities. To better ensure successful projects and the market case for these projects, budgets shall be provided for project development, implementation, monitoring and technical assistance to implementing agencies. Transparency - continued promotion of open data to increase public access and awareness on budget data and other program information to facilitate appreciation and analysis, and to promote transparency and accountability in public services. Accordingly, the posting of bids and awards on the PhilGeps, and the publication of the Transparency Seal and ARTA Citizen Charter will continue to be Good Governance Conditions under the PBB to institutionalize these transparency conditions. 21 | P a g e  PA 312 – GOVERNMENT BUDGETING The Expenditure Management Cycle The Budget Cycle 22 | P a g e  PA 312 – GOVERNMENT BUDGETING NAME: ________________________________ Exercise 2 Instruction: Answer the following. 1. Discuss the objectives of PEM. 2. Enumerate and define the PEM tools in the Philippines. 3. Explain the Expenditure Management Cycle. 23 | P a g e  PA 312 – GOVERNMENT BUDGETING Lesson 3 BUDGET SYSTEMS AND EXPENDITURE CLASSIFICATION A. Budgeting Systems 1. Line-Item Budgeting In this method the budget is separated into budget categories and objects or line items. A typical budget category is Operating Expenses. Lines under this category would be salaries, travel, and supplies. It is also called “Item of Expenditure Approach” as it controls expenditures at the department or agency level with emphasis on the accounting aspect of governmental operations in terms of items bought or paid. Funds for the entire business are typically allocated under one of these lines. There might or might not be any indication as to how much is allocated to individual departments or divisions. What is typically allocated for the coming year is based on what was allocated for the current year and past patterns of expenditures. 2. Incremental Budgeting Used with line-item budgeting but any increases or decreases are based on expected increases or decreases in funds for the coming year. 3. Formula Funding A formula is determined on which to base funds allocated to various units. The formula is typically based on something which is measurable within the system. In businesses it could be number of products produced In education at the public grade school level, it is typically average daily attendance; At public colleges and universities, it is typically a formula based on something that defies description. Formulas can still be applied to line-items after the funds have been allocated. 4. Planning-Programming Budgeting System (PPBS) Basically, it’s a goals based budgeting system. Specifically, it has the following salient features: each unit/department within an organization is allocated funds based on need according to the plans/objectives of that unit. If plans remain the same, you can expect your budget to remain the same with some modest increase for inflation; 24 | P a g e  PA 312 – GOVERNMENT BUDGETING funds allocated will have to be on some percentage basis based on total funds available; specification of objectives to be achieved through government spending and expenditures; existence of a multi-year planning and programming process which incorporates and uses an information to present data in meaningful categories essential to major executive decisions, thus a budget system which is future and planning-oriented; selection of a decision from various alternatives to achieve program objectives where the choice is arrived at using economic method of analysis such as cost-benefit analysis and feasibility studies which leads to minimization of costs and comparison of costs and benefits especially when benefits can be quantified; existence of analytic capability used by the agencies by permanent specialized staffs to meet objectives; existence of a budgeting process which can take broad program decisions, translate them into more refined decisions in a budget context, and present the appropriate program and financial data for presidential and legislative action; systematic use of analysis throughout the process, hence holistic and integrative in approach requiring economic and planning skills; and individual departments/units still based their requests on line-items and will expend their funds through line items. 5. Zero-Based Budgeting Basically, it’s another goal-based system of budgeting. In this system however, each unit/department must justify each penny it gets. The assumpti on is that each agency/department starts anew at zero and must give justification for every request. It is an operating, planning, and budgeting process which requires each manager to justify the entire budget request in detail, and shifts the burden of proof to managers to justify why should spend money. In other words, ZBB is a management and budgeting process which necessitates each manager responsible for a major activity, cost center or function to justify fully his budget proposal following a systematic method of identifying, analyzing, evaluating, and ranking present and new projects. As a kind of comprehensive budgeting approach, ZBB calls for the analysis of all budgetary expenditures to assess effectiveness in achieving organizational goals. In effect, ZBB actually supplements PPBS in the setting up of priorities for government expenditures. In concept, ZBB refers to the yearly analysis, evaluation, and justification of each activity, program or project starting from a “zero” performance level. “Zero- Base” means the analysis of the entire budget from a starting point of zero or from scratch. The idea is to “zero-in” on only the most important elements, projects, or activities to be included in the budget. In this way, the most important projects may succeed with adequate funding rather than distribute the resources scarcely among many things and achieve nothing after all. 25 | P a g e  PA 312 – GOVERNMENT BUDGETING The DBM as cited by Briones 2000, summarized the main features of ZBB as follows: 1. It is a total budget approach. All activities proposed, whether existing or new are analyzed, evaluated, and justified rather than just increased from current operating levels; 2. It is a budget based on need. ZBB requires that all activities proposed be analyzed and evaluated systematically without reference to past practices. Program goals based on constitutional mandates and enacted to meet problems or needs that are of lesser priority today are reevaluated in terms of present conditions. 3. It reallocates resources. ZBB shows where resource should be allocated to ensure attainment of objectives. 4. It identifies alternative ways and levels of performance and funding. ZBB challenges each manager to look for alternative ways of performing an activity. Consequently, the ZBB system hopes to achieve the following objectives: 1. strengthen the present performance budgeting system by the application of systematic analysis and techniques to budget formulation; 2. eliminate or reduce the funding of low-priority activities in order to fund more important ones; 3. improve the quality of management and budget information; and 4. encourage the application of improved or new performance measurements. B. Budgeting Approaches Different countries have taken different approaches to, and several traditions exist, each with its specific features consistent with the overall administrative “culture.” The following should be read with this basic consideration in mind, although it is intended to describe generally valid principles and common ground. 