Budget module: getting it, managing it and shedding it

Andrew GrahamAndrew Graham

School of Policy StudiesSchool of Policy Studies

Queens UniversityQueens University

MPA 827 2014MPA 827 2014

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“ Every agency wants more money; the urge to

survive and expand is built in.”

Aron Wildavsky

Another definition

A budget process is a system of rules governing the decision-making that leads to a budget, from its formulation, through its legislative approval, to its execution.

Karl-Martin, Ehrhart, Roy Gardner, Jürgen von Hagen, and Claudia Keser Budget Processes: Theory and Experimental Evidence, November 2000

The Budget as an Instrument of Public Policy and Management

• Planning Instrument

• Political Instrument

• Social Instrument

• Economic Instrument

• Legal Instrument

Source: Jerome B. McKinney and Lawrence C. Howard, Public Administration: Balancing Power and Accountability (Oak park, IL: Moore Publishing, 1979)

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Control Steps taken by management to

ensure that objectives are attained.

Planning Developing objectives for

acquisitionand use of resources.

A budget is a financialplan for achieving the financial and

operational goals of an organization. It expresses what is to be undertaken

in the defined period and authorizesthe financial authorities needed.

A budget is a financialplan for achieving the financial and

operational goals of an organization. It expresses what is to be undertaken

in the defined period and authorizesthe financial authorities needed.

What is a Public Sector Budget?

• Result of intense planning process, short-term decisions, roles of the dice and political nuance

• Budgets from Ministers of Finance, i.e. high level political documents not the sole source of program funding: • Statutory funding• Self-funded programs

Management budget sets limits, targets and authorities to get on with the work

Legal instrument to allow spending = Appropriations

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Budget Perspectives

• Budget applies differently at different levels

• Government-level: broad, policy-driven, focus on change and announcements, combines revenue with expenditure

• Department: will focus on overall results, generalized allocation to program pockets, more detail

• Unit: budget is tightly defined, focus on inputs, highly specific, focus on defining resources available

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Our focus is departmental and unit-based.

Our focus is departmental and unit-based.

Budgeting in time ContextHistoric Information

Evaluating Performance

Controlling operations

Forecasting & Planning

Plus Effects of Outside Environment

Future

Informati

on

Curr

ent

Info

rmat

i

on

Current Operating Data

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Budget Architecture

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Types of BudgetsTypes of Budgets• Operating Budget:

– also called recurrent budget

– funds designated to continuing operations

“Plan for the day-in and day-out operations of the organization. It is generally prepared for one year.”

• Capital Budget: – budget for permanent works: defining permanent

– tends to combine current year and future year plans

– current year often transferred into Operating Budget

“Plan for the acquisition of buildings and equipment that will be used by the organization in one or more years beyond the year of acquisition.”

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Types of Operating BudgetsTypes of Operating Budgets

Budget TypeBudget Type CharacteristicsCharacteristics General UseGeneral Use

Line ItemLine Item Expenditures and Expenditures and revenues are related revenues are related to commoditiesto commodities

ControlControl

PerformancePerformance Expenditures and Expenditures and revenues are related revenues are related to workloadto workload

Management Management efficiencyefficiency

Program/Program/ResultsResults

BasedBased

Expenditures and Expenditures and revenues are related revenues are related to public goalsto public goals

Planning and Planning and ImpactImpact

Not mutually exclusive.Not mutually exclusive.

Types of operating budgets

15Not mutually exclusive.Not mutually exclusive.

Line Item Operating Budget

• Simplest form of budgeting

• Budget information organized according to types of expenses, expenditure or cost categories

• Often detailed in object codes – little detail.

• Primary orientation is expenditure control and accountability: permits inter-budget cost comparisons, creates common reference points

• Relatively easy to prepare

• Does not provide any information regarding activities and functions of a program

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Line Item Operating Budget Example

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Budget of the Killaloe General Hospital for Fiscal Year 200X

Object Code Budget100. Salaries 8,000,000200. Supplies 2,000,000300. Rentals 250,000400. Professional Fees 750,000

Total 11,000,000

Line Item Budgeting

Limitations:

• Rigid, unable to cope with

• rapidly changing priorities and circumstances

• creation of new government services

• Budget evaluation mechanism difficult without mechanism to link things to be bought with things to be done.

