INTERNATIONAL MONETARY FUND

Fiscal Affairs Department

ITALY

BUDGET SYSTEM REFORMS

Teresa Ter-Minassian, James Daniel, Annalisa Fedelino, Marc Robinson, Justin Tyson, and Michael Keating

May 2007

Contents Page Abbreviations and Acronyms ....................................................................................................3

Executive Summary ...................................................................................................................5

I. Introduction ............................................................................................................................8

II. The Main Constraints on Transparent and Effective Spending Decisions..........................10

III. Lessons of Selected International Experience of Budget Reforms....................................16

A. Improving Expenditure Prioritization .....................................................................18 B. Delivering Better Services ......................................................................................27 C. Enhancing Accountability for Performance............................................................30

IV. A short-to-medium term budget reform strategy for Italy.................................................32

A. Current Reform Plans and Steps to Date ................................................................32 B. Main Components of a Further Reform Strategy....................................................38

Tables 1. Mandatory Spending by Economic Classification, 2007.....................................................11 2. Reserve and Special Funds ..................................................................................................15 3. The Relation between Goals and Tools for Budget Reform................................................17 4. Spending by Ministries Selected for the Spending Review.................................................35 5. Possible Outline of a Spending Review Process in Italy .....................................................42 Boxes 1. Italy Budget Process: Main Documents.................................................................................9 2. Top-down policy priorities ..................................................................................................11 3. The basic budget appropriation units...................................................................................12 4. Reprioritization in the U.K. and Australia under the Spending Review Process ................16 5. Outcome and Output-Based Programs.................................................................................19 6. Main Differences between Program Classification and Functional Classification of Expenditures ........................................................................................................................20 7. Program and Ministry Structure in the French System: An Example .................................21 8. UK Departmental Spending Review: Sequence of Activity................................................23 9. Public Service Agreements in the United Kingdom............................................................29 10. Initial steps with spending review in Italy .........................................................................36 Annexes I. Program Costing ...................................................................................................................48 II. Selected Performance Indicators – New York City, U.K., Australia..................................52 III. Australia: Reconciliation of Expense Estimates ................................................................51

I.

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ABBREVIATIONS AND ACRONYMS

BOI Banca d’Italia CIPE Comitato Interministeriale per la Programmazione Economica COFOG Classification of the Functions of Government DPEF Documento di Programmazione Economica e Finanziaria EMU European Monetary Union ESA 95 European System of Accounts EU European Union GFS Government Finance Statistics ISTAT Istituto Nazionale di Statistica MEF Ministero dell’Economia e delle Finanze RGS Ragioneria Generale dello Stato RPP Relazione Previsionale e Programmatica SIOPE Sistema Informativo per le Operazioni degli Enti Pubblici

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PREFACE

In response to a request from the Italian authorities, a mission from the Fiscal Affairs Department (FAD) of the International Monetary Fund visited Rome during March 21–April 3, 2007 to advise on reforms of the budget system to support better spending prioritization and efficiency. The staff team comprised Mrs. Ter-Minassian (head), Messrs. Robinson and Tyson, and Ms. Fedelino (all FAD), and Mr. Keating (expert, Australia). Mr. Daniel (EUR) joined the mission for the last few days. In addition, Messrs. Dufty and Hughes (UK Treasury) participated in a workshop on international experience organized on March 29, and in other meetings during March 28-April 01, 2007. The mission met with Minister Padoa Schioppa, Undersecretary for Economy and Finance Sartor, other representatives from the Ministry of Economy and Finance, the newly formed Technical Commission for Public Finance, an inter-ministerial working group on education, the Audit Court, the Bank of Italy, the Department of the Government Program, the Department of Public Function, the ministries of Education, Justice, Transport, Infrastructure, Interior, and the parliamentary Budgetary Committees of the Senate and the Chamber of Deputies with their respective Technical Offices. The mission would like to express its gratitude for the excellent cooperation it received from all government officials, and the hospitality provided by the Ministry of Economy and Finance.

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EXECUTIVE SUMMARY

There is a growing recognition among Italian policy makers, and in the society at large, of the need to substantially improve the effectiveness and cost efficiency of public spending programs. This is needed to create fiscal space to attend to new spending priorities, while further reducing the general government deficit and debt and moderating the already relatively high tax burden; and to increase the transparency of allocation of budgetary resources, and the value citizens receive from their taxes through public goods and services. However, the current budget system poses significant obstacles to the achievement of these objectives. This report reviews the main weaknesses of the system, and outlines, also in the light of relevant international experience, a number of possible steps—several of which build on initiatives already begun by the Italian authorities—to tackle them. Weaknesses of the current budget system The main weaknesses of the current budget system can be summarized as follows (Chapter II):

• An “incrementalist” approach to budget formulation, with the bulk of public spending extrapolated from year to year with marginal changes, without a proper re-examination of the relative value of spending programs; and with limited reflection of the government’s priorities into budgetary choices.

• An excessively fragmented structure of the voted budget, with some 1,500 line items which bear no clear relation to the objectives of public spending.

• The lack of a meaningful medium-term orientation in the budget process, with existing forward projections not representing true baselines for subsequent budgets.

• A budget approval process in Parliament which allows a proliferation of micro-oriented amendments (about 12,000 presented during the discussion of the 2007 budget).

• A plethora of ex-ante controls on budget execution, constraining budget managers’ flexibility in using inputs and fostering a focus on legal compliance, rather than on efficiency in the delivery of public services

• A relatively weak information base on the cost of different spending programs, and on their effectiveness in terms of relevant outcomes; and, relatedly

• Little focus by policy makers on the budget outturn, especially in terms of the results of public spending programs and their cost; and weak accountability for performance.

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Ongoing and planned reforms

The Italian authorities have already taken a number of steps aimed to address some of the weaknesses outlined above. More specifically, they have:

• initiated the preparation of a program classification for the budget;

• begun a spending review for selected ministries;

• started strengthening capacities both in the Ministry of Economy and Finance (MEF) and in Parliament to evaluate spending;

• made significant progress in strengthening the information base on the execution of the cash budget, including at the subnational level;

• begun a restructuring of ministries, to better align organizational structures and manpower allocation with policy priorities; and

• signed a memorandum of understanding with the social partners, to open a dialogue on the human resource implications of these reforms.

