Baku Engineering University

Economics and Administrative Sciences

Faculty

Budget and Treasury

Modern Budget
Systems

Lecture 5
Samra
Talishinskaya
 Outline

1. The nature of the problem

2. Incremental line item budgeting

3. Beyond incrementalism

4. Performance budgeting

5. Program budgeting

6. Conclusion

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Features of alternate budget
formats
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 1. The nature of the problem

Budgeting in the public sector is a complex exercise. It involves the

combination of information from multiple sources, bringing together different
perspectives and dealing with diverse interest groups, all influencing complex
decisions. Fragmentation is inevitable between the center and the line,
between budgeting and implementation, and between different types of
spending. Over time, methods to deal with difficult choices, complexity, and
fragmentation have developed within budgeting systems.

Budgeting in the public sector is fundamentally different from budgeting in the

private sector. At the heart of the difference are the absence of a bottom line
and the presence of a shared and limited source of funding. The dynamics that
surround public budgeting play out in a financing context in which the aim is
not to make money by spending money, but to reach a wide range of public
objectives, some of them intangible. In a public budget, the goals of spending
are complex and difficult to measure, and they may relate only indirectly to the
activities that are being funded.
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 1. The nature of the problem

Public budgeting, therefore, occurs in a politically fraught environment where

different public
objectives compete for a share of limited available funding in the absence of a
relatively
objective yardstick, such as contribution to profit, by which to choose among
them; where the incentive to keep costs low in order to maximize profit is not
present; where performance is difficult to measure; and where sanction and
reward systems operate in the context of longstanding public service practices.
This context of public budgeting gives rise to ubiquitous
problems.

The first revolves around the incentive of individual claimants to maximize

their claim on budgetary resources. Whenever many spending units depend on
one source of income, each dependent unit will consider its own expenditure
increases to be too small to affect the total significantly and will feel free to
pursue its own interests without considering the effect of its actions on the
source. In public finance, the tax burden of a spending program is spread
across many groups and individuals, and claimants to resources are therefore
likely to perceive a much lower cost to their proposed spending programs than
the actual social cost.
Consequently, claimants for example, spending ministries or external interest
groupswill
therefore almost always demand a higher level of spending than is socially
optimal. This phenomenon is known as the tragedy of the commons.
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 1. The nature of the problem

It is for this reason that constraints on the aggregate level of spending are
critical. Without
such constraints, just adding together the total claims of ministries to produce
a budget would
result in unsustainable deficits or tax burdens.

Choosing among the different claimants, however, introduces a whole separate

set of budgeting problems. There is not a single objective measure or reliable
objective methodology
by which tradeoffs can be made. Ultimately the choice between funding roads
or schools,
between funding region A or region B, or between funding services to poorer
beneficiary groups rather than middle-income and rich groups is a political
choice.

Instead of maximizing, the strategy is to behave in ways that allow the system
to get by, come out all right, and avoid the worst. Incremental line-item
budgeting practices offer well established methods for satisficing within a time-
delimited budget process.
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 2. Incremental line-item budgeting
In the third edition of their seminal work, The New Politics of the Budgetary
Process,Wildavsky and Caiden (1997) describe a traditional system of budgeting,
which they dub classical budgeting. The main identifying characteristic of this
system is incrementalism.

Wildavsky and Caiden argue that budgeting systems revert to incrementalism

because budgeting is complex, with many interrelated items, and because technical
difficulties arise when choosing between competing options. As Wildavsky and
Caiden (1997: 45) put it, Endless time and unlimited ability to calculate may help.
But time is in short supply, the
human mind can only encompass just so much, and the number of budgetary items
may be huge. The programs to which funds are allocated and their associated
outputs in the real worldfor example, roads, teaching hours, serviced hospital
bedshave different values for different people. There is no objective method of
judging priorities among different programs.