1. Nature of legislative authorizations a. Basis of Appropriations The nature of the authorization granted by the legislature depends both on the budget system and on the nature of the expenditure. Although there are exceptions (notably “permanent authorizations”), these authorizations are granted through appropriations, which are specific authorizations enabling the government and its agencies to spend money. The legal basis for appropriations is normally provided in statutory law. Such law should, however, avoid excessive detail, and procedural guidance should be provided by administrative law in order to permit incremented reform. Appropriations may be grouped into the following broad categories: 26 | P a g e  PA 312 – GOVERNMENT BUDGETING obligation-based appropriations - give rights to make commitments and to make cash payments according to these commitments, without a predetermined time limit. Such appropriations have their own life cycle and are not limited to one year. This system is no longer used for all expenditures, but may be used for special programs (e.g., in U.S., Philippines, or Micronesia) Cash-based appropriations - give authority to make cash payments over a limited period of time, generally corresponding to the fiscal year. This system is the most widespread. In principle, appropriations define cash limits that cannot be exceeded, but there are exceptions. At least for goods and services, they correspond also to a limit of entering into contractual commitments. They cover the payments due. In a few countries (e.g., the U.S.), the budget for a few selected programs includes multiyear budget authorizations. Accrual-based appropriations cover full costs, for the operations of a department and other increases in liabilities or decreases in assets. Full costs are the goods and services consumed (as opposed to acquire) over a period. Therefore, depreciation for physical assets, variations in inventories and variations in liabilities are added to actual payments to calculate the full costs of a program. For personnel expenditure, accrual- based appropriations can also cover pension superannuation liabilities. For a subsidized loan, an accrual-based appropriation covers the actuarial value of the interest subsidy. For assets of national interest (i.e., roads), an accrual-based appropriation can include depreciation of these assets. The distinction between assets of national interest and assets owned by a department is an important element in determining the running costs of a department, and consequently the appropriation for the activities of this department. In the same way, depreciation of assets shared by different programs must be divided among the programs. Determining full costs of a program requires adequate costs measurements systems. b. Authorizations for Multiyear Programs A few countries (e.g. France) include in their budgets, aside from cash appropriations, authorizations for forward commitment for some categories of expenditures (mainly for investment). These authorizations for forward commitment authorize commitments covering a multiyear period, but annual appropriations are still required to make payments. In some developing countries, these are shown in the development/investment budget (e.g., Indonesia). They differ from obligation-based appropriations which also cover multi-year programs but are authorizations to pay as well as to commit. In other countries, these authorizations for forward commitment are not included in the budget but are prepared by the government for internal management purposes. For example, in Australia they are defined as a share of the multiyear estimates and are approved 27 | P a g e  PA 312 – GOVERNMENT BUDGETING by the Cabinet. In a few countries (e.g., the U.S.A.) the budget includes multiyear cash authorizations for some programs. c. Permanent Appropriation/Authorization Several countries include in their budgets permanent appropriations or authorizations for debt service, entitlements, etc., which is explained by the nature of obligations related to these categories of expenditures. As these expenditures are legally mandatory and recurrent, a different budgetary treatment is understandable. In some countries, for constitutional reasons, salaries of judges are permanent appropriations and are not submitted for legislative approval. However, generally the estimates of relevant expenditures that are to be incurred over the fiscal year are shown in the budget. This is required, whatever the nature of the authorization. Some countries (e.g., France) distinguish between restricted appropriations which give a specific limit and approximate appropriations which cover expenditures that are obligatory but cannot be forecasted accurately (such as debt servicing). d. Gross Terms As indicated above, to formulate and assess correctly the government policy and its activities—including its business activities—expenditures and revenues should be shown in the budget in gross terms, even if the authorization of the Parliament and the budget execution controls concern only netted appropriation (i.e., expenditures that exceed commercial revenues). e. Annual Rule Budgets are almost always annual (although the “fiscal year” can be the calendar year or some other 12-month period). A shorter period would be disruptive for management; a longer period would be subject to an increasing margin of uncertainty. However, some programs are multiyear and, generally, making shifts in the composition of the budget needs time. The annual framework is generally insufficient for resource allocation and should be supplemented with specific procedures for multiyear commitments and multiyear expenditure estimates. The annual rule also induces distortions in management when strictly applied and when the carrying forward of expenditure is strictly forbidden. 2. Basis of the budget Budget systems can be classified according to the basis of appropriation defined earlier. a. Cash Budgets A cash-based budget is a budget where most of the appropriations are on a cash basis. Therefore, in a cash-based budget, appropriations define limits for payment and annual commitment, that is, financial obligations met within the fiscal year and the annual trances of multiyear commitments. A cash budget fits well the need for compliance and expenditure control. Commitments and payments are 28 | P a g e  PA 312 – GOVERNMENT BUDGETING controlled on the basis of the authorizations of the Parliament. Macroeconomic objectives, such as the cash deficit, are directly linked to the appropriations. b. Obligation-Based Budget In an obligation-based budget, appropriations define cash and commitment limits, but for certain, there is no time limit for payment. An obligation-based budget needs to be complemented with an annual cash plan for the appropriations that are obligation based. c. Accrual-based budget An accrual-based budget can be defined in two ways: v A budget where appropriations are on an accrual basis and are not a limit for cash payment or commitment (e.g., the New Zealand budget). Cash payments are controlled, but through separate means rather than on the basis of the appropriations. v A budget that presents accrual information and projections of the balance sheet of the government, but where appropriations also define cash limits. Many budgets of local governments in developed countries are presented along these lines. In Iceland, the budget is presented both on cash and on accrual basis. Generally, the term “accrual-based budget” refers to the former definition, which is adopted in this volume except where specified. Hence, cash payments and commitments cannot be controlled directly from accrual-based appropriations and separate additional mechanisms must be put in place to control cash. For appropriations, the distinction between cash-based and accrual-based budgets concerns mainly pensions, running costs and in New Zealand, other items such as “purchase of national assets (e.g. national parks, highways, parliament buildings)”. Currently, in New Zealand, transfers and “capital contributions to increase in investment in a department” remain appropriated on a cash basis.4 With respect to interest; there is no difference between an accrual-based appropriation and a cash-based appropriation. An accrual-based budget is aimed at fostering performance. Since full costs are budgeted, agencies have strong incentives for assessing their costs. On the other hand, the presentation in the budget of accrual information on liabilities or interests subsidies presents advantages for transparency and policy formulation. These two advantages are distinct, since improving the budgetary treatment of financial liabilities and subsidies does not require including depreciation into the Parliament’s authorization. Despite these advantages, attempting to implement accrual budgeting in developing and transition countries would pose major problems. Before thinking of abandoning a cash budget system, the following elements must be considered: v Accrual budgeting alters the traditional rules for compliance. Parliament’s authorizations would not be cash-commitment-based and would include 29 | P a g e  PA 312 – GOVERNMENT BUDGETING depreciation. Moreover, for good services, there may be a time lag between the acquisitions and the payments, on the one hand, the consumption of goods acquired and the uses of appropriations on the other. Therefore, if appropriations are established on an accrual basis, it is essential to establish additional mechanisms for ensuring that