These steps clearly go in the right direction, but will need to be carried forward, in some cases expanded, and complemented by additional actions.

The way forward

Drawing lessons from international experience (Chapter III), this report suggests a package of reforms (Chapter IV).

• On reforming the budget structure, progress should be made in developing a sound program-based budget classification, with full involvement of spending ministries and the MEF in defining programs; and the accounting system should be modernized to measure accurately programs’ costs. It would be prudent to introduce the new program structure in the 2008 budget on a pilot basis, and to make it fully operational in the 2009 budget.

• On spending reviews, these should: (i) become an integral part of the Italian budget system; (ii) generate information to be reflected in improved baseline budget estimates; and (iii) point to any needed revision of spending legislation. Line ministries should receive appropriate incentives to cooperate fully, for example by being allowed to keep part of the savings identified in the spending review. The Education and Transport ministries, which are more advanced in preparations, should complete their reviews in time for the 2008 budget; other ministries, including some already identified, should follow in 2008. A review cutting across ministries should also be given consideration.

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• On reforms of the budget preparation process, a number of steps could be taken to improve the content and transparency of current documentation, including a substantial recasting of the rolling three-year budget estimates to reflect the cost of delivering policy objectives embedded in existing legislation. The budget documentation should also provide a consolidated picture of how the baseline budget and the proposed legge finanziaria map into the final budget estimates, by program.

• On reforms of the budget approval process, once the spending programs are defined and properly costed, the Parliament should appropriate the budget on a program basis. The much reduced number of spending programs (compared to the 1,500 line items currently included in the budget) would allow to focus parliamentary discussions on strategic policy priorities and their trade-offs with current policies.

• On reforms of budget execution, monitoring, and reporting, ex-ante controls during budget execution should be drastically streamlined, so as to allow managers to allocate funds within each program. Performance indicators for programs should be developed, based on existing and new information (such as users’ surveys), to strengthen ex-post monitoring and budget managers’ accountability for results.

This package of reforms will need to be supported by a well-structured communication strategy. This should highlight how the different stakeholders (parliament, the MEF, the spending ministries, civil servants, and society at large) can benefit from these reforms; and establish milestones for implementation that are sufficiently ambitious to deliver visible results in the relatively near term, but not unrealistic so as to make them unachievable. For their success, reforms will also need to be appropriately sequenced. In this regard, international experience suggests that: (i) the development of a well-structured program classification should be the first step; (ii) appropriations by programs should take place only after reliable cost estimates of programs have been developed and reflected in the accounting system; and (iii) the development of reliable indicators of performance and review of relevant programs should precede the introduction of performance targets. In addition to possible political resistance, additional stumbling blocks stand in the way of reform implementation. There may be a need to modernize the legal system—while the current reforms are predicated on an “unchanged legal framework”, it is possible that the 1978 accounting law may need to be amended. Implementing these reforms will also have significant human resource implications, including a need for increased geographic and functional mobility of civil servants. Finally, these reforms will only affect the central government, which accounts for about 40 percent of total spending; hence, addressing the quality of spending in a meaningful way will require complementary reforms in the complex system of intergovernmental relations—an area where some progress is being attempted.

I. INTRODUCTION

There is an increasing recognition in Italy that the quality of public spending needs to be improved. On one hand, the country faces a number of fiscal challenges that include continuing steadily on the path of fiscal consolidation and public debt reduction while halting unsustainable increases in the (already relatively high) tax burden; and creating the fiscal space for meeting rising spending needs (such as the costs of an ageing population, and the need to revamp deteriorating infrastructure and boost research) that loom ahead. On the other hand, enhancing Italy’s productivity will be essential for raising its growth potential and addressing competitiveness shortfalls vis-à-vis important trade partners. It is in this context that the issue of spending better—that is, leveraging available resources to deliver improved public goods and services, and/or generating savings to be channeled to new priority initiatives—has gained prominence in the political debate. Aware of these challenges, the government is preparing to undertake a number of structural reforms. In a document approved by the Council of Ministers on January 25, 2007, the Minister of Economy and Finance noted that, among other shortcomings, the current budget process has not allowed a proper allocation of scarce resources, supported by the definition of spending priorities and monitoring of achievable results.1 To this end, the government has initiated several reforms, such as an assessment of public spending in selected ministries through spending reviews; the introduction of a program-based budget classification; and support to parliament in its efforts to reform the parliamentary budget approval procedures. These initiatives, to be supported by a new public finance commission (Commissione Tecnica per la Finanza Pubblica), are seen as initial steps to enhance public spending’s effectiveness and efficiency. Significantly improving the quality of spending will require overcoming a number of weaknesses. This report provides a diagnostic of these shortcomings (Section II); distills lessons from international experience with relevant reforms (Section III); and outlines a recommended reform strategy for Italy over the short to medium term (Section IV). The report addresses only selected aspects of the budget process in Italy. A comprehensive analysis of the Italian public financial management system would go beyond the scope of this report; in any case, the detailed workings of the system are well documented elsewhere.2 For comprehensiveness, Box 1 highlights the main steps and documentation of the current budget process, as a quick reference for the discussion in the rest of the report. 1 “Orientamento del Ministero dell’Economia e delle Finanze in materia di struttura del bilancio e di valutazione della spesa.” 2 See, for example, Vegas, G., D. Da Empoli, and P. De Ioanna, Il bilancio dello Stato. La finanza pubblica tra governo e parlamento, Le Guide Il Sole 24 Ore (Milan: 2005 edition).

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Box 1. Italy Budget Process: Main Documents

Timing

Document

Purpose

June-July

DPEF Documento di Programmazione Economico-Finanziaria

Officially starting the budget cycle for the following year, it contains a medium-term plan for the budget and prospects for the economy. It is presented separately to both houses of parliament, and requires a resolution. The deficit limit approved in the resolution is binding for the finance law, unless an adjustment note to the DPEF (nota di variazione) is presented by the government jointly with the RPP (see below).

