2006 OECD Asian SBO
Top-down Budgeting
A Tool for Central Resource Management
December 15, 2006
Korea Institute of Public Finance
John M Kim, PhD
jhrv@kipf.re.kr
Outline
1. What is it?
2. Why do it?
3. How to do it?
4. Caveats
2
What is Top-down Budgeting?
KO REA INSTITUTE O F
PUBLIC FINANC E
It is not: Bottom-up Budgeting

–
–
–
Traditional way of budgeting
Sum of ministry budgets  Total budget
• Difficult to control aggregates (total budget, deficit)
• Difficult to control allocation among major sectors
– Defense vs. pollution control vs. infrastructure, etc.
Additional Problems
• Focus on annual numbers (myopic)
• Inefficient process
– Iterative negotiations (game-playing & adjusting for
totals)
– Inability to utilize ministries’ expertise
3
What is Top-down Budgeting? (2)
KO REA INSTITUTE O F
PUBLIC FINANC E

It is: Budgeting in 2 Steps
①
Ceilings (aggregate numbers)
1) Decide total spending & deficit levels (agg. ceiling)
2) Decide allocation among major policy areas (sectoral
ceilings: about 30)
– Defense vs. pollution control vs. infrastructure, etc.
②
Intra-sectoral allocations (details)
1) Ministry/agency budgets
4
What is Top-down Budgeting? (3)
KO REA INSTITUTE O F
PUBLIC FINANC E

It is: A Division of Roles/Responsibilities
①
Ceilings (aggregate numbers)
1) Final decision by PM & Finance Minister
2) Focus on
 Aggregate fiscal management
 Medium-term perspective (multi-year ceilings)
 Policy priorities
②
Intra-sectoral allocations (details)
1) Ministries formulate their own budgets
2) But must follow rules
5
What is Top-down Budgeting? (4)
KO REA INSTITUTE O F
PUBLIC FINANC E

It is:
①
Effective for fiscal consolidation
②
A key tool for enforcing MTEF (NFMP) decisions
(ceilings are often multi-year limits)
③
Ensures spending is aligned with priorities
④
Efficient in time and effort
⑤
Utilizes ministries’ expertise
6
Outline
1. What is it?
2. Why do it?
3. How to do it?
4. Caveats
7
Urgency of Reform?
KO REA INSTITUTE O F
PUBLIC FINANC E

Huge deficits ca.1990 in many OECD countries
forced them to adopt major fiscal reforms
1991
• Fiscal
1992
1993
1994
1995
1996
1997
1998
1999
2000
Balance (% GDP)
Australia
-3.8
-6.0
-5.6
-4.6
-3.7
-2.2
-0.5
0.6
1.6
0.1
Canada
-8.3
-9.1
-8.7
-6.7
-5.3
-2.8
0.2
0.5
1.6
3.2
Denmark
-2.4
-2.2
-2.9
-2.4
-2.3
-1.0
0.4
1.1
3.2
2.5
1.8
1.4
2.5
3.1
4.2
3.8
3.6
1.9
3.1
6.9
Netherlands
-3.2
-4.4
-3.6
-4.2
-4.2
-1.8
-1.1
-0.8
0.4
2.2
Sweden
-2.0
-7.8
-11.4
-10.8
-7.7
-3.1
-1.6
2.1
1.3
3.7
Utd. Kingdom
-3.1
-6.4
-7.9
-6.7
-5.8
-4.4
-2.2
0.4
1.1
1.6
OECD
-3.7
-4.6
-5.0
-4.2
-3.9
-3.2
-1.8
-1.4
-0.9
0.0
Korea
8
Different Motivation for Korea
KO REA INSTITUTE O F
PUBLIC FINANC E

Top-down adopted as key part of 4 fiscal
reforms
1) Need for longer-term perspective
Anticipate need for controlling future spending
growth in social welfare, etc.
2) Efficiency
a. Need to focus on broader policy priorities
b. Eliminate unproductive games in budget
negotiations
c. Utilize ministries’ expertise
3) Need to focus on performance management,
rather than controlling inputs
9
(What are Korea’s 4 Reforms?)
KO REA INSTITUTE O F
PUBLIC FINANC E
1.
National Fiscal Management Plan
–
2.
Medium-term (5-year) fiscal plan for 14 sectors
Top-Down budgeting
–
–
3.
Tier 1: Fixed spending envelope for each sector/ministry
Tier 2: Autonomy for line ministries in own budgets
Performance Management
–
–
4.
Assess performance of spending programs
Enhance link between performance and budget
Digital Budget and Accounting System
–
–
–
Program Budgeting
Accrual Accounting
Computerization of accounting system
10
(Why the 4 Reforms?)
KO REA INSTITUTE O F
PUBLIC FINANC E