cash is kept under control, both in budget preparation and in budget execution. Accrual budgeting has proven to be neutral or even good for fiscal discipline in New Zealand, since this country has effective internal cash controls also. In other countries, accrual-based appropriations must be seen as an abandonment of cash controls and therefore opening a new door to misappropriation and corruption. v Accrual accounting presents advantages. Accrual accounting does not necessarily mean accrual budgeting although these terms are commonly confused. Accrual budgeting requires accrual accounting, but developing an accrual accounting system does not require abandoning the cash-based budget (e.g., the U.S. has implemented recently a full accrual accounting system, but has maintained its cash-budgeting system). v Requirements for “full” accrual accounting, which is a prerequisite for accrual budgeting, are heavy, and a progressive approach to improving accounting would be to focus first on financial liabilities (i.e., to implement what is called a “modified accrual accounting system”). Improving cost measurement and assessing full costs is desirable. However, this is not easy and full cost estimates cannot be very accurate at the start. In developing countries, it would be quite questionable to begin with a government-wide exercise and define the use of appropriation on the basis of rough depreciation estimates. Developing and transition countries should focus on consolidating their cash budget, improving their system for tracking the uses of appropriations, and gradually improving their accounting system. Box 2 Clarifying Some Terms A few years ago, the adjective accrual was often used in budgetary jargon to define expenditures at the delivery/verification stage. Currently, accrual is defined as in the Generally Accepted Accounting Principles (GAAP) of the accountants' profession. Therefore, the following the areas of confusion should be avoided: Expenses versus accrued expenditures. For operating costs, a budget on an accrual basis is does not show accrued expenditures. It shows accrued expenditures plus depreciation plus/less variations in inventories and losses plus/less advance payments. Accrual accounting versus "accrued) expenditures accounting. The expression expenditures accounting" which has been used in some countries, refers to the registration of expenditures at the delivery/verification stage. Monitoring expenditures at this stage is a key element for sound budgeting, and is strongly recommended, but if is not accrual accounting. (In theory, accounting for expenditures at the delivery/verification stage is the only way of assessing the arrears accurately. Accounting only for commitments over estimates arrears). Accrual accounting versus modified accrual accounting. Some accounting systems that were called accrual accounting systems in the early 1980’s should now be called "modified accrual accounting system", as "accrual accounting" for government corresponds today to commercial accounting. In this volume, the expression full accrual accounting is used instead of accrual accounting when necessary to avoid any confusion between “accrual” and “modified accrual. Operating deficit - deficit on an accrual basis versus deficit on a commitment basis. A commitment refers to an order placed or a contract awarded. In budgetary jargon, the deficit on a commitment basis is often similar to the deficit on a cash basis plus change in arrears. It does not at all correspond to the operating deficit defined by accrual accounting principles. 30 | P a g e  PA 312 – GOVERNMENT BUDGETING 3. The Traditional Approach: Compliance Budgeting A major aim of the traditional budgeting system is to make the budget a tool for financial compliance. A cash-budget fits this aim within the budget; expenditures are classified by organization and object of expenditure (line item), e.g. transportation of things, full-time personnel, etc., to control the use of resources. Budgets prepared in this way are often very detailed and in some countries include several thousand line items. Line-item budgets were (and in a number of countries still are) associated with an "input-oriented" budget preparation with detailed ex-ante controls and/or rigid appropriation rules (e.g. rules regulating or forbidding transfers between line items). However, these aspects can change country by country. In a number of countries, the control system is aimed only at avoiding transfers between personnel expenditure and other items, and detailed line items may be included in the budget for information only. Therefore, one should not confuse a justified criticism of an excessively detailed and rigid line-item budget with criticism of line-item budgeting itself. A major criticism of the traditional budget system is that it does not deal with key issues of government objectives, their links to the budget, the services to be delivered by the government; the search for the most efficient combination of inputs to deliver services, etc. Thus, since the early 1950s, various performance/program budgeting reforms in both industrialized and developing countries attempted to address these issues. As reviewed briefly below, the results of these reforms have been usually disappointing compared with their costs, and in a few cases even counter productive. In the 1980s, the focus changed to macroeconomic stabilization, and budgetary reforms were essentially aimed at making the budget an effective tool for fiscal policy. Several developing countries still imported performance/program budgeting approaches (with generally poor results), but PPBS was no longer the dominant international paradigm. As long as it is comprehensive and includes an appropriate economic classification, the traditional budget format fits well the requirements for macroeconomic stabilization. Currently, performance-oriented budgeting approaches are regaining popularity. 4. Performance/Program Budgeting It is fundamental not to confuse performance orientation in the budget system, which can be fostered in a number of appropriate ways, with the specific system known as performance budgeting. In performance budgeting, the budget shows the purposes of the expenditure, the costs of the “programs” proposed for those purposes, and measurements and results under each program. Therefore, performance budgeting includes the following features: v Government activities are divided into broad functions, programs, activities, and cost elements. A “function” corresponds to a broad objective of the government (e.g., promotion of agriculture). A “program” is a set of activities that meet the same set of specific objectives (e.g., development of crop production). An “activity” is a subdivision of a program into homogenous categories (e.g., irrigation project). Cost elements are the inputs, and costs are measured on an accrual basis. A criterion used to delimit the activity 31 | P a g e  PA 312 – GOVERNMENT BUDGETING category is the level at which performance indicators can be elaborated and costs measured. The operational aims of each program and activities are identified for each budget year. v Performance indicators and costs are established, measured, and reported. (In the 1950s, the aim was to establish standards and norms, again with highly doubtful impact.) The hierarchy of “function,” “program,” and “activity,” is comparable to that of the government structure (“ministry,” “directorates,” and “divisions“ or projects). But there is no systematic relationship between the functional structure of the budget and the organizational structure of government. Indeed, a major problem with program budgeting is the disconnect between the program structure and the administrative structure8 and the resulting complexity, lack of “ownership”, and loss of accountability. The first experience with performance budgeting on a wide scale was launched in 1949 in the U.S., following the recommendations of the Hoover Commission. Emphasis was put on full cost measurement, evaluation of workload, and unit costs. The 1951 U.S. budget included listings of the programs or activities by budget account and narrative statements of program and performance, some of them presenting workload and cost information, calculated on an accrual basis. The experiment was a failure and the U.S. abandoned it soon thereafter, although some of the lessons learned proved useful later and was incorporated into the budget reforms of the 1990s. A generation before the emergence of the “New Public Management”, a performance budgeting