September

Relazione Previsionale e Programmatica (RPP) (Sezione I and II) Note Preliminari al Bilancio di Previsione (per Ministeri)

It provides a draft fiscal program with estimates and description of new proposed policies; and includes draft finance law and supporting documents from each ministry. It needs to be presented to parliament by end-September. It contains two sections. Sezione 1: international and domestic medium-term prospects Sezione II: technical details on the baseline budget projections (bilancio a legislazione vigente) and impact of finance law Ministries submit detailed budget proposals by UPBs (the basic budget classification unit, see Box 3).

Disposizioni per la Formazione del Bilancio Annuale e Pluriennale dello Stato (Legge finanziaria)

The Finance law (finanziaria) puts into law new budget proposals. It needs to be approved before the end of the year (typically approved in mid/late December)

Bilancio di Previsione dello Stato per l’Anno Finanziario e Bilancio Pluriennale per il Triennio

The Budget law (legge di bilancio) authorizes all revenue and spending consistent with existing law. It needs to be approved before the end of the year (typically approved in mid/late December)

September- December

Provvedimenti collegati

These are legislative measures associated with the finance law, to be approved by mid-November.

Bilancio per Capitoli This ministerial decree informs line ministries of their budget broken down by chapters.

January

Bilancio dello Stato per Centri di Costo

This is the state budget (accrual by cost centers).

Rendiconto Generale della Amministrazione dello Stato

It provides an annual statement of budgetary outturns.

Disposizioni per l’Assestamento del Bilancio dello Stato e dei Bilanci delle Amministrazioni Autonome

This is the revised/adjusted budget for previous year. Typically presented to parliament in June, it may remain open for a few months.

June

Relazione sul Rendiconto Generale dello Stato

This is the report by Auditor General (Corte dei Conti) on the budget outcome for the preceding year.

Source: MEF website; and “Italy: Report on the Observance of Standards and Codes—Fiscal Transparency Module” (International Monetary Fund, October 2002) http://www.imf.org/external/pubs/cat/longres.cfm?sk=16137.0

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The primary focus of this report is on central government spending. This is also the coverage of the Italian budget law (legge di bilancio, Box 1), which relates to the state level (central ministries and autonomous agencies). As this accounts (net of intergovernmental transfers) for only about 40 percent of general government’s spending, it is evident that addressing the quality of spending in a meaningful way will require complementary reforms in the complex system of intergovernmental fiscal relations—an area that has remained undefined years after a major constitutional reform assigned new responsibilities to subnational governments. While these issues are not covered in this report, it is nonetheless important to acknowledge their relevance, as reflected in a new legislative proposal recently put forward by the government.

II. THE MAIN CONSTRAINTS ON TRANSPARENT AND EFFECTIVE SPENDING DECISIONS

The current system for formulating and managing public spending decisions in Italy is affected by a number of shortcomings, spanning budget formulation, execution, and reporting. These are briefly reviewed in this chapter.3 Spending decisions do not appear to reflect fully and clearly the government’s policy priorities. In principle, line ministries are supposed to reflect the priorities outlined in the government program in their budget proposals (Box 2); in practice, the current budget structure (see below) and the legal requirements associated with spending decisions do not facilitate the budget prioritization process.4 As outlined in the 2002 Report on the Observance of Fiscal Standards and Codes (ROSC) Fiscal Transparency Module, the budget preparation process mainly reflects the impact of past legislation on spending, and therefore has come to have an incremental focus. The budget that emerges tends to have a strong focus on legal compliance, rather than on strategy, driven by the so-called current (pre-existing) legislation (legislazione vigente).

3 For a more detailed diagnostic, see “Italy: Report on the Observance of Standards and Codes (ROSC)—Fiscal Transparency Module (IMF, 2002). See also Monticelli, Carlo (2006) “La Trasparenza dei Conti Pubblici in Italia: Alcune Proposte” (mimeo).

4 Article 81 (clause 4) of the Constitution establishes that “any other [than the budget] law involving new or increased expenditures must specify the resources to meet these expenditures.” This requirement has been interpreted as an obligation to establish all spending by law and indicate the source of its funding,

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Box 2. Top-down policy priorities

The Prime Minister’s office plays a significant role in setting out the policy priorities so that they reflect the government’s agenda. The Dipartimento per il Programma di Governo, which reports to the President of the Council of Ministers, is charged with setting out the strategic goals and objectives of the government. This process, which is done in consultation with the various ministries and supported by the Comitato Tecnico Scientifico per il Controllo Strategico nelle Amministrazioni dello Stato, produces a document outlining the government’s strategic objectives (the government’s program for 2007 is available at http://www.governo.it/Presidenza/controllo_strategico/direttive.html).

These objectives are expressed as a combination of outputs, desirable outcomes, and standards to be achieved. Currently they are not explicitly assigned to specific ministries. The Prime Minister’s office is also working alongside ISTAT (the national statistics agency) to identify a set of initial indicators to track performance, but acknowledges that the culture and systems of performance measurement are still quite underdeveloped. Source: Mission’s meeting with Dipartimento del Programma di Governo. Pre-existing legislation is not systematically reviewed in the resource allocation process to ensure alignment with the government’s policy objectives. The process of determining the non-discretionary elements of existing legislation is undertaken by the General Accounting Office (Ragioneria Generale dello Stato, RGS); this process has come to include the vast majority of expenditure, estimated by RGS itself at around 92 percent for the 2007 budget (Table 1), thus leaving little space for new initiatives within a given budget envelope.

Table 1. Mandatory Spending by Economic Classification, 2007

Mandatory spending 1/ TotalIn billions of

eurosAs share of total

spendingspending

Current spending 368.0 92.1 399.4 Of which:

Salaries 71.2 84.9 83.9Goods and services 5.6 65.6 8.6

Capital spending 25.7 92.0 28.0

Total 393.7 92.1 427.4

Source: Table 1, 2007 Budget Law proposal (October 1, 2007, Act of Chamber of Deputies 1747); and RGS glossary (available under the RGS website).1/ Includes "legislative factors" (fattori legislativi , i.e. spending that is "absolutely rigid", asquantified by the supporting legislation); and mandatory spending (spese obbligatorie, i.e.spending that cannot be eluded or postponed, assigned to specific chapters, by ministry).

