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March 17, 2010

Italy: Toward Modernizing Public Finance Management

Posted by Lusine Lusinyan 

The year 2009 ended with a milestone for Italy’s public financial management system. The Accounting and Public Finance Law (n. 196, 12/31/09) was enacted overhauling a long outdated 1978 law on accounting (n. 468) and marking a first step in bringing Italy’s public financial management in line with best international practices. Its focus on the broader public administration, harmonization of accounting systems, and strengthening expenditure control and monitoring are steps in the right direction. But the reforms fail to address the need to strengthen multi-year expenditure planning and top-down budgeting as keys to establishing and maintaining fiscal discipline. Going forward, ensuring smooth transition and coordination with ongoing fiscal federalism reform at the same time as designing effective implementation mechanisms will be a challenge.


Italy’s new Accounting and Public Finance Law entered into force in January 1, 2010, replacing a 30 year old legal framework, with an objective to better align the country’s public financial management with realities of a changing economic system (even if, in part, with a long delay), including changes arising from Italy’s EMU membership and deepening decentralization process. The law, however, appears to be a combination of some important changes in a positive direction, institutionalization of some of the practices already in place, little or no changes in a number of key areas, and some changes toward objectives yet to be clarified in subsequent legislation. Selected aspects of the new legal framework are discussed below.


What Is Changing?

Wider coverage: The new law explicitly acknowledges the role of all the units of the general government (amministrazioni pubbliche) in achieving the fiscal policy targets and puts an emphasis on an extended application of the accounting and PFM principles and regulations to include all such units, in contrast to the previous law which focused on the state budget (other sectors of the general government account for over 40 percent of total spending).

Emphasis on harmonization, coordination, and data quality: The law envisages harmonization of accounting systems—which in turn should be in line with those used under the EU excessive deficit procedure—and reporting practices across different levels of government, and improved intra-governmental coordination of fiscal policy. A unified legislation (testo unico) for all PFM matters is eventually to be adopted by 2013. In recognition that such and other data-intensive initiatives, like expenditure monitoring, control, and analysis, would not be possible to implement without adequate information system support, a single database for all general government units is to be established within the finance ministry.

New budget cycle with new/renamed instruments and more medium-term focus: The newly created Public Finance Decision (Decisione di finanza pubblica or DFP), which replaces both the June medium-term Economic and Financial Planning Document (DPEF) and the September Forecast and Planning Report (RPP), will be submitted to parliament by September 15 (see Chart of Italy's New Budget Cycle). In turn, DFP will be informed by the opinion of the permanent Conference for the coordination of public finance (Conferenza Unificata) and the parliament based on the guidelines for DFP that will be issued by mid-July. Fiscal planning, as in the past, will have a three-year planning period; a three-year draft budget based on unchanged legislation will be prepared, and the measures required to meet the DFP targets for each of the three years will be detailed in the Stability Law.

Move toward cash based budgeting: The current approach to budgeting using a dual (and, in part, also a mixed) system   of “legal accrual” (competenza giuridica) and cash basis will change toward the system on a cash basis only, subject to a two-year trial period. Abandoning the concept of “legal accrual”, largely blamed for the creation of the system of carry-forwards, is a welcome step. The eventual use of accrual accounting is not clearly envisaged in the law and no specific transition period is identified, so the accrual-based system will be presented for information purposes only.

Focus on flexibility and new budget classification: By assigning a single manager to a program, the law aims at strengthening the managerial responsibility, while making the program a unit of the parliamentary vote is seen as a way to strengthen the link between the parliament’s policy-making role and the budget. The law also ratifies the functional classification and the shift to missions and programs introduced in 2008, but the revisions of the state budget structure will continue in 2010-11 to better align the parliamentary vote to functions of the state administrations. The new expanded composition of the adjustable area of the budget together with a parliamentary vote that may either adopt or reject a spending program in its entirety is expected to lead to a higher degree of flexibility of the budget. Nevertheless, the relative size of adjustable spending may still be very small, especially since the law suggests that any spending can be defined as non-adjustable.

Expenditure control, monitoring, analysis, and focus on performance and results: The setting up of the comprehensive database with information on budget projections, implementation and outturn for all levels of government is seen as a major instrument for strengthening expenditure control and monitoring. The law institutionalizes the recently adopted practice of expenditure reviews, with such reviews planned to take place every three year. Expenditure reviews are also expected to contribute to formulating performance indicators; in turn, the government is delegated to define, by end-2010, a system of simple and measurable performance indicators corresponding to budgetary programs.


What Is Not Changing?

Non-inclusiveness of the budget process and coverage of new measures:  Policy measures with fiscal implications can still take place outside the regular budget process weakening the relevance of the latter. At the same time, compliance with the constitutional requirement of ensuring coverage/funding for any new expenditure-increasing (or revenue reducing) measure is strengthened by ratifying the current practice of ensuring the funding in terms of all three balances (net financing balance of the state budget, cash balance, and net borrowing requirement of the general government) and by making the coverage clause automatic. However, it remains to be seen whether, as a result, this would effectively strengthen the control over public finances. 

Absence of binding medium-term expenditure ceilings and of strict top-down budgeting: While medium-term fiscal projections will continue to be approved by the parliament, spending projections for only the first year will be considered as limits for commitment and payment authorizations and still not strictly binding. The lack of expenditure limits and the practice of using the adjustment notes for DFP to revise the fiscal objectives will likely continue undermine the top-down procedure.

Lack of a credible current-policy baseline: The law appears to acknowledge the need for having an alternative to the baseline scenario based on unchanged legislation, but falls short of reaching the objective of firmly establishing such objective. Only maximum financing needed to “normatively confirm” the commitments for main spending aggregates under a no-policy change assumption will be provided in DFP.

Little attention to long-term scenarios and fiscal risks: While information content of public finance documents is expected to improve, contributing to more transparency and stronger parliamentary control, discussions of long-term fiscal developments and fiscal risks will not be part of budget documents. 

Lack of independent scrutiny: The new framework does not bring in more formal independent scrutiny and assessment of macrofiscal forecasts and budgetary policies. Parliamentary oversight will remain the main means of analyzing government’s policies as well as monitoring and controlling (though without specifying how) fiscal developments. 


What are the Challenges Ahead?

Anticipating the changes coming with the new law, the government tried to apply some of the modifications already to the 2010 budget process, but the attempt did not prove successful. The plan to have a ‘light’ budget failed as hundreds of new provisions were added during the parliamentary discussions. Streamlining the budget is, however, not a new idea, and its implementation has been problematic in the past, too, given constitutional constraints which have cut across other areas of PFM reform as well. This example demonstrates that a fundamental question remains about how effectively changes legislated by a law can be implemented when constitutional realities remain unchanged and given that these changes are not binding for successive laws.

Completing the reform will require considerable time and effort, including to ensure a smooth transition and coordination with other reforms, notably fiscal federalism and public administration modernization. The government has also been delegated to put in place, over the coming one to three years, the implementing legislation in a number of key areas such as adjustments to accounting systems, expenditure control and analysis, modalities for setting up spending limits, and move toward a cash-based budgeting. However, sequencing of these initiatives does not always appear to be optimal (for example, harmonization of accounting systems is envisaged to be completed before the move to a cash-based system). Overall, the ongoing reform is a big challenge but at the same time a unique opportunity for the authorities to design effective implementation mechanisms, even as some key constraints remain, that would help further strengthen Italy’s public finances and enhance fiscal discipline and performance.


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