experiment was launched in 1954 in the Philippines, following the U.S. example. For fiscal year 1956, twelve government agencies adopted a performance budget model; detailed line items were abandoned and expenditures were presented in the budget by blocks corresponding to programs and projects. The system reverted back to the more traditional model, as a result of the constant complexities of the “performance budget” and some loss expenditure control. Currently, the resulting presentation is basically for information, showing capital and current expenditures for each agency and subordinate spending unit and performance indicators. The preparation of budget submissions focuses on programs rather than on line items. However, these changes in the budgetary decision-making process are more formal than real. In the U.S., by 1964, 80 percent of federal agencies provided cost information in their budget requests. However, the need to take into account also the qualitative aspect of expenditure led to the Planning Programming Budgeting System (PPBS), launched in 1965. PPBS aimed at ensuring a better linkage between objectives and goals, programs and activities. In the planning phase, systems analysis was used to establish the objectives and identify related solutions. At the programming stage, means were reviewed and compared to the solutions identified at the planning stage. Sets of activities are grouped into multi-year programs, which are appraised and compared. Finally, the budgeting phase translates these programs into the annual budget. The initial objective of PPBS was to integrate program budgets into budgetary decision making and to overcome administrative compartmentalization by making programs independent of organizational affiliation. PPBS proved impossible to implement not only because of (predictable) bureaucratic resistance, but because reaching a perfect and indisputable rational organization of government objectives and activities is illusory. In addition, this 32 | P a g e  PA 312 – GOVERNMENT BUDGETING approach muddled up ministers responsibilities and hampered accountability.9 Program budgeting and PPBS-like approaches were attempted over and over again in many developed countries in the late 1960s and the 1970s, but generally not for long and were abandoned in the 1980s. In the late 1970s, another experiment—Zero-Based Budgeting (ZBB)—was attempted in the U.S. as a reaction to the drawbacks of purely incremental budgeting. In a pure ZBB system all programs are evaluated each year and must be justified from scratch. The fact that resources have already been granted to a program does not necessarily mean that it must be continued. The ZBB approach is useful for occasional expenditure reviews, but is practically impossible to undertake each year for the preparation of the annual budget. In actual fact, ZBB was accommodated by focusing scrutiny on a few marginal programs. In any event, the U.S. Congress decided to review the traditional budget presentation and put aside the voluminous and complex ZBB documentation. In developing countries, attempts to introduce program budgeting and systems to manage were been pursued in the 1980s, rarely drawing on the lessons of experience of the previous decade, and usually with the encouragement (or pressure) of international donors and enthusiastic endorsement of international consultants9. In Asia, aside from the Philippine experiment mentioned above, experiences in program/performance budgeting were carried out in India, Malaysia, Singapore and Sri Lanka. Results were uneven, and far from the initial ambitions of the proponents of the PPBS system in the 1960s. Experience was similarly unfavorable in Latin America (Petrei, 1998). As a result, (and probably for good reason) in developing countries where program budgeting was introduced, it has typically been sidelined and its role sharply reduced compared to the initial design. Quantitative program goals are defined, but “play no role in budget discussions, or are they used to monitor the use of program funds” (Petrei, 1998, p. 391). Much the same has happened in Asia and the Pacific. On the positive side, these experiences have contributed in some countries to improve the presentation of the budget. Also, it is possible that they may have led to a somewhat greater performance orientation by budget officials although, as noted, there is a variety of less costly ways to introduce greater focus in performance. Box 3 Program Project Activity in the Philippines: An Example of Budget Presentation Department of Health Programs I. General Administration and Support II. Support to Operations a. Health information and health education services b. Health human resource development program c. Health policy and development program d. Department legislative liaison office e. Executive liaison and coordination f. International health relation g. National drug policy h. Essential national health research i. Support to regional health training centers j. Local government assistance and monitoring service III. Operations a. Public health services b. Public health care program c. Health facilities and operations d. Standards, regulations, licensing and regulations, and other health facilities 33 | P a g e  PA 312 – GOVERNMENT BUDGETING e. Provision of drugs and medicines, medical and dental supplies and materials, vaccines, reagents, and other biological supplies Projects I. Locally-Funded Projects a. Provision for construction, improvement, repair and rehabilitation/renovation and purchase of equipment of special hospitals, medical centers, sanitaria, regional hospitals, central office and regional field health offices and financial assistance to other health facilities on a priority basis. b. Acquisition of ambulance and other health related equipment c. Aid to Dr. Jose Rizal Memorial Foundation Hospital in Dasmariñas, Cavite II. Foreign-Assisted Projects a. First Water Supply, Sewerage and Sanitation Sector Project (IBRD Loan No. 3242 PH) b. Philippine Health Development Project (IBRD Loan No. 3099 PH) c. Palawan Integrated Area Development Project (ADB Loan No. 1033/1034 PHI) d. Urban Health and Nutrition Project (IDA Loan No. 2506 PH) Source: General Appropriations Act, Philippines, 1998. 5. Other Performance-Oriented Approaches a. Increased flexibility Some countries (e.g., Australia, Sweden, and Singapore) have recently introduced “block” appropriations which involve allocating a lump sum to line ministries or agencies, which are then free to determine the best mix of economic inputs to produce their services. Canada’s Envelope Budgeting System of the 1980s was in many ways a precursor of these block budgets. While increased flexibility in budgeting is desirable in principle, without a hard financial constraint it is likely to lead to the “needs” mentality which is antithetical to good PEM. Given a hard financial constraint, the appropriate degree of flexibility depends on the country’s context, especially the soundness of governance system and the accountability regime. Thus, for example, eliminating the separation between wage and non wage expenditure could have undesirable outcomes in many developing countries and transition economies, by leading to even greater overstaffing than is the case, even lower maintenance xpenditure, and opening up new possibilities for corruption. Weak compliance may require accurate monitoring of budget execution of specific particular items. A number of developed countries have reduced the number of appropriations in their budget in to increase flexibility in project and management. This is desirable in a number of developing countries that define an appropriation for each subordinate spending unit within a ministry or a department, or for each project. However, the policy objectives should be clearly presented to the legislature and should not be altered during budget execution (e.g., it would be questionable to mix primary education and higher education into one appropriation or to allow unrestricted resource transfers between these two sub sectors). But certainly, excessive detail in line-item classification and rigidity of rules lead to inefficiency and disempowerment without any corresponding advantage. Some developed and developing countries have adopted a progressive approach to granting flexibility to line managers, linking it to some agreement on goals and performance. This approach is notably developed in Malaysia (see box 3). It could fit the situation of several developing countries or transition economies which do need to make their