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The current budget classification, which is not structured around programs, does not allow analysis and implementation of allocation decisions in line with policy priorities. The budget is appropriated on the basis of UPBs (unità previsionali di base), which in turn are composed of chapters that provide information of a functional and economic nature (capitoli). The content and size of the UPBs vary significantly, with little resemblance to standard functional budget classification categories (Box 3).

Box 3. The Current Budget Classification

The basic unit of budget classification is the chapter (capitolo). Each chapter is mapped into standard economic and COFOG functional classification, and has a four digit code: the first number indicates whether it is for current payments (numbers 1 to 6); capital payments (numbers 7 and 8); or for payments with respect to financial transactions (number 9). A chapter may be prorated across as many as ten functions (at the third level), but must map to one economic object. For example, chapter 2643 (goods and services of the Ministry of Economy and Finance) maps into 10 different functions (on the basis of 10 coefficients; the largest share, equal to 37 percent, is attributed to function 1.1.2.3: budget policies). Given that most spending requires a legal basis, chapters are also mapped to the substantive laws which give rise to them. These are listed in a document (nomenclatore degli atti), which quotes all the laws relating to each chapter. For example, chapter 2643 is associated with 14 pieces of legislation, ranging from a 1929 royal decree to the 2004 finanziaria. Chapters are grouped into Unità Previsionali di Base (UPBs), which provide the minimum level of parliamentary appropriation. The Ciampi reform (Law 94/1997) introduced UPBs to reduce considerably the number of budget items from some 6,000 chapters to about 1,000 units. Each UPB was assigned to a specific manager, but without functional or programmatic purpose. There is a general prohibition on transferring budgetary appropriations between UPBs, except for the office of the prime minister. In the 2007 budget, there were about 1,500 UPBs and some 4,500 chapters. UPBs may vary significantly in size. For example, in the 2007 budget, UPB 4.2.1.18 (fiscal federalism) amounts to some €45 billion; UPB 4.1.1.0 (administrative spending, funzionamento) to which the above mentioned chapter 2643 belongs, amounts to €120 million; while UPB 4.2.3.25 (management of port workers) amounts only to some €870,000. Source: “Italy: ROSC Fiscal Transparency Module” (2002); and various MEF documents available at http://www.rgs.mef.gov.it/VERSIONE-I/Norme-e-do/Bilancio-e/Disegno-di/index.asp The budget is structured around a three-year framework, yet budget discussions focus narrowly on a one-year horizon. This is due to a number of factors:

• A sound system of forward estimates is not implemented. Estimates for outer years are not binding or sufficiently robust to give certainty to both the MEF and line ministries about “baseline” spending in the bilancio a legislazione vigente (budget law, Box 1)—this is a critical shortcoming in a system, like the Italian one, where most spending is driven by pre-existing legislation.

• While information on the macroeconomic framework underlying the budget projections and the main aggregate revenue/spending is generally available, it is not

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immediately clear, nor transparently reported, how the various macroeconomic assumptions translate into budget projections—with the concomitant risk that, as macroeconomic projections change, budget forecasts are re-opened.5

• There is no top-down medium-term overall expenditure ceiling that would guide the budget preparation process.6

The non-binding nature of estimates in the outer years has led to haggling between the MEF and line ministries in the budget preparation stage over the appropriate costing of existing legislation. Line ministries do not have confidence that any savings identified within the baseline can be kept and directed to new policies—hence, they do not face the right incentives for properly costing their spending but rather tend to overstate the projected cost of delivering existing policies in an incrementalist approach to budget planning. Moreover, there is as no systematic review of current expenditure and legislation, nor an explicit requirement for an up-front identification of fiscal space for new initiatives. The lack of a strategic approach in the budget preparation process carries over to the parliamentary budget discussions. As resource allocation discussions at the executive level focus on small and detail-oriented inputs, rather than on programs and results, so do parliamentary discussions, where elected members juggle multiple amendments with reportedly limited awareness of their policy impact. The budget baseline (tendenziale) per se receives almost no scrutiny by parliament, to the point that there are no proposed amendments to it—a further proof that its construction is not transparent or well understood. Indeed, the excessive number of UPBs (even if they corresponded to well-defined objectives) prevents coherent choices and decisions by parliament; and the cumbersome approval process for the financial law (finanziaria, which contains new spending proposals) has led to an ever increasing number of proposed amendments to the law (which topped 12,000 in 2006). This has often culminated in last-minute omnibus financial laws where strategic priorities are not (and cannot) be identified, and where UPBs may be used as vehicles to cater to particular interests. As a result, the relationship between the initial budget estimates and the subsequently voted appropriations is not transparent. There is no reconciliation of how UPBs have

5 The macroeconomic framework is available in the beginning of the budget process (as highlighted in the Relazione Previsionale e Programmatica); however, details of the underlying model are unavailable and no updates to the overall macro or fiscal framework are formally issued at the end of the budget process, regardless of changes in the targeted deficit ratios. For some information on modeling techniques currently applied, see Dipartimento del Tesoro. I Documenti Programmatici: Ruolo, Strutture, Processi e Strumenti del MEF, 2006. 6 The Document of Economic and Financial Programming (DPEF), presented by end-June, includes only a nominal deficit target that is binding for the budget documents submitted to parliament at end-September.