• New budgets based on previous budget with increments for price increases

• No evaluation of whether objectives are still met or cost-effective

Line Item Budgeting

Advantages:

• Easy to make

• Micro-level expense control

• Where the rubber hits the road: this is the details that bedevil

• Reliance on past data

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Responsibility Centre/ Program Budget

• Distributes budget to internal units: Responsibility Centre

• Program could involve several responsibility centres

• Important means of assigning resources to program objectives, specific offices and specific locations

• Seldom see this on its own for operational purposes

• Usually in combination with a line item approach

• Designed to follow the money.

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A responsibility centre is part of the organization, such as a department or unit, for which a manager is assigned responsibility, usually with spending authority for the assigned budget as well as

responsibility for its proper use.

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Responsibility Center Budget - ExampleResponsibility Center Budget - Example

Budget of the Killaloe General Hospital for Fiscal Year 200XResponsibility Centre Budget

01. Operating Room 4,000,000

02. Laboratory 1,000,000

03. Radiology 1,000,000

04. Patient Care 2,500,000

05. Outpatient Care 1,500,000

06. Administration 1,000,000

Total 11,000,000

Program Budget - Example

Bureau of Public Safety and Leisure Services FY 200x-0y

Program Program Element Amount

05 -Public Safety 0501-Fire Protection 3,500,000

0502 - Police 5,000,000

Subtotal 8,500,000

06 – Leisure Service 0601 – Parks 2,000,000

0602 – Library 1,000,000

Subtotal 3,000,000

Total 11,500,000

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Program and Line Item Budget - Example

Bureau of Public Safety and Leisure Services

Detailed Budget Information FY 200x-200y

Program Program Element

Responsibility Centre

Line Expenditure

Amount

05- Public Safety

0501 – Fire Protection

050101- Central Office

Staffing 250,000

Supplies 500,000

050102 – Upper Level Station

Staffing 1,250,000

Supplies 150,000

050103 – River Street Station

Staffing 1,200,000

Supplies 150,000

Total 3,500,000

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Functional Budgets

• Result of combining a line item (input) and program approach

• Functional Budgets focus on the major functions performed by an organization.

• Combine elements of Line-Item and Responsibility Centered budgets

• This format is often used for external reporting

• Note the line item detail

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Functional Budgets - Example

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Budget of the Killaloe General Hospital for Fiscal Year 2011

RC 100. Salaries

200. Supplies

300. Rentals

400. Professional

Fees

Total

01. Operating Room

3,250,000 250,000 50,000 450,000 4,000,000

02. Laboratory

550,000 350,000 25,000 75,000 1,000,000

03. Radiology 450,000 450,000 0 100,000 1,000,000

04. Patient Care

2,000,000 400,000 0 100,000 2,500,000

05. Outpatient Care

1,050,000 125,000 25,000 50,000 1,250,000

06. Admin 700,000 425,000 50,000 100,000 1,250,000

Total 8,000,00 2,000,000 150,000 850,000 11,000,00

Program Budgets/ Results-Based Budgets

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•Budgets meant to link funding to expected results

•Program formulation and resources justification involve a set of predefined objectives, expected results, outputs, inputs and performance indicators which constitute a logic framework

•Performance in achieving results is measured by predefined performance indicators.

Performance Budget – small and unpretentious Example

Road Maintenance Budget FY 2006-2007

Activity Cost Formula Amount

Paving Roads Miles to be paved: 10

Cost per mile: $400K

4,000,000

Resurfacing Roads Miles: 5

Cost per mile: $150K

750,00

Total Road Maintenance Costs

4,750,000

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Performance budgets/results based budgets

Strengths:

• Budget based on outputs• Emphasis on performance and results• Greater autonomy and flexibility meant to follow• Greater accountability and reporting• Departments more aware of outputs and cost of producing

outputs• Puts decisions on deployment of resources in the hands of

people at operations

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Performance budgets/results based budgets

Shortcomings:

• No clear link to desired outcomes – the attribution issue• Lack of focus on key internal processes• Generally poor costing of inputs to results – the path is not

clear• With tighter fiscal position, need for greater emphasis on

inter-ministry allocations• Diminishes need for cost control and basic probity.

Flexible budget

Organizations often experience more or less volume than

budgeted. Flexible budgets look at expected revenues, expenses, and net

income under different volume assumptions. The key to flexible budgeting is the identification of:

Fixed Costs - which do not change with volume. Variable Costs - which do change with volume.

Flexible budget results are normally shown in a side-by-side columnar format.

A flexible budget is a form of "What if?" analysis.