budget systems more flexible and efficient, while 34 | P a g e  PA 312 – GOVERNMENT BUDGETING avoiding the risk of overruns in public spending, weaker expenditure control, or wider corruption. Box 4 The Modified Budget System In Malaysia The Modified Budgeting System (MBS) was first introduced in 1990. Under this system, the Controlling Officer is responsible for determining the performance of his department in terms of output and impact, which are recorded in the program agreement for his department. The program agreement is a document that records inputs, outputs and impact of an activity as agreed upon between the Federal Treasury and the department during budget execution. To enable Controlling Officers to manage their resources more effectively, a generalized approach to expenditure control would be used. Controlling Officers are given greater powers in the utilization of the organizations resources. For example, they can transfer resources across ctivities within a particular program without prior approval from the Treasury. Input monitoring, however, is not abandoned. Source: Tan Sri Dato' Seri Ahmad Sarji bin Abdul Hamid, Chief Secretary of the Government of Malaysia, “Improvements in the Public Service for the year 1992,” 1993. b. Instruments for measuring and improving performance Several countries have developed performance measurement systems. An emphasis is put on the "3Es", that is, Economy, Efficiency, and Effectiveness. Economy is “the acquisition of the appropriate quality and quantity of financial, human and physical resources at appropriate times and at the lowest cost concerned,”12 and may be assessed through input measures and comparisons with norms and standards. Efficiency is the relationship between outputs and the resources used to produce them, and is measured by cost per unit of output. Effectiveness is the extent to which programs achieve their expected objectives, or outcomes. As a general rule, performance should be measured by that mix of input, output, outcome that is appropriate to the specific sector in the country concerned during the relevant period. From the budgetary point of view, developing greater performance orientation calls for giving more responsibility to managers; developing realistic indicators; and cost measurements; implementing accrual accounting in the agencies that deliver services; and structuring the ministries' budget to set up performance indicators at the appropriate level (the activity or an agency sub program). However, performance orientation does not necessarily call for major changes in the budget system. Inputs are still important as a budgetary guideline; the link between performance and the budget is indirect and often inferential rather then direct and automatic; and budgetary pressure moves the use of performance indicators more to the ex-post evaluation.13 This assessment, drawn from the experience of developed countries, is even more applicable to developing countries, with their weaker governance system and administrative capacity limitation. Indeed, the confusion between performance orientation as the goal and performance budgeting as one means of fostering such orientation, has led to the costly introduction of program budgeting (or output budgeting) without any positive impact on performance orientation itself. In most developing countries, regardless of the budgeting innovations introduced, some form of line-item budgeting should be kept as an essential safeguard of the public resources. c. The “agency model” and the accountability framework 35 | P a g e  PA 312 – GOVERNMENT BUDGETING Following the approach developed by the United Kingdom under its Next Steps program, some countries are developing an organizational model that separates the delivery of services and administrative tasks from policy formulation. By drawing a boundary around operational functions (such as payment of pension checks) and giving the task to a separate entity, the responsibilities and expected performance can be clearly specified and staff and managers can be made accountable for performance. In theory, this approach could improve efficiency in service delivery. However, caution is required before considering its implementation, especially in developing countries or transition economies. The “separate entity” can easily in practice deteriorate into extra-budgetary fund and disappearing budgets. It is also questionable whether organizational reform is really needed to clarify mandates (e.g., compared with appropriate delegations of authority). Finally, there are risks for both sound policy-making and effective implementation in an excessively rigid boundary between the two, with policy formulation increasingly isolated from realities of delivery of programs and services.15 No general statement can be made on these issues other than to emphasize the grave risk of importing these practices without careful consideration. Their applicability depends on experience, culture, and administrative capacity each country. Several OECD countries have extended their accountability framework. The traditional accountability for financial compliance is maintained, but has been extended to accountability for efficiency and economy in operations and to some accountability for outcomes. Line ministers and/or agencies are accountable for their performance, assets and liabilities. Full financial disclosure is required from them. Each agency is viewed as a separate entity with its own accounts, and must produce annual financial statements that disclose its financial performance, assets, and liabilities. d. Output budgeting Output budgeting, which has been adopted in New Zealand, and, to some extent, in some Pacific Island countries, represents the culmination of the performance budgeting approach and, as such, carries all its advantages and risks. The data requirements, methodological difficulties, and demands on implementation capacity are vast. Output budgeting is based on the “principal- agent” paradigm, whereby the ministers are seen as principals and the executive agencies as their agents. "For example, the Police Commissioner contracts with the Minister of Police to provide a certain level of policing services, patrols, community security programs, road safety commercials, etc. The commissioner does not contract to lower the crime rate.16 The crime rate is affected by many variables beyond the control of the Commissioner." In New Zealand, a single agency may have as many as 150 outputs (e.g. for the Treasury).17 Budgetary appropriations are defined by classes of output. Output classes are category of conveniences and are defined by the act as any grouping of similar outputs.18 They are more or less similar to what is called in other countries, a subprogram or activity. Appropriation management rules (transfers between classes, budget execution controls by the Auditor-General) are established at this level. The number of appropriations is relatively high. There are about 500 to 700 appropriations (classes of output) in the budget.19 "One factor that explains the 36 | P a g e  PA 312 – GOVERNMENT BUDGETING number of output classes is the effort to ensure that funds are spent on particular activities (such as managing contracts) and are not pooled with other administrative expenses.” The costs of outputs are determined on the basis of the costs of inputs. This mode of calculation and the number of output classes have not yet allowed the budgeting processes to be fully output-oriented.21 However, it is expected that some outputs will be classified into a class C where their costs would be based on output prices instead of input prices (e.g., benchmark prices). As noted, the data, administrative, and transaction requirements of implementing an output-budgeting system are heavy, and include an accrual budgeting system cost measurements, contract negotiations between ministers and managers, and intensive monitoring of results, including the elusive factor of output quality. The benefits could be substantial in theory, but there is little evidence of a positive across-the-board impact of the approach, even in New Zealand. The Ministry of Finance officials in most developed countries have considered output budgeting and concluded against recommending it. As for developing countries, the international consensus is that the approach is wholly unsuitable, although a few exceptions are conceivable. C. Expenditure Classification 1. The Importance of A Good Classification System Classifying expenditures is important in policy formulation and the