The limited period of time within which budget decision makers prepare and
examine a subsequent years budget does not allow them to examine whether each
stream of recurrent spending is justified or to consider all alternative uses for the
funds. Besides, such a process would need to include in the calculations future
funds already spoken for on account of contractual or quasi-contractual
commitments that were made in previous years and that span years. The base of
spending is therefore taken almost as a given, and the focus of the budget process
is on making marginal changes to this base, albeit on making new spending
proposals, bidding for new funds, or
decreasing spending in various ways. Working with a given base enables
management of the
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calculations and resolution of conflicts within the budget preparation time frame.
 2. Incremental line-item budgeting

The most significant determining factors of a new years budget are all
previous budgets. Many items are rolled over from year to year as a standard.
Once programs are judged to be satisfactory, they become part of the
budgeting base and are rarely challenged. Because
programs are usually associated with internal and external interest groupsfor
example,
officials employed to run a program and the programs beneficiaries
discontinuing a program involves a difficult internal and external political
process in which there are losers. The focus of the budget process thus
becomes a narrow range of increases and decreases.

When a project or a program is included in the base, it is not only for the
budget year, but for all future years until it is challenged. In other words, in
classical budget practice, spending agencies have a fair expectation that the
base they have established incrementally over years will be funded in the next
budget year. In addition, there is also an expectation that they will
receive what Wildavsky and Caiden (1997: 46) term a fair share of some
proportion of funds
that are available for distribution, whether because of an increase in total
expenditure or because of decreases to some agencys funding.

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 2. Incremental line-item budgeting
Traditionally, budgets were arranged by line item. Many countries still have
budgets that are classified in accordance with specific line items. When
budgets were first brought to legislatures, every separate piece of spending
got approved in all its particular details. In other words, a legislature would
consider an agency request to build a bridge, relevant input by input: the
number of labor hours required, the number of logs for the supports, and so
forth. However, as the number of agencies and their activities grew, a limited
number of
standardized items were selected under which activities needed to be
described. Over time, previously approved programs were reflected in bulk by
agency against the standardized line items, effectively for reapproval. Only
new spending proposals were considered separately as a project or program, to
be absorbed in subsequent years in the funding base.

In recent years, many countriesincluding developing countrieshave moved

away from the line-item system to compliance with the International Monetary
Funds Government Finance Statistics system of economic classification (IMF
2001). However, this move has not
necessarily brought a fundamental change to how budgeting is done: budget
decision makers
use the new economic classifications, instead of line items, to control inputs. It
is only when allocations are first made to a classification of programs and
subprograms that substantial shifts in how budgets are decided can be
engineered.

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 2. Incremental line-item budgeting
This delinking of base spending from the coherent sets of activities they fund
underpins typical input-based incremental line-item budgeting practices. Instead
of looking at the activities that were being fundedand that were in line with the
budget control requirements of budget classificationspending and central
control agencies looked at classes of inputs when spending cuts were required.
Instead of discontinuing lower-priority activities, these agencies applied spending
cuts to inputs across all activities, whether of low or high priority.

In an incremental line-item budgeting system, decision making about the bulk

of spending is
thus reduced to concentrating on changes in various input itemspersonnel,
equipment, maintenance, utilities, or transportationthat make up programs
rather than to looking at programs (or subprograms) as wholes.Hence, though
all programs are affected negatively by spending cuts, no single program
needs to be shut down, and the difficult process of
negotiating the discontinuation with stakeholders can be avoided. As Wildavsky
and Caiden
(1997) note, the line-item form enables decision makers to concentrate on the
less divisive issue of how much for each item, rather than how much for one
set of beneficiaries over another.

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 2. Incremental line-item budgeting

An illustration of a
typical line-item
budget: department
of education
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 3. Beyond incrementalism
In practice, decisions never vary significantly from the status quo, because
decisions are made through a process of political bargaining and because it is
easier to continue the existing pattern of distribution rather than to try
radically new proposals. Budget participants avoid reopening old issues or
considering radically different choices, because doing so would make
agreement difficult. Although further analytical models were developed
subsequently to describe the way in which policy decisions are made, in
practice the debate that the models sparked on how public policy choices
should be made resulted in a number of experiments to change policymaking
and budgeting methods, notably the introduction of a planning
programming- budgeting (PPB) system and of zero-based budgeting into
federal-level
budgeting.

Elsewhere, however, the idea that incentives and better information can
improve purely incremental budgeting practices produced a series of
innovative approaches to budgeting that
focused on better information and alignment of incentives. Modern budgeting
systems (and
reform programs to shift more traditional systems) often include
various elements of these approaches.