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Volume of Breakfast Provided[1] 300 450 600

Expenses

Salaries 50,000 50,000 50,000

Supplies[2] 180,000 270,000 360,000

Rent 14,400 14,400 14,400

Other 5,000 5,000 5,000

Total Expense 249,400 339,400 429,400

Revenues

Municipality 200,000 200,000 200,000

Fund raising 75,000 125,000 125,000

Total Revenue 275,000 325,000 325,000

Surplus/(Deficit) 75,000 (14,400) (104,400)

[1] Assuming that the service is provided 200 days a year[2] Assume the cost per meal is $3.00 with little flexibility for economies of scale.

Hot Meals for School Flexible Operating Budget for 200X

Off-Budget Expenditures• Off-budget expenditures refer to financial transaction that are

not accounted for in the budget

• Most public budgets exclude certain governmental activities

• Generally (but not always) refers to activities of public enterprises, credit provided or guaranteed by government or subsidies channelled through the tax system

• Increasing trend to include them in the financial statements of government

• Weaker control of these, but there is control nonetheless

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Off-Budget Expenditures

Introduction of accrual also highlights financial obligations of a non-cash nature that create potential liabilities for the government, e.g. loan guarantees

The main forms of off-budget expenditures are:• off-budget funds;• direct loans;• guarantees;• Public Private Partnerships (PPPs)• Public sector entities that are commercial and legally

excluded from the budget, e.g. Post Office.

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A fund is defined as a fiscal accounting entity with a self-balancing set of accounts

recording cash and other financial resources, together with all related liabilities and

residual equity or balances, and charges, which are segregated of the purpose of

carrying on specific activities or attain certain objectives for which special regulations,

restriction or limitations apply.

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Funds in Budget Architecture

Funds in Budget Architecture

• Often funds are managed and reported separately – leading to a separate set of financial statements.

• The use of funds restricts budgetary flexibility but displays allocation for specialized purposes in a transparent way – funds are often mandated in accounting standards or law, e.g. for municipal governments.

• Often, special funds are created to segregate monies for programs for special purposes or as a result of unique designated revenue sources

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Funds in Budget Architecture

• Use of funds varies with governments

• Municipal governments tend to be built almost entirely around funds.

• The federal government and provinces will create special funds for a variety of purposes, some that are linked to unique sources of funds through fees or special taxes, some of which are administered at arms length from normal practice.

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Fund TypesGovernment Government

FundsFundsProprietary

FundsFiduciary Funds

General FundGeneral Fund

Special Revenue Special Revenue FundFund

Capital Projects Capital Projects FundFund

Debt Service Debt Service FundsFunds

Special Special Assessment Assessment

FundsFunds

Enterprise Funds

Internal Service Funds

Expendable Trust Funds

Nonexpendable Trust Funds

Agency FundsProvides for

ongoing activities of a self-sustaining

operation

Assets held in Trust by the Organization

Revolving Funds• An authority, in the case of government usually a

statutory one, to use the revenues generated from an activity to finance it.

• This authority generally continues on a permanent basis from one year to the next without further authority being needed.

• Always created through budgetary expenditure means, but then those funds move off-budget.

• Although surpluses or deficits may occur from year to year, they are generally expected to balance out over time.

• Many arrangements exist for the use of retained earnings, with the principle being that the fund retains its earnings unless some form of gain sharing is put in place.

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Zero Base Budgeting• Objective to “reset the clock” each year.

• Traditional incremental budgeting assumes that there is a guaranteed budgetary base-the previous year’ level of appropriations -and the only question is how much of an increment will be given.

• Zero Based Budgeting implies that managers need to build a budget from the ground up, building a case for their spending as if no baseline existed- to start at zero.

• Resources are not necessarily allocated in accordance with previous patterns and consequently each existing item of expenditure has to be annually re-justified.

The purpose of ZBB is to reevaluate and reexamine all programs and expenditures

for each budgeting cycle by analyzing workload and efficiency measures to

determine priorities or alternative levels of funding for each program or expenditure.

Through this system, each program is justified in its entirety each time a new

budget is developed.

Strengths of ZBB

• ZBB does not assume that last year’s allocation of resources is necessarily appropriate for the current year.

• The systematic nature of such a fundamental review imposes a discipline on the organization which has produced in practice secondary advantages.

• It produces in a readily accessible form more and better management information.

• If implemented well, ZBB can eliminate a sense of “entitlement” to cost increases.

• Improved discipline in developing budgets.

• More meaningful budget discussions during plan review sessions.

Weaknesses of ZBB• ZBB vastly overestimates people’s ability to calculate.

• Multiple impacts often ignored

• The ranking process is difficult

• The implementation of a ZBB system requires a great deal of time.