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varied from the initial baseline projections to the final voted allocations—a process that would nonetheless prove formidable in the current system of 1,500 UPBs. The current system for allocating and managing resources is not conducive to a culture of managerial responsibility. Pre-existing legislation tends to be interpreted as binding the content of specific chapters; and during the fiscal year, the RGS exerts a function of ex-ante control to ensure compliance with the law. All these factors combined—the perceived non-discretionary nature of most expenditure, the focus on legal compliance rather than outcomes, and the rigidities imposed by ex-ante controls—do not foster a culture where managers feel responsible for budget outcomes. In addition, as additional spending can be financed via special funds during the year (Table 2), managers do not face hard budget constraints. Operational flexibility is also hindered by the rules on reallocation of funds across budget chapters. Article 2 clause 4.5 (2.4 quinquies) of the 1978 Accounting Law allows managers (through a ministerial decree) to reallocate between budget chapters in the same UBP; however, this flexibility only applies to those UPBs that are classified as discretionary. The only exception is capital expenditures under certain conditions. A notable example of a non-discretionary input in the Italian context is staff, thus depriving managers of important trade-offs in the cost-effective delivery of public services. In practice, this limits reallocations to a small portion of total expenditure (as shown in Table 1). Virements across UPBs need approval from the RGS and supplementary approval from parliament. Consequently, there is currently little accountability for the cost-effective use of resources. The process for approving and controlling the use of resources, together with the lack of routine performance information, breaks the link between managerial actions and attainment of the policy objectives established at the beginning of the budget cycle, thus making it hard to create incentives for accountability. Line ministries feel that spending is driven by, and controlled from, the MEF; while the MEF believes that line ministries should have greater ownership of their budgets and better prioritize within their budget envelopes. The budget outturn is audited by the Audit Court to ensure legal compliance with the approved budget, but this is done primarily on the basis of financial information. Limited use is made of non-financial information to measure performance; in any case, this would be a hard task given the absence of clear performance expectations at the formulation and approval stages of the budget. According to the parliamentary Budget Committees, reports by the Audit Court do not receive much attention from legislators, nor do they play a significant role in the resource allocation decisions for the following year.

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Table 2. Reserve and Special Funds

Name Legislative basis

Ministry Purpose

Access rules

Fund for mandatory spending (fondo di riserva per le spese obbligatorie e d’ordine)

Accounting Law 468/1978 article 7

MEF Elenco 1 Budget Law

To increase allocations of chapters related to mandatory spending (listed by ministry/chapter in Elenco 1).

Decree of Minister of Economy, to be registered by Audit Court.

Fund for carry-over of unspent capital allocations (fondo speciale per la riassegnazione dei residui perenti delle spese in c. capitale)

Accounting Law 468/1978 article 8

MEF To release funds previously authorized but not yet spent for projects.

Decree of Minister of Economy, to be registered by Audit Court.

Fund for unforeseen spending (fondo di riserva per le spese impreviste)

Accounting Law 468/1978 article 9

MEF Elenco 4 Budget Law

To increase allocations for spending chapters, without impinging on future budgets on a continuous basis.

Decree of President of the Republic; proposed by Economy Minister and to be registered by the Audit Court.

Fund for cash authorizations (fondo di riserva per le autorizzazioni di cassa)

Accounting Law 468/1978

article 9-bis

MEF To increase cash allocations to chapters with insufficient funds, in line with the “objectives of public finance.”

Decree of Minister of Economy, to be communicated to Audit Court.

Fund for authorization of current spending from permanent law (fondo di riserva per le autorizzazioni di spesa delle legge permanenti di natura corrente)

Accounting Law 468/1978

article 9-ter

MEF To provide additional funds for UPBs that face funding shortfalls, consistent with “objectives of public finance”

Decree of the Minister of Economy; proposed by relevant minister and to be communicated to the relevant parliamentary commissions.

Special funds (fondi speciali)

Accounting Law 468/1978 article 11

MEF Elenco 5&6 Budget Law

(and tabella A and B finanziaria)

To fund financial impact of legislative changes to be introduced after the budget is approved (finanziaria lists them, their cost, and the relevant ministries).

Can be accessed after the relevant laws are approved. Funds expire if not used.

Various reserve funds

Various laws (typically,

finanziaria laws)

Relevant ministries Purpose established in the law creating these funds; for example, fund for good and services.

Funds to integrate budget allocations (assegnazioni/integrazioni di bilancio)

Accounting Law 468/1978 article 12

MEF Elenco 2&3 Budget Law

These funds are not included in the budget; they provide an ex post channel to address shortfalls in budgetary appropriations for specified purposes (tax refunds; debt service, etc.)

Decree of President; proposed by Economy Minister. The rendiconto lists, ex post, the decrees that effected such integrations and their reasons.

Source: Law 268/1978; Vegas, G., D. Da Empoli, and P. De Ioanna (2005); and various budget documents. Note: Amounts of these funds cannot be immediately traced in the budget documents. According to RGS and other government officials met by the mission, the amounts allocated to theses funds are not significant, and have become less relevant over time. Some funds are actually “emptied” during the parliamentary budget discussions, as resources originally allocated to some of these reserve funds are “siphoned off” to other budgetary uses.

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III. LESSONS OF SELECTED INTERNATIONAL EXPERIENCE OF BUDGET REFORMS

Over recent decades, many countries have implemented major reforms of their budgeting systems, as part of wider strategies of public sector reform with broadly three overarching goals: (i) delivering the government’s policy priorities; (ii) improving the efficiency and effectiveness of public services; and (iii) enhancing accountability for the use of taxpayers’ money. More specifically:

• A key focus of international budget reforms has been the improvement of expenditure prioritization to deliver the government’s policy priorities. Budgeting systems should be capable of allocating limited public funds to the services that deliver greatest perceived benefit to the community. The social payoffs of these prioritization reforms have been clearly demonstrated. (Box 4).

• Better prioritization is important, but it is only part of what is required to improve the efficiency and effectiveness of services. Prioritization per se does little to improve efficiency—that is, to lower the cost at which services are delivered. And while better prioritization is a significant part of improving service effectiveness, improved program design and management are equally relevant. An important element in the reform agenda for improving the efficiency and effectiveness of public spending has been the improvement of performance information, particularly through performance measures and evaluation.

• The provision of performance information to the public and to Parliament is shown to play a significant role in holding the government to account for the results achieved by its policies.