Anticipate fiscal difficulties driven by aging & other
socioeconomic changes
–
Population aging and low fertility rate
•
Old population (65 and above): 7.2 (2000)  14.4(2019)
•
Total fertility rate: 6.0(1961)  2.1(1982)  1.19(2003)
 Less workers must support welfare of more elderly people
Public pensions and health care financing will suffer most
–
Society demands better quality of life (social welfare, education,
culture, environment)
–
Economic growth slowing down  so will tax revenues
Increase rate of national tax revenues(annual average)
1980~1990
1991~1997
1998~2003
2004~2008(Proj.)
17.0%
14.7%
8.6%
About 8%
–

Emphasis on participation and transparency
Spending growth may outrun revenue increase, so try to get
fiscal system in good shape before it’s too late
11
(Some Background: Current Fiscal Status)
KO REA INSTITUTE O F
PUBLIC FINANC E

Up to the financial crisis, Korea’s public finances were solid, thanks to
two decades of balanced budgeting

Some deterioration resulted from coping against crisis (national debt
more than doubled), but fiscal situation remains better than most other
OECD countries
<Korea’s National Debt>
Total Debt (in tn. won)
% of GDP
1997
60
12.3
2000
111
19.2
2001
122
19.6
2002
134
19.5
2003
166
23.0
2004
204
26.2
<General Government Debt in OECD Countries, 2003>
Korea
USA
Japan
OECD
Total Debt (% of GDP)
23.0
62.8
157.3
76.0

What does this mean for the 4 Reforms?
Korea’s reforms are not driven by an immediate crisis, but this may
end up somewhat undermining the momentum of the reforms
12
Top-down vs. Bottom-up
KO REA INSTITUTE O F
PUBLIC FINANC E
Comparison of Bottom-up & Top-down Approaches
Bottom-up
Top-down
Ministry-by-ministry analysis that
ignores economic forecasts
Macro-oriented fiscal analysis
based on economic forecasts
Annual, myopic time horizon
Multi-year perspective, especially
for investments
Time-consuming negotiations
Delegated authority
Ownership of proposals is more
agency-specific
Creates joint ownership of
proposals
Reactive
Proactive
13
Top-down vs. Bottom-up (2)
KO REA INSTITUTE O F
PUBLIC FINANC E
• Top-down and bottom-up methods are complementary
− Information for evaluating new initiatives
− Program reviews for monitoring programs/activities
Approaches to Determining Expenditure Ceilings
Top-Down Approach
Bottom-Up Approach
Overall
Ceiling
Sectoral
Ceiling
Overall
Ceiling
Sectoral
Ceiling
Program
Review
Sweden
○
○
-
-
△
Netherlands
○
○
-
△
○
Utd. Kingdom
○
○
-
△
○
Denmark
○
○
-
△
○
Korea
○
○
-
△
○
Canada
○
-
-
○
○
Australia
○
-
-
○
○
Chile
○
-
-
○
○
○ : actively used, △ : used as reference, - : not used
14
Results?
KO REA INSTITUTE O F
PUBLIC FINANC E

No more excessive budget requests
–

Increase rate of budget requests in the general account
dropped significantly: 30.8%(’04)  11.7%(’05)  7.0%(’06)
Self-initiated restructuring of spending by line
ministries
–
Restructuring of multi-year programs and introduction of new
programs have nearly doubled
<Comparison of FY 2004 and FY 2005 budget requests>
’04 Budget ’05 Budget
Change
Programs
308
416
134
Restructuring
Amount
multi-year programs
-1.6
-2.7
-1.1
(trillion won)
Introduction of
new programs
Programs
351
459
108
Amount
(trillion won)
1.5
3.0
1.5
15
Outline
1. What is it?
2. Why do it?
3. How to do it?
4. Caveats
16
Example of Linking Multi-year Plans
to the Annual Budget (Sweden)
Current
Year
(n)
KO REA INSTITUTE O F
PUBLIC FINANC E
Plans for Future Years
n+1
n+2
n+3
2004
FY 2005
•Total Ceiling Fixed
•Finalize 27 sect. ceilings
and annual budget
FY 2006
•Total Ceiling Fixed
•Adjust 27 sect. ceilings
using budget margin
FY 2007
•Total Ceiling Fixed
•Set 27 Sect. Ceilings
+ budget margin
2005
FY 2006
•Total Ceiling Fixed
•Finalize 27 sect. ceilings
and annual budget
FY 2007
•Total Ceiling Fixed
•Adjust 27 sect. ceilings
using budget margin
FY 2008
•Total Ceiling Fixed
•Set 27 Sect. Ceilings
+ budget margin
2006
FY 2007
•Total Ceiling Fixed
•Finalize 27 sect. ceilings
and annual budget
FY 2008
•Total Ceiling Fixed
•Adjust 27 sect. ceilings
using budget margin
FY 2009
•Total Ceiling Fixed
•Set 27 Sect. Ceilings
+ budget margin
17
Budget Formulation in Bottom-up
vs. Top-down Systems