• Attempts by agencies to manipulate priority listings by ranking popular items lower than items that would have little chance of funding – the Musical Ride.

• Established programs have political support and they will continue to receive their share of the budget regardless of any analysis produced.

The Budget Process

The budget process A process of planning and control.

A look ahead at what an organization can and can't do

A process of allocating scarce resources to unlimited demands

The Budget Cycle

- Preparation – based on guidelines– normally done by responsibility center managers

- Review and Adoption

- Implementation and Control

- Evaluation of Results and Feedback

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Budget Process: Know it and Use itEvery organization has a budgetary process of some kind

Increasingly they attempt to be strategic for the organization

Managers are not simply recipients of budgets: they are players in the budget process

Sustaining programs, getting program changes, resisting change or helping it all mean knowing how the budget process works and using it to your advantage

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The Budget Cycle

Length of time required to prepare, administer & close

out a single year budget.

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Expenditure Management Cycle – Broader than Just the Budget Cycle

Planningsystem

Medium termplans, e.g. three

year rolling plans

Annual budgetsDevelopment,recurrent and

revenue

Fund releaseprocedure, e.g...

warranting

Accounting forrevenue andexpenditure

Public expenditurereview Institutions

Reports andfinancial statements

Audit system

Project monitoring

Projectappraisal

Resourceallocation

Liquidity

managem

ent

Expen

ditur

e

contr

ol

Monitoring

& controlling

Post eventreview

Accountability

Expenditurereview

Financial management system boundaries

Source: Adapted from Integrated Financial Management. Michael Parry, International Management Consultants Limited. Training Workshop on Government Budgeting in Developing Countries. THE UNITED NATIONS. December 1997.

Budget Calendar

Elements of an Effective Budget Cycle• Basic framework exists and is used• Desired outcomes known• Linkage to strategic plans• Common format, readily understood• Timetable for preparation clear and reasonable• Set of directions – rules of the game• Budgetary and program limits known• Established methodologies for costing and forecasting

where needed• Directions on availability of new funds, use of current

funds and reallocation rules

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Simple Simple Budget Budget

CycleCycle

Start/RestartStart/Restart

Strategic Planning Phase

Budget Preparation Phase

Budget Review Internal

Executive

Results FeedbackAuditing for Compliance and

for Results

Budget Review and Approval – Legislative

Budget Execution

What to look for in a strategic budget linkage

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Strategic Plan

Does this organization know its Mission?

Does this organization have an end state or

vision?What are the ground rules or basic operating assumptions and principles?

Does it have a grip on reality – what is its situation analysis including risks.

Does it have goals and objectives that make sense?

Are there targets with measures that we can

understand.

Does what it is going to do this year mesh with its goals and

mission?

What’s it going to cost?

Is it sustainable?

Budget Processes as a Planning Tool

• Budgets are where the rubber hits the policy road

• Budgets clear permissions to move ahead on plans

• Delivery capacity on plans directly linked to resources available

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Budgets as a Control Tool

When a budget is approved, the expenditure estimates become appropriations

An appropriation both authorizes expenditures and limits expenditures

Both defines and limits managerial discretion

Can be used to limit uses to specific allotments or funds

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Building the Budget

• This is the process of micro-budgeting

• Building the budget logic but also the budget story

• Within organizations, tends to be a two-way process: direction from above and input from below

• Often costs are driven by variables outside the control of line managers, e.g. collective bargaining

• No guarantee that funds will be allocated to cover costs

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Pluses and minuses of top-down and bottom-up approaches to budgeting.Pluses and minuses of top-down and bottom-up approaches to budgeting.

Building the budget: understanding costs, need and demand

Role of past experience, especially in incremental situations

Types of measures:

• Need• Demand• Workload

Productivity assumptions and targets

Revenue assumptions

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Budget GamingBudget Gaming

Projections (Fore and Aft) and Forecasts

• Budgets often build on previous year’s base plus or minus

• Differing set of assumptions: optimistic and pessimistic

• Controllable and uncontrollable costs

• Fixed and variable costs

• Direct and indirect costs and the full cost principle

• Treatment of overhead

• Mandated standards

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Tensions Inherent in Public Sector Budgeting

• Revenue versus expectations

• Central agency versus program organizations

• New versus old

• Complexity versus clarity

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The authorizing Process: From the Perspective of the legislature

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Key Actors in Budget Process

Finance ministry or treasury: Coordinate & drive budget process

Spending departments: Responsible for expenditures within their jurisdiction.

Head of State & Cabinet: Make political decisions about tradeoffs.