Box 4. Reprioritization in the United Kingdom and Australia under the Spending Review Process

Under the Spending Review (SR) system initiated in 1998, the United Kingdom has demonstrated a striking capacity to achieve major shifts in expenditure, creating scope to fund important new expenditure priorities by cutting low priority/ineffective programs. Over the decade since the first SR, there has been a deliberate and large shift in priorities toward frontline public services in three key sectors: health, education and transport. As a result, the share of these three priority services in total public expenditure increased from 28 percent in 1997-98 to 34 percent by 2007-08. By contrast, the share of social security spending has fallen from 30 percent to 27 percent over this period due in part to the success of the Government’s welfare-to-work program. The Expenditure Review Committee (ERC) system which has operated in Australia for more than twenty years demonstrated a capacity, during two episodes of fiscal consolidation in the mid-1980s and mid-1990s respectively, to target expenditure cuts at low-priority programs, and thereby avoid recourse to clumsy and indiscriminate “across-the-board” cuts. This not only softened the pain of expenditure cuts, but also made fiscal consolidation more sustainable

17

There are a number of key tools that have been experimented with for achieving these goals. For simplicity, the tools described here are mapped into the three goals above: (i) tools for improving expenditure prioritization; (ii) tools for delivering better services; and (iii) tools for enhancing accountability. This grouping should not be rigidly interpreted, as in most cases these tools are useful in the attainment of more than one overarching goal. Table 3 shows the relationship between goals and tools for achieving them.

Table 3.The Relation between Goals and Tools for Budget Reform

GOALS TOOLS

Improving expenditure

prioritization

Delivering better services

Enhancing accountability

for performance

Program budgeting

X X X

Spending reviews

X X X

Medium-term focus/ sound forward estimates

X X

Budget process for prioritization

X

Performance indicators X X

Evaluation X X

Performance targets X X

Results-based funding X

Input flexibility X X

Performance information to parliament

X

Performance auditing

X

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A. Improving Expenditure Prioritization

Tool 1: Program Budgeting

For expenditure prioritization purposes, the program classification of expenditure is particularly valuable. It is for this reason that the French have, following in the footsteps of many other countries, introduced a program classification to replace their previous budget classification (by chapters which were largely input-based). This was a cornerstone of the budgeting reforms undertaken following the Loi Organique relative aux lois des finance (LOLF) of 2001. The Italian government has decided to adopt a similar approach to program budgeting, in which overarching missions are designated, and a number of programs are then identified within each mission.7 Programs should be the basis of budgeting, and not solely an instrument of transparency. While one of the purposes of programs is to report, after the event, the purposes for which government used public money, programs can do much more than that. They can be used as the basis of budget preparation by the government, with agency budget requirements being estimated and evaluated on a program-by-program basis. They can also be the basis on which the parliament appropriates money to ministries in the budget law, as is done in a large number of countries including France. As part of this, “forward estimates”—discussed below—can be formulated on a program basis. To be of maximum use for priority-setting, programs should generally be outcome and output-based. That is, they should represent groups of services (“outputs”) which are unified first and foremost by the fact that they share (one or more) common intended outcomes.

7 For example, the 34 missions employed in France in 2005 included “health”, “security” and “justice.” As an example of the program structure, the justice mission comprised 5 programs including “judicial justice,” “prison administration,” and “judicial protection of youth.”

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Box 5. Outcome and Output-Based Programs Outcomes are impacts of government services on individuals, social structures and/or the physical environment. Examples are the protection of natural flora and fauna; the acquisition of knowledge (literacy, numeracy etc) by students; and reduced crime. Thus a Nature Conservation program is an outcome-based program which groups all outputs designed to protect natural flora and fauna. Similarly, a Higher Education program would group a range of services with aim to achieve (amongst other things) knowledge outcomes. This example of a Higher Education program illustrates a further point which applies to many programs in a well-designed classification system: although shared outcome(s) are the first criterion upon which the program is based, the program is further defined (and distinguished from related programs such as Primary Education) by the nature of its client group (students who have completed and advanced beyond secondary education). The reason why programs should in general be outcome-based is that in this way they will best capture the key expenditure prioritization choices which most concern the government at the highest level of budget decision-making. Concretely, what ministers and the finance ministry should be most concerned about in setting expenditure priorities is “guns or butter” type choices: how much should be spent on defense versus education, how much on preventative health versus health treatment services, etc. Some of the lessons for international experience for good program design are: • Programs may not correspond exactly with a functional classification of outlays (see

Box 6).8

• The objective of each program should be clearly and briefly stated, as should the program’s strategy for delivering this objective.

• Strategic planning, at the government-wide or agency-specific level, should be harmonized with program planning. In particular, the objectives and strategies articulated with respect to a ministry’s programs should be part of its strategic plan.

• Programs should be agreed by the Finance Ministry and relevant line ministry, rather than decided unilaterally by the latter. The best approach is for the line ministry to develop a proposed structure, and for this to be reviewed by, and coordinated with, the Finance Ministry.

8 There is a limited number of exceptions to this proposition, the principal being “administration” programs.

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Box 6. Main Differences between Program Classification and Functional Classificationof Expenditures

Both the functional classification (COFOG) and a program classification have the overall objective of classifying expenditures according to the purpose for which the expenditure is incurred. Beyond that common objective, however, the two classification systems have different purposes. The objective of a program classification is operational, i.e. to allocate resources on the basis of government policy priorities, so as to focus budget managers on the achievement of policy goals. In a program classification, transfer of responsibility for a program from one ministry to another would see the classification of expenditure transferred as well, so as to ensure accountability for program delivery. The objective of COFOG, on the other hand, is statistical, i.e. to provide a consistent basis for reporting expenditure that does not vary over time or between countries. COFOG is therefore independent of the structure of government. Expenditure on a particular program will always be classified in COFOG in the same way, irrespective of whether administrative responsibility for the program is shifted from one ministry to another. This is a strength of a reporting system such as COFOG. An important practical difference between the two classification systems is in the aggregation principle (i.e. the rule or basis for grouping expenditures together). In COFOG, the second and third levels combine activities that have quite different characteristics from a management perspective. For instance, lower secondary education (the third level in COFOG) includes the provision of education in schools, second-chance secondary education for adults, inspection of schools, and grants or other support provided to students to attend schools.1 Typically, different institutional units within an Education Ministry would be involved in delivering some of these services, and performance would be measured differently. The management perspective should be kept in mind when designing programs if the objective is to facilitate greater flexibility and accountability. When defining programs, the first question that should be asked is: do these services have a common specific policy objective? ________________________________ 1 See http://unstats.un.org/unsd/cr/registry/regcs.asp?Cl=4&Lg=1&Co=09.2.1

• Programs should generally not cross the boundaries of ministries, because each

ministry needs to receive a clearly defined budget. (In the new French system, some missions cross ministries, but all ministries receive program appropriations which are theirs alone. See Box 7.)