identification of resources allocation among sectors, the identification of activities of the government and the level at which performance should be assessed (if a performance-oriented approach is developed; the establishment of accountability for compliance with the Parliament’s authorizations, policies, and performance; analysis; and day-to-day budget administration. An expenditure classification system provides a normative framework for both policy decision making and accountability. The best-known classification systems are the functional “Classification of the Functions of the Government (COFOG),” developed by the United Nations, and the Government Financial Statistics (GFS) classification, developed by the IMF. Other classifications, however, can also be useful, as discussed below. Expenditures must be classified for different purposes, such as: the preparation of reports that fit the needs of report users (policy decision makers, the public, the budget manager); the administration of the budget and budgetary accounting; and the presentation of the budget to Parliament. Paradigms in public expenditure management often govern the organization of the expenditure classification system, but paradigms change from time to time. To respond to different demands and needs the solution is not to find the budget classification that fits a paradigm, but to identify elementary classifications that are needed. Undoubtedly, the function of these elementary classifications in the budget process will depend on the approach to public expenditure management, but the first step is to establish them in a coherent manner. Expenditures should also be reported along the international standard classification, defined in GFS. However, it should be noted that the GFS manual provides guidelines on classification for reporting purposes only. They are not intended as budget or account classifications. Moreover, GFS focuses only on economic and functional 37 | P a g e  PA 312 – GOVERNMENT BUDGETING reporting, while a budget classification needs to be an instrument for policy formulation, budget administration and accounting. According to the different needs for policy formulation, reporting and budget management expenditures must be classified according to the following categories: function, for historical analysis and policy formulation (e.g., COFOG); organization, for accountability and budget ration; fund (source of financing, EBF-special accounts, if any) any other category needed for budget ration or to take into account special requirements; economic category, for statistics (GFS) and object (i.e., line item), for compliance controls and economic analysis; program and activity and output, for policy formulation and performance accountability (depending on the definition of these categories and on the approach to public expenditure management). 2. The U.N. Classification of the Functions of Government (COFOG) A functional classification organizes government activities according to their purposes (e.g., education, social security, housing, etc.). It is independent of the government organizational structure. A functional classification is important in analyzing the allocation of resources among sectors. A stable functional classification is required to produce historical surveys of government spending and to compare data from different Fiscal Years. The Classification of the Functions of Government (COFOG) established by the United Nations is presented in the SNA and GFS manuals. The objective of COFOG is to give a standard classification for international comparisons. It is consists of into 14 major groups, 61 groups and 127 sub groups.24 The COFOG, or at least its 14 major groups, is widely implemented in developing countries. Oftentimes, however, industrialized countries have their own functional classification, which may be either limited to about 10 to 15 functions, or much more detailed. For developing countries that do not yet have their own functional classification, adopting COFOG instead of a customized classification presents significant advantages. It is already established and well-documented in the GFS manual. It facilitates international comparisons. A country may desire to reorganize the COFOG classification, as it is considered in GFS.25 In this case, a mapping table between COFOG and the country functional (and 21 program) classification or 38 | P a g e  PA 312 – GOVERNMENT BUDGETING between the country organizational classification and COFOG should be established to allow reporting when needed under COFOG. Public reports showing expenditures along functional categories should be prepared. They do not need to be excessively detailed, but should show at least government expenditures along functions similar to the 14 major groups of COFOG, completed by the most important groups (box 13). Box 5 FUNCTIONAL CLASSIFICATION: Grouping of COFOG Functions as Shown in GFS 1. General Public Services and Public Order § general public services § police order and safety affairs 2. Defense 3. Social Services a. Education affairs and services § Preprimary and primary education § Secondary education § Tertiary § Other b. Health affairs and services § Hospitals § Clinics, practitioners § Other c. Social security and welfare d. Housing, water supply. Sanitation e. Culture and Recreational affairs 4. Economic Services a. Fuel and energy affairs b. Agriculture, forestry, fishing and hunting c. Mining-Manufacturing-Construction d. Transportation and communication § Roads § Other transport § Communications e. Other economic affairs and services 5. Expenditures not classified by major group a. NC Interests b. Intergovernmental transfers 3. GFS Economic Classification An economic classification of expenditures is required for budget analysis. Issues such as, the share of wages in government expenditures, and the weight of transfers to public enterprise, for example are crucial. At the very least, the economic classification must be fully consistent with the GFS economic classification of government expenditures. The object/line-item classification is more or less an economic classification, but, in many countries should be, revised or reorganized to be compatible with the GFS economic classification. Reports based on GFS generally use net concepts, for “lending minus repayments,” “financing,” and “net surplus or deficit of departmental enterprises,” although the memorandum items of GFS include the gross flows. It must be stressed that these net items can be sufficient for macroeconomic analysis, but not for budget formulation and management. In the accountants' books, gross flows must be recorded. From the policy formulation point of view, the item “lending minus repayments” should be to separate loans, repayments, acquisition and sale of equity or assets detailed broken down (assets acquired for policy purposes are consolidated with lending in GFS). The SNA classification is different from the GFS. Full reporting along the SNA in preparing the national accounts is desirable. 39 | P a g e  PA 312 – GOVERNMENT BUDGETING However, this issue is related to the implementation of an accounting system covering, besides the budgetary operations, the assets and the liabilities of the government. GFS is moving to an accrual basis for reporting government expenditures and liabilities, in the interest of creating greater statistical comparability between fiscal and national accounts. Box 6 GFS Economic Classification 1. Expenditures for goods and services 2. Wages and salaries 3. Employer contributions (pensions—social contributions) 4. Other goods and services 5. Subsidies 6. Current transfers 7. Interest § Domestic § External 8. Capital expenditures 9. Capital transfers 10. Lending minus repayment Loans 11. Repayment of loans 12. Sales of assets 13. Other (Not presented in the 1986 version of GFS). Source: IMF. 4. Object (Line-Item) and Input Classification For budget management purposes, the traditional budgets include an object classification (also called “line-item classification”).28 This object classification groups purchases along categories used for budgetary control and monitoring, such as different categories of personnel expenditures, travel expenses, printing. For goods and services, the object classification is an input classification. a. Relationship with an economic classification As indicated above, the object (line-item) classification needs to be compatible with the GFS economic classification (with details for the item “lending minus repayment”). Often, for goods and services, this requires