Legislature: Scrutinize & authorize revenues and expenditures.

Supreme audit institutions: Audit government accounts for compliance and performance.

Others: Media, civil society organizations, donors & international financial institutions.

B u d g e t t a b l e d i n t h el e g i s l a t u r e

C o n s i d e r a t i o n b yp a r l i a m e n t a r yc o m m i t t e e ( s )

P a r l i a m e n t a c c e p t s ,a m e n d s o r r e j e c t s t h eb u d g e t

F i n a n c e m i n i s t r y o rt r e a s u r y i s s u e sg u i d e l i n e s t o s p e n d i n gd e p a r t m e n t s o r a g e n c i e s

S p e n d i n g d e p a r t m e n t ss u b m i t d r a f t b u d g e t s

N e g o t i a t i o n a n d f i n a ld e c i s i o n s b y e x e c u t i v e

D r a f t i n g L e g i s l a t i v e I m p l e m e n t a t i o n A u d i t

F u n d s a p p o r t i o n e d t os p e n d i n g d e p a r t m e n t s t oi m p l e m e n t a c t i v i t i e s

F i n a n c e m i n i s t r ym o n i t o r s s p e n d i n g

R e q u e s t f o r l e g i s l a t i v ea p p r o v a l o f a d j u s t m e n tb u d g e t i f n e c e s s a r y

S u p r e m e a u d i t i n s t i t u t i o na s s e s s e s d e p a r t m e n t a la c c o u n t s a n dp e r f o r m a n c e

A u d i t r e p o r t s p u b l i s h e da n d r e v i e w e d b yp a r l i a m e n t

B e f o r e b e g i n n i n g o f r e l e v a n t f i s c a l y e a r F i s c a l y e a r s t a r t s a n d e n d s F o l l o w i n g e n d o f f i s c a l y e a r

S t a g e s o f t h e a n n u a l b u d g e t p r o c e s s

Drafting stage

• A draft budget that can be submitted to legislature.

• Mostly internal to the executive, secretive.

• Sets fiscal policy & estimates revenues on projections to establish total resources.

• Finance ministry or central office issues guidelines to spending departments.

• Budget requests from spending departments.

• Negotiations at bureaucratic and political levels.

Legislative stage

• Budget tabled in the legislature/council/board.

• Considered by parliamentary committee(s).

• Parliament votes on Supply. Council approves budget.

Execution/implementation stage

• Funds apportioned to departments to implement activities.

• Central financial controller monitors spending – more or less.

• Request for legislative approval of adjustment budget if necessary – Supplementaries.

• Fiscal risks are inherent in a changing economic environment – purpose of contingency reserves.

• In-year adjustment decisions should be transparent and thoroughly scrutinized.

Audit stage

• Supreme audit institution assesses departmental accounts and performance.

• Audit reports should be published promptly and submitted to parliament.

• We will look at this stage in more detail in a later session.

Factors That Undermine Fiscal Discipline

Unrealistic Constraints

When totals are selected for political reasons, without regard to their achievability, they may weaken fiscal discipline.

Unrealistic Budgets

Some governments (especially in poor countries) adopt budgets that that purport to show fiscal discipline but have little to no possibility of being implemented.

Entitlements When citizens have a legal right to payments from the government regardless of budget conditions, it may be difficult to stay within fiscal targets.

Contingent Liabilities

The cost of contingent liabilities often is underestimated when the government accepts the risk (such as guaranteeing loans or the performance of enterprises). When the cost comes due (because of default or other contingency) it is not controllable through ordinary budget means.

Perverse incentivesSpenders have incentive to use all the resources provided them; if they don’t, they risk cuts in the next budget

Information asymmetryService providers know more about outputs and costs than do those who allocate resources: To get more money, providers manipulate or withhold information from superiors

RigidityManagers have no opportunity to use their skills and information to improve efficiency

Compliance costsDetailed, ex ante controls are costly and drive out initiative and variation

Budget maximizing behaviorInasmuch as government must pay whatever it costs to operate its programs, inefficient producers are rewarded with bigger budgets

CaptureGovernment is captured by service providers: it lacks independent information on performance and must purchase services from them

Factors that Degrade Operational Efficiency

Practices that Strengthen Fiscal Discipline

• Targets should reflect political commitments made by government leaders.

• Targets must be realistic and achievable.• Targets should be set and enforced within a

medium-term fiscal framework.• Limits on aggregates should be supported by

sub-targets on sector/portfolios.• Fiscal constraints should cover mandatory

spending.