• Following the introduction of programs, the organizational structures of ministries should be reviewed, to make them more results-focused and align them more closely with the program structure. It is generally a mistake to base programs structure on pre-existing organizational structures as this is often defined around processes or functions, and not the purpose of the programs.

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Box 7. Program and Ministry Structure in the French System: An Example

Mission Solidarity and

Integration

Program Policies for

Social Inclusion

Program Equality Between Men and Women

Program Sickness

Protection

Program Actions for Vulnerable

Families

Program Welcome and Integration of

Foreigners

Program Handicap and Dependence

Program Implement-

ation & Support of Health and

Social Policy

Ministry of Employment, Social Cohesion and Housing Ministry of Health and Solidarity

• Budgeting by programs requires that accounting systems be enhanced, to provide reasonably accurate program costings. Program budgeting requires that expenditure on inputs be allocated to programs. As discussed in Annex 1, cost allocation is a demanding challenge, particularly with respect to “indirect” costs.

• Because of the complexity of indirect cost allocation, it is reasonable in the early years of a program budgeting system to have “administrative” programs in each ministry covering overhead costs (such as ministry-wide support services), notwithstanding that such programs violate the principle that programs should be outcome and output based. The objective should, however, be to gradually reduce and then finally eliminate such programs, as improvements in the capacity of accounting systems to allocate indirect costs to programs improve. (See Annex 1).

Tool 2: Spending Reviews

The basic purpose of a spending review is to improve the quality of public services. It focuses on the objectives of government programs, their relevance to current government priorities, the outcomes being achieved and at what cost. Because of its in-depth probing, a

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spending review is an important source of information to improve the prioritization of public expenditures and resource allocation. Spending reviews are normally based on programs, and it is difficult to carry them out if information is not available on a program basis. In some cases, however, activities such as the provision of information and technology services across government ministries may be the subject of a spending review. Major spending reviews may also cut across a number of departments and involve a group of programs that impinge on a policy outcome such as improving the transfer of disadvantaged people from welfare to work.9 In addition, it is also important that tax expenditures be included in the range of spending reviews, and this is normally best done in conjunction with a review of those spending programs that service a broadly similar purpose.10 Spending reviews are necessarily about changing programs and thus require that choices are made. Where spending reviews have proved most useful, such choices have not been confined to only a small amount of “discretionary” expenditure, as that limits what can be achieved by spending reviews. Indeed, countries have been prepared to review entitlement programs, such as pensions, to improve, for example, their effectiveness in encouraging people to move from welfare to work or to postpone their retirement. All spending ministries are typically expected to develop an agenda of spending reviews and undertake some review activity regularly. These spending ministries are best placed to identify the areas with the best potential for efficiency gains within their programs. Spending reviews are, however, most effective if they target those programs where there is reason to believe that cost effectiveness can be substantially increased and significant savings realized (for the criteria to identify priorities for a spending review, see Box 8). Some of the most significant spending reviews consider cross-cutting issues—such as child poverty or how to improve assistance to disabled people to return to work—that cover a range of programs in more than one ministry. Such reviews necessarily involve staff from the relevant spending ministries, but are often led by someone from a central agency to ensure proper coordination; for example, from the Prime Minister’s office. 9 These cross-cutting reviews can also encourage closer cooperation between ministries on common policy problems and can identify duplication of functions

10 For example, a review of income support to families might cover the tax expenditures along with the government outlays for this purpose.

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Box 8. UK Departmental Spending Review: Sequence of Activity

Analysis of Expenditure by Program/Objective

Breakdown of expenditure by program with analysis of historic cost profile, current expenditure and forecast trends.

Identifying Areas of Highest Priority/Return

Identify areas of high priority programs based on, e.g.:

Identify scope for improving value for money in programs or processes where, e.g.:

• the relationship with Government priorities and objectives;

• high economic or social returns to additional expenditure;

• substantial baseline pressures on forward expenditure; or

• the impact of exogenous pressures.

• objectives have lapsed or been achieved;

• the link between spending and outcomes is weak;

• input or unit costs are high relative to public, private or international benchmarks; or

• there is large performance variation across delivery units.

Reprioritization of Expenditure

Revised forward estimate based on: Revised performance framework including

• resources that can released from low value for money programs or areas of expenditure; and

• additional expenditure required on high priority programs or areas of expenditure.

• outcome objectives for new programs; and

• performance targets, measurement and monitoring arrangements.

Delivery Planning and Implementation

Agreed delivery plan setting out revised appropriation, policy reforms, legislative and administrative changes and other actions required to refocus expenditure on objectives identified and remove obstacles to their

achievement. Source: U.K Treasury’s contributions during the mission. Often a spending review will extend beyond identifying the scope for improved efficiency and will propose options for re-designing the program(s) to improve overall cost effectiveness. The outcome of such a review will typically identify the scope for some savings, but some or all of these savings may be used to improve the quality of those programs, and in some cases spending reviews may result in well-formed proposals for additional expenditures on high priority programs or areas of expenditure.