only to grouping the objects into sets of objects that fit the GFS classification. This can be done by reorganizing the object classification to make the objects a subcategory of GFS economic categories, or any other method of grouping. For transfers and other items, it may be necessary to provide break down of objects into homogenous categories that fit the GFS classification, but this concerns only few budget items, compared with goods and services. The economic classification of development expenditures, which in several developing countries is distinct from the object classification, must also fit the GFS standard. In some countries, all development expenditures are classified as capital expenditures, although the development budget includes goods and services expenditures, while the recurrent budget includes capital expenditures. A unified economic classification covering both the recurrent and the development budgets is needed. Subcategories of this classification can be specific to either the recurrent or the development budget, for example, transport of things in the recurrent budget and consulting services in the development budget. Nevertheless, both budgets must share at least a basic economic classification that fits GFS. 40 | P a g e  PA 312 – GOVERNMENT BUDGETING Capital expenditures should be defined strictly according to the SNA standard. The SNA definition of capital expenditures does not correspond necessarily to the country’s common definition of capital expenditures. This requires to defining a subcategory that fits the SNA definition within the country's category, capital expenditures. b. Management and control implications The object classification is or was often associated with ex-ante detailed controls. A budget formulation focusing mainly on inputs and rigid appropriation management rules (i.e., rules for transfers between line items) leads to poor budgeting. In several countries, this requires revising appropriation management rules and often to rationalizing objects classification. Budget execution control processes are discussed in chapter 6. However, issues related to controls or line-item budgeting should not lead to abandoning input classification, which is required in any management system. For internal management, close monitoring of inputs is required. The Ministry of Finance does not need to review the allocation of resources between expenditures for paper and other supplies, but the managers of the spending units may need to do so. Some expenditure items for which there are risks of arrears generation (such as utilities' services consumption) must be monitored centrally in many countries. Moreover, in some countries, rules for either protecting some items (such as electricity consumption) or on the on the other hand capping other categories of expenditures (e.g. mission of ministers abroad) are desirable. However, these rules should focus on what it is necessary and are not supposed to be permanent. What can be a problem for compliance one year will not necessarily be a problem the following year. Regarding aspects related to control, some line-item classifications are both too detailed and yet not adequately specified. The solution is not to increase the number of items, but to incorporate a special item temporarily into the classification whenever so required. c. Input classification for “expenses” The traditional object classification as well as the GFS economic classification concerns expenditures. Under an accrual accounting system, expenses instead of expenditures are posted; the economic classification must be complemented by categories proper to expenses (e.g., depreciation of physical assets, superannuation liabilities) 5. Administrative Classification An administrative classification of expenditure (by governmental organization) is needed for clear identification of responsibilities in public expenditure management and also for day-to-day administration of the budget. Expenditures must be divided into separate sections for each ministry, department, or agency. The administrative classification of expenditures obviously needs to be tailored to the organizational arrangements for public expenditure management (e.g. the hierarchical levels within a line ministry that deal directly with the "Treasury"). The administrative classification should be organized along the different levels of responsibility and accountability in budget management (e.g., the 41 | P a g e  PA 312 – GOVERNMENT BUDGETING entity that is accountable to Parliament, the administrative levels that deal with the Ministry of Finance for budget preparation). In ome countries, expenditures are presented by organization but not always at the same level of aggregation heterogeneous manner. For example, personnel expenditures are presented by ministry, while other current expenditures are presented by lower level government entities. This could be suitable for administration and controls, hampers the assessment of the running costs of the different department and agencies. 6. Program classifications As discussed earlier, a program is a set of activities that meet the same set of objectives. Compared with COFOG functions, classifications by program takes into account the country policy objectives or administrative context. In some developing countries, a classification of expenditures by program has been set up, often as part of attempts to implement a PPB system. To establish these programs, an exercise to establish the chain objective-program has sometimes been carried out. However, programs are often barely a nickname for an organization, or a sub- function of the COFOG, or only a grouping of individual investment projects, while the recurrent budget is presented in the traditional manner. Programs may located within a line ministry or be a cross ministries. The major problem when preparing a program classification is avoiding both an overambitious approach that can not be implemented and an approach that would be limited to adding useless category to the existing classification system. A classification by program can be recommended for different purposes, from developing a performance-oriented budgeting approach to increasing the readability of the budget In the latter case, the COFOG classification can be program classification, provided that it is supplemented with other classifications dealing with special policy issues relevant to the country’s policy context (e.g., an environmental program, a nuclear program). The issue of reconciling of the program classification with the organizational structure of the government is one of the points that generated debates on the pros and cons of program budgeting and explains its failure. Actually, to set up performance indicators, accountability requirements suggest that the organization of programs and activities should fit the governmental structure. Programs should be defined by line ministries and could in a majority of cases, correspond to a major subdivision of this line ministry. Activities or subprograms should be defined in the most convenient manner to establish performance indicators. The classification of expenditure by activity cannot be established from the top and must be prepared by relevant line ministries and agencies and then discussed with the Ministry of Finance. Interministerial programs can be established for special cross-cutting issues. However, it is certainly not necessary to reorganize the whole budget classification system to take into account a limited number of interministerial programs. A table annexed to the budget showing which activities are covered by these intersectoral programs is sufficient for decision-making and for follow-up the program implementation. 42 | P a g e  PA 312 – GOVERNMENT BUDGETING 7. Expenditure Classification in An Output Budgeting System Output budgeting requires distinguishing appropriations related to outputs from other appropriations. Thus, the New Zealand budget distinguishes the following seven classes of appropriation.31 "(i) output classes, e.g., policy advice, management of contracts, policing, custodial services, etc.; (ii) benefits, e.g., unemployment, domestic purposes, scholarships; (iii) borrowing expenses, e.g., interest expenses, premiums, borrowing, other finance costs; (iv) other expenses, e.g., restructuring costs, litigation costs, loss on sale of fixed assets, overseas development aid; (v) capital contributions, increase in investment in a department or an SOE to increase its output capacity or improve its efficiency; (vi) purchase and development e.g. state highways, national parks, Parliament Buildings of capital assets and; (vi) repayment of debt e.g., foreign currency debt repayment. Benefits and capital contributions are appropriated on cash basis, borrowing expenses on an accrual basis, but this is also done in a majority of countries with a cash budget system. Outputs are appropriated on an accrual basis. 