PUBLIC FINANC E
Strategic resource allocation emphasized
Line Ministries
Before
MoF
NFMP
Now
KO REA INSTITUTE O F
MoF
Budget Requests
Budget Formulation
( by line items)
(line item-oriented)
Cabinet
Meeting
 Total
Ceiling
 Sectoral
Ceilings
Line Ministries
Budget
Formulation
Within Ceilings
Y+1
MPB
Consultation
and Review
Y+1
Y+5
18
Determining Expenditure Ceilings
KO REA INSTITUTE O F
PUBLIC FINANC E

Overall Ceiling
Prudent Economic Assumptions (Growth, etc.)
– Sensitivity analysis
– Independent panel or private sector forecasting
– Built-in bias for lower growth rate
② Fiscal Rules for Good Discipline
– Sweden: structural surplus of 2% GDP
– Chile: Structural surplus of 1% GDP
– UK: Balance current budget over econ. cycle
– Surplus automatically goes to repaying debt
①
19
Determining Expenditure Ceilings (2)
KO REA INSTITUTE O F
PUBLIC FINANC E
Sectoral Ceilings

–
Must not affect overall ceiling
–
Usually overlaps with ministerial boundaries
(good program budget design)
−
New initiatives may be required to be funded from
savings from existing programs
20
Determining Expenditure Ceilings (3)
KO REA INSTITUTE O F
PUBLIC FINANC E
Operating/Capital Ceilings

–
Ministries tend to favor operating expenses
–
Denmark: separate ceilings for current & capital
expenses
•
−
Sub-ceiling for salaries/wages in operating ceiling
UK
•
Current expenses: Golden Rule
•
Capital expenses: Sustainable Investment Rule
21
Determining Expenditure Ceilings (4)
KO REA INSTITUTE O F
PUBLIC FINANC E

Number of Ceilings
–
−
Korea (200+) vs. Sweden (27)
Optimal number is around 30
• More ceilings make budgeting decisions politically
difficult
• Need to give ministries room to exercise autonomy
to ensure their proactive participation
• This means Budget Office needs better tools:
• Performance management
• Information system to monitor execution
• Enhanced analytical capacity for policy
assessment
22
Determining Expenditure Ceilings (5)
KO REA INSTITUTE O F
PUBLIC FINANC E
Buffers against Contingencies

–
Built-in buffers in prudent forecasts
 Windfalls (repay debt, tax cut, etc.)
−
Budget Margin
•
Overall Ceiling = Sect. Ceilings + Budget Margin
•
Covers unexpected changes (forecasts errors, etc.)
and institutional reforms after ceilings were fixed
•
Usually does not cover new policy initiatives
23
Determining Expenditure Ceilings (6)
KO REA INSTITUTE O F
PUBLIC FINANC E

Expenses in or excluded from ceilings?
1) Discretionary expenses usually included
2) Mandatory expenses (social security
entitlements, etc., mandated by law)
•
Sweden, Korea, Chile, Netherlands: included
•
Canada, Denmark: excluded
3) Interest on debt
•
Sweden, Denmark: excluded
•
Chile, Netherlands, Korea: included
24
Determining Expenditure Ceilings (7)
KO REA INSTITUTE O F
PUBLIC FINANC E
Funding for new policy initiatives

•
Sweden: must come from existing ceilings
•
Most countries have review process to judge
new initiatives  adjust ceilings
•
Australia, Canada: Cabinet committees
•
Netherlands, Denmark: simply verify fit with
coalition agreement
•
Chile: pooled “Bidding Fund” from savings on
obsolete or poorly performing programs
25
Outline
1. What is it?
2. Why do it?
3. How to do it?
4. Caveats
26
Conditions for Top-down Budgeting
KO REA INSTITUTE O F
PUBLIC FINANC E
Good monitoring system to compensate for
delegation of authority to ministries

–
–
Enhanced policy capacity + Behavioral change

–
–
Budget Office: better forecasts & projections, must be
able to defend fiscal rules, but work better “together”
with line ministries
Ministries: need to learn internal allocation decisions
Strong PM & Finance Minister
Commitment to rule-based budgeting (Fiscal Rules)


–

Performance & program reviews
Information system to monitor execution
Remove arbitrariness in budgeting decisions, but
leave room for flexibility and judicious
discretion/autonomy
Support from the legislature
27
Remaining Tasks (Korea)
KO REA INSTITUTE O F
PUBLIC FINANC E

Areas for improvement
–
–
–
–

Consensus and understanding on the top-down system
Ex-ante consultations with line ministries when setting
spending ceilings
Further expansion of autonomy at line ministries
Insufficient preparation and guidelines by MPB
Future plans
–
–
–
–
Surveys and consultations with line ministries
Sectoral and ministerial spending ceilings set after
sufficient discussions
Active use of performance assessments to restructure
spending programs
Detailed budget formulation guidelines
28
KO REA INSTITUTE O F
PUBLIC FINANC E
This ends the presentation
Thank You!
29