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Establishing the right incentives is crucial to secure ministries’ participation in spending reviews. In this regard, the prospect of being able to retain some or all of the savings from a spending review, along with the scope to reallocate resources more effectively and the development of firmer forward estimates of future program expenditures, are important incentives for ministries to undertake spending reviews. The share of savings retained by the program ministry typically depends upon the significance of the savings and where the main ideas for achieving the savings originated—inside or outside the program ministry. The experience shows that spending reviews can lead to decisions—often taken in the budget context—to seek parliament’s approval to change legislation. In particular, where mandatory programs, such as entitlements, are subject to a spending review, that may well lead to proposals that require changes in legislation. More generally, spending reviews will lead to proposals to change legislation where there is a need to redesign a program to meet its objectives more efficiently or effectively. In effect, legislation is then seen as the means for delivering policy objectives rather than as a constraint that confines policy objectives, and the means for achieving them, to preservation of the status quo. The procedures and timing of spending reviews are flexible, with some broad common features. In the United Kingdom, spending review occurs every three years, with two Comprehensive Reviews across all spending ministries over the last decade. One important outcome of the UK spending review is an agreed set of budget forward estimates for the next three years. In other countries, there is a regular rolling agenda of spending reviews that focus on particular programs or on particular policy issues. These reviews are usually monitored by the Finance ministry, with its more direct involvement for the more significant reviews. Although these reviews are less comprehensive than the approach in the U.K., the sequence of activity is generally the same as shown for the U.K. in Box 7. The activities of officials in both the spending ministries and especially in the budget department change from a focus on haggling over funding for existing activities to program analysis—which focuses mainly on program efficiency and effectiveness. The skill set required is different from that of “traditional” budget analysts and managers. Also, the relations between spending agencies and the budget department should reflect joint efforts to improve program effectiveness rather than centering on an essentially adversarial role. The budget department should be a source of advice to agencies in the development of performance indicators and on best practice evaluation. Often in countries where spending reviews are most advanced, the budget department is expected to keep a register of all significant evaluations and advise the government on the planning of future evaluations that the government might want to commission.

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Tool 3: Strong Medium-Term Framework and Sound Forward Estimates

A strong medium-term focus for the budget is the basis for resource allocation, helps maintain expenditure control over time, and assists in responding to new priorities. It also helps with prioritization by forcing baseline changes to be linked to policy changes.

A robust system of forward estimates of the cost of existing policy—which does not need to be renegotiated each year—is essential to achieve a medium-term budget focus. Budget systems based on forward estimates work best where agencies accept that they are properly funded, and that their estimates will be updated by an agreed set of rules for future years to cover the cost of continuing existing policies. For example, this updating can involve an agreed set of rules, so that it becomes a purely technical exercise by Finance ministry officials, as in Australia. All changes in the estimates from one budget to the next are in response to changes in budget parameters (such as the rate of inflation), and are subject to agreed rules, or reflect changes in existing policy; it is possible to track these changes from one budget to the next (Annex II). In the U.K., forward estimates are set for the three-year period following a spending review, but there is scope to re-examine the base estimates of the cost of existing policies at the time of the next spending review.11 The important feature of a robust forward estimates system—however updated and rolled forward—is that it removes annual haggling over the cost of existing policy and allows agencies to plan with confidence. The budget process is then focused on policy changes and how the effectiveness of programs can be improved. The incentives for spending review are maximized as agencies can then identify the potential savings against firm estimates of program costs. For some purposes projections of future government outlays can be extended beyond the normal budget year plus three to consider the budgetary pressures that may result from longer term challenges. For example, the response to climate change, the future needs for the provision of infrastructure, and the fiscal implications of an ageing population all require a longer time frame to inform current policy making. Forward estimates of programs also provide the basis for ensuring that managers confine their spending within the limits of those estimates. Any potential overspends are then matched by savings found elsewhere or (to a limited extent) by shifting funds between

11 Most countries provide for some reserve funding in their budget to cover unforeseeable and unavoidable new expenditures and forecasting errors. These reserves are, however, typically no more than 2 percent of total outlays in the budget year, and rather more as they increase over the forward estimates period. Brazil, Spain, and the U.K. all cap contingency reserves at 2 percent of spending; Australia, which imposes very tight constraints over its budget estimates, has a contingency reserve in the budget year of only 0.7 percent.

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years.12 In addition, the experience has been that, where the Finance ministry only attempts to control the total spending on a program, it is typically more successful than when it tries to control many different program inputs. The reality is that managers will only take responsibility for living within their budgets if they have the necessary flexibility and there is limited central intervention.

Tool 4: Budget Process’ Focus on Priority Setting

International experience suggests that an effective budget process must be driven from the top, especially in the initial stage when the broad strategic directions for the budget must be set. This initial strategic guidance is essential if the budget is to truly reflect the government’s principal priorities and if spending reviews are to realize their full potential. The advice normally covers an assessment of the budgetary scope for spending, taking into account any commitments on the size of government outlays and taxation and the fiscal deficit and/or government debt. The strategic guidance might also extend to areas identified for review and possibly targets for savings to be achieved, and/or an envelope for new spending on a net basis after savings have been included. This advice on spending/savings targets does not necessarily cover all spending ministries or even all activities/programs of those ministries receiving such advice. The expectation is, however, that any changes in areas not covered by the advice would be budget neutral, at least on a net basis when aggregated across a ministry. A budget process focusing on priority setting and incorporating a spending review necessarily entails more policy choices and therefore calls for ministers’ stronger role. In those countries which have the most advanced budgeting systems, the strategic guidance is typically provided by the Prime Minister working in collaboration with the Finance Minister. It may then be ratified by the full Council of Ministers. Subsequently, ministers will then bring forward their budget submissions that reflect the initial guidance and cover all new policy proposals to spend or to save, including the outcomes from the individual spending reviews for relevant ministries. Ministers usually have the right to shift resources from one program to another when preparing their budgets, as long as these transfers are agreed to be cost-neutral. The full realization of this flexibility requires that staff are also transferable. In a number of countries, a sub-committee of senior ministers undertakes the intense process of examining budget submissions. This always includes the Finance Minister, and

12 In Australia, for example, program managers can carry over funds to the next year where there is underspending, but they must borrow forward from next year’s forward estimates, when they over-spend in the current year.

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sometime the Prime Minister.13 The decisions taken by this sub-committee may, in some countries, need to be ratified by the full cabinet; in other countries, such sub-committees have sufficient authority to determine the budget without reference to full cabinet. Less significant decisions may be taken bilaