Policy-Based Budgeting: How to Spot the “Fakes”

Governments introduce budget reforms programs for all kinds of reasons, noble or otherwise. But how can we tell if their declared good intentions are real? How can we identify genuine reform from “fake” reform? A recent paper by the Washington-based Institute for State Effectiveness provides a dozen examples of red flags for identifying “fake” budget reforms. It focused on two closely related areas of budgeting that are commonly found in PFM reform programs:

• Policy-based budgeting, defined as a process where “the fiscal strategy and the budget are prepared with due regard to government’s fiscal policies, strategic plans, and adequate macroeconomic and fiscal projections.”

• Performance-based budgeting, defined as a form of budgeting that “aims to improve the efficiency and effectiveness of public expenditure by linking the funding of public sector organizations to the results they deliver, making systematic use of performance information.”

There are government systems that claim to be using performance and policy-based budgets, but they often exist in name only. These are what are called the ‘fakes.’ Fakes are damaging as they prevent the public finance system from working as intended.

So how can we spot a fake? The paper goes into detail on some of the key technical processes that deliver good policy and performance-based budgets. It ends with advice that governments and their advisors should look out for some of the following red flags:

Policy-Based Budgeting Red Flags

1. No medium-term perspective – only an annual budget is prepared and published.

2. No rolling forward estimates – the budget year baselines for appropriations are not set by rolling over the previous year’s first forward year.

3. Macro-fiscal models are being used outside the resource allocation process – projections of GDP, inflation, revenue, expenditure and other macro-fiscal variables are not used in budget formulation.

4. No explanation of the changes in the budget and fiscal strategy from the previous year - changes due to parameters, estimates variations and new policies are not disclosed.

5. No high-level debate on fiscal space creation and filling – ministers are not briefed on the room to adjust fiscal policy.

Performance-Based Budgeting Red Flags

6. No reporting by standard functions of government – there is no reporting on spending by the international standard for the Classification of the Functions of Government (COFOG).

7. Annual reports are not easily comparable to the budget – the same financial and non-financial performance tables are used in budget documents and annual budget execution reports.

8. No reliable reporting of performance targets – there is an absence of historical performance data.

9. Performance targets are not actually used to manage performance - reporting performance targets is largely seen as a compliance exercise rather than a real part of the performance management cycle.

10. Lack of linkages between agency level performance targets and the data monitored by the central budget office – performance information is not used by the central budget teams responsible for preparing and implementing the budget.

The paper also identifies two red flags that are linked to institutional factors:

11. The administrative culture is not focused on performance – in getting the basics right, an important principle is to “foster an environment that supports and demands performance.”

12. There is no aggregate fiscal discipline – there are implausible estimates of fiscal aggregate figures (revenue, expenditure and fiscal balance) over the medium term.

The presence of any of these red flags does not necessarily meant that the system is not working. But it may point to areas where efforts are needed to make improvements. By attending to the red flags, a performance and policy-based budget can be made to work as intended. It becomes a very powerful tool, especially in the right hands, to ensure money is raised and spent efficiently and fairly.