Three early attempts to bring better information and greater rationality to the
budgeting table were initiated in the United States at the federal level.
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 4. Performance budgeting
The past two decades have witnessed a growing interest in performance
management and budgeting reforms, in response to louder public demands for
government accountability in industrial countries. These reforms are intended
to transform public budgeting systems from control of inputs to a focus on
outputs or outcomes, in the interest of improving operational efficiency and
promoting results-oriented accountability. These experiences have significant
relevance for public sector reforms in developing countries.

Public budgeting systems are intended to fulfill several important functions.

These functions include setting budget priorities that are consistent with the
mandate of the government, planning expenditures to pursue a long-term
vision for development, exercising financial
control over inputs to ensure fiscal discipline, managing operations to ensure
efficiency of
government operations, and providing tools for making government
performance accountable to citizens.

The most fundamental function of a budget is to control public expenditure,

which is
commonly carried out by exercising financial control over inputs. Input controls
have been more concerned with how much money is spent and how it is spent
than with what it is spent on. Input controls often put ceilings or caps on each
category of expenditure, or even each item of expenditure.
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 4. Performance budgeting
The budget also functions as a very significant statement of government
policies, one in which policy objectives are reconciled and implemented in
concrete terms. The budget sets forth policy priorities and levels of spending,
ways of financing the spending, and a plan for managing the funds.

A budget is not only a tool of macroeconomic policy but also a management

mechanism. It
provides a key source of constraints on and incentives for public servants
demanding better public services at lower costs. Last but not least, the budget
document can be a major tool of accountability, whether to the legislative body
or to the press and the public. It can help hold administrators accountable not
only for the funds they receive but also for a given level of
performance with those resources. It can either give citizens a sense of
ownership and control
and respond to their interests, or it can alienate them by making it difficult to
participate in the budgeting process or making budgetary information
inaccessible.

Each of these functions is a potential use of a public budget. Typically, a

budgeting system
cannot execute these functions equally well at the same time. The relative
strength of each function depends on budgeting tools and techniques, but
most critically on political decisions about which issues matter to the
government. The government budget, therefore, is oriented around those
issues.
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 4. Performance budgeting
The traditional line-item budget presents expenditures by inputs and resources
purchased. The budget is classified by disaggregated objects of expenditure
and by operating and capital expenditures. Operating expenses include cost
objects for day-to-day operations such as salaries, pensions, and health
insurance costs; office supplies and printing costs; and utility costs. Capital
outlays include purchases of long-lived assets such as buildings, machinery,
office equipment, furniture, and vehicles.

A prominent feature of a line-item budget system is that it specifies the

line-item ceiling
in the budget allocation process to ensure that agencies do not spend in
excess of their caps.
Thus, the budget facilitates a tight fiscal grip over government operations. The
strengths of such a system rest on its relative simplicity and its potential
control of public spending through the detailed specification of inputs.
Throughout much of the 20th century, central budget offices and finance
ministries have been aggressive proponents of controlling public resources,
which explains why line-item budgeting has endured despite relentless
budgeting reform efforts.
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 4. Performance budgeting

The line-item approach embodies several impediments to promoting efficient

and effective public planning and management as well as to fostering results-
oriented accountability in public sector institutions.

A line-item budget emphasizes inputs; it provides information on how much

money is spent
and how it is spent rather than on what it is spent. It does not link inputs
with outputs and
therefore says nothing about how efficiently resources are used. The
line-item budget tends to focus decision making on detailswhether the
general office expenses (pencils used, printing paper consumed) are
appropriate and how much they have gone up or down compared with the past
years budgetrather than on efficiency and effectiveness.

The focus on detailed line-item control leads to micromanagement of agency

operations by central budget offices and finance ministries and to hierarchical
controls within the agency. Public managers thus exercise very limited
managerial discretion and cannot be held
accountable for the performance of government activities.
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 4. Performance budgeting

An illustration of
performance budgeting:
Australias child care
program
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 4. Performance budgeting

An illustration of
performance budgeting:
Australias child care
program (contd.)
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 4. Performance budgeting: Basic concepts

Performance budgeting is a system of budgeting that presents the purpose and

objectives for which funds are required, the costs of programs and associated
activities proposed for achieving those objectives, and the outputs to be produced
or services to be rendered under each program. A comprehensive performance
budgeting system quantifies the entire results-based chain as follows:

Inputs and intermediate inputsresources to produce outputs

Outputsquantity and quality of goods and services produced

Outcomeprogress in achieving program objectives

Impactprogram goals

Reachpeople who benefit or are hurt by a program.