8. Other Special Classifications In developing countries, expenditures must be classified by source of financing (domestic resources—consolidated fund and counterpart funds—loans, grants).EBFs or Treasury special accounts if any, need to be identified. Other special classifications may be needed for managing the budget. For example, Parliaments often request a presentation of expenditures by region. This issue depends on the country context, but must be kept in mind when reviewing a budget classification system. An information system for budget management must be able to integrate classification requirements that were not expected when it was designed. 9. Implementation Issues a. Expenditure classification and budget management From the budget management point of view, the most important issues related to expenditure classification are the following: § For tracking uses of appropriations (“budgetary accounting”), organizing the books, coding the transactions, etc., it is necessary to define an expenditure classification that includes at least the administrative classification (possibly completed with a subdivision of spending unit by activity), funding (financing source, EBF, if any, etc.), and the economic-object classification. § For presenting the budget to the legislature, it is necessary to define the appropriation, i.e., what is binding for the executive (e.g., the budget of a ministry, a program within a ministry, each individual object). § For managing the budget, it is necessary to determine at which level rules for transfers between budget items, controls, etc., are established (i.e. at line-item level, at economic category, at the level of programs, etc.). 43 | P a g e  PA 312 – GOVERNMENT BUDGETING Sometimes, a “rationalization” of the object code has led to increased ex- ante controls or to their extension to the development budget, because additional line items have been introduced. A change in budget classification must include a review of appropriation management rules and of the impact of the change on the administration of the budget (appropriation management rules are discussed in chapter 5). b. Administrative and institutional issues Classifying expenditure requires first an identification of the technical and institutional constraints on reforming the system. Attention must be paid to the organization of the books and the information systems. For example, when interest is mixed with amortization, there is an obvious need to separate them, but even more important is the scrutiny of how the debt management office keeps its books. Also, badly designed or documented information systems can be an obstacle to reforming expenditure classification. Therefore, a review of current applications and software is generally required when reforming the expenditure classification system33. On the other hand, software and application developments should not only be compatible with the existing classification but also allow further changes in classification. Reforming expenditure classification cannot solve deficiencies in reporting caused by institutional arrangements. A powerful extra budgetary fund will not want to show its expenditures along any classification, whatever the classification system. Compatibility with COFOG, GFS, or anything else will not resolve deliberate and systematic misreporting. Bad, or badly-presented, information is useless under any classification. Institutional issues must be addressed as such. c. Reporting along COFOG and coding Changes in the organization of the books should focus on what is required to identify transactions properly. Often, a reform of the budget classification system attempts to include into the hierarchical nomenclature or the codes used in the day- today administration, the codes of all categories needed for reporting (COFOG, program, etc). Consequently, the coding system used to register the transactions becomes cumbersome and difficult to manage; when budget execution is not fully computerized. This has contributed to halting or delay the reform of the expenditure classification system in several countries. Fortunately, these cumbersome nomenclatures can be avoided, as explained below. For example, countries that have a detailed administrative classification do not need to change the format of the books or the coding of their forms to report under COFOG. They need only to classify spending units along COFOG. (A similar suggestion is made in the SNA and GFS manuals35). If a report on payments is available by division/project and if division/projects are classified along COFOG, it is possible to present the payments along COFOG simply by linking the report on payments and the table that classifies organizations along COFOG categories. This can be done easily with a personal computer and a spreadsheet. In a few special cases, 44 | P a g e  PA 312 – GOVERNMENT BUDGETING where several functions are assigned to a spending unit, it is necessary to classify the activities of the relevant organizations along COFOG, but this does not require a major change in the classification structure. A similar approach can be adopted for programs. The coding system used in the day-to-day administration of the budget must identify this lowest common denominator, but does not need to describe all its attributes. The activity can be attached to organizations, functions, and programs, but need not be attached to all these categories when coding the forms, vouchers, etc. A small addition to the administrative code is sufficient to identify the activity. Therefore, in the day-to-day administration of the budget, to present expenditures by program or along the COFOG classification it is sufficient to recorded for each transaction the administrative code, an activity code established by spending unit or project and, the object and financing source codes. In a number of countries, a hierarchical budgetary nomenclature (coding system) is used in the day-to-day administration of the budget. The nomenclature is organized as follows: § line ministry § directorate § spending unit § object § the budget code including the administrative and object codes. Hierarchical, or decimal, coding helps in classifying homogeneous categories and is useful within a manual management environment, but it should be simple, and redundancies should be avoided. Within a computerized environment, on the other hand, hierarchical nomenclature is not very useful. The first task of an informatics expert when setting up a budget data base will therefore be to detail the hierarchical nomenclature in order to set up tables and link them by relationships. Each table should correspond to only one category of the budget classification system, and codes should be defined table by table, category by category. 45 | P a g e  PA 312 – GOVERNMENT BUDGETING Name: _________________________________ Instruction: Answer any three of the following questions for. EXERCISE NO. 3 1. What are the different budgeting systems? Comprehensively discuss each of them? 2. Compare and contrast authorizations for multi-year programs from permanent authorizations? 3. What are the other performance-oriented budgeting approaches? Explain Each of these. 4. What the different categories of classifying government expenditures? Explain each of these. 5. What are the different expenditure classifications? Discuss at least three of these. 46 | P a g e  PA 312 – GOVERNMENT BUDGETING Lesson 4 PRINCIPLES OF SOUND BUDGETING AND FINANCIAL MANAGEMENT Following are the principles of sound budgeting and financial management according to the Public Expenditure Management (PEM) Handbook of the World Bank. The approach in the handbook is shaped by principles that focus on the institution and are widely accepted as underpinning sound budgeting and financial management. Comprehensiveness and discipline. Lead the list. This is because the annual budget process is the only mechanism available, at least between elections, to discipline decision making. Comprehensiveness requires a holistic approach to diagnosing problems, understanding all the links and evaluating institutional impediments to performance and then finding the most appropriate entry point t