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 4. Performance budgeting: Basic concepts

As a by-product of the information provided by the results-based chain,

performance budgeting can also yield useful indicators of the efficiency and
quality of government operations. Here are a few examples of such indicators:

Qualitymeasures of service such as timeliness,

accessibility, courtesy, and accuracy
Client satisfactionrating of services by users
Productivityoutput by work hour
Efficiencycost per unit of output.

In comparison with traditional line-item budgeting, performance budgeting allows

for more flexible use of fiscal resources and shifts the focus from inputs to results
(see an example of a performance budgeting results chain). A performance
budget focuses on the results to be achieved. With its program structure, the
performance budget changes the focus of discussion from detailed line items to
the broader objectives and performance of public
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 4. Performance budgeting: Basic
concepts

Performance Budgeting
Results Chain:
An Application
in Education
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 4. Performance budgeting
For performance budgeting reforms to achieve their objectives, a number of
considerations must be kept in mind while implementing such reforms.

Budget Classification
Performance budgeting shifts the focus on resource allocation from the objects of
expenditure to the public programs that are designed to serve strategic
objectives of the government. Funds are allocated to various objectives (results),
and spending agencies manage the lump-sum allocation in seeking more cost-
effective and innovative ways of achieving results. Central
budget control focuses on the achievement of program goals by each agency,
rather than by
the detailed line itemization of the agencys budget.

Performance Measurement and Reporting

An effective performance budgeting system depends on reliable performance
measurement
and reporting. Because performance measurement and reporting do not
directly affect
budgetary allocations, the initiative does not immediately incur financial risks
for public
managers and therefore serves as a good entry point for reform. The
construction of a
performance measurement and reporting system provides a channel for public
officials to
reach agreement on program goals and objectives, to discuss and compromise
on the selection
of performance measures, to address their questions and concerns, and to
overcome
misgivings about performance budgeting.
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4. Performance
budgeting

Performance
Management
Reform in Denmark
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Implementation of Performance Budgeting in Selected
Industrial
and Developing Countries
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Implementation of Performance Budgeting in Selected
Industrial
and Developing Countries
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 5. Program budgeting systems
Since the middle of the 20th century, the pressure to spend more effectively
and develop better budgeting techniques produced an almost universal
acceptance that budgeting is not only about planning for inputs, but also,
perhaps primarily, about planning for the results that governments want to
achieve. In developments that can be traced back to the introduction of
program budgeting in the United States in the 1940s, more results-oriented
budgeting
techniques were developed in iterative processes that benefited from the
countrys own and other countries mistakes.

Although a lot of the early development occurred in industrial countriesthe

transfer of programming budgeting to the United Kingdom in the 1970s, New
Zealands output focus in the 1980s, Swedens system of management by
objectivesthe use of results-oriented budgeting by the United Nations as a
precondition for aid assistance triggered its quick spread to the developing
world.
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 5. Program budgeting systems
In 1965, the United Nations published A Manual for Programme and
Performance Budgeting. This book advocated performance budgeting
comprising program structures, a system of accounts and financial
management, and a measurement of efficiency. Program budgeting is
defined as follows:

Programming, or the subdivision of the government budget for information

purposes into programs and activities representing identifiable units with similar
aims or operations

Identifying the operational aims of each program and activity for the budget
year

Budgeting and accounting so that the separate costs and revenues of each
program are shown

Measuring the outputs and performance of activities so that these can be related
to the activities costs and to operational aims

Using the relevant data to establish standards and norms so that costs and
performance can be evaluated and government resources can be used more
efficiently.

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5. Program budgeting
systems

An example of
program budget
format
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 6. Conclusion

In this lecture we have:

learned traditional budgeting systems;

learned deficiencies of traditional budgeting;

acquainted with types of other budget formats

learned different budget formats through country examples

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 Budget and Treasury

Questions and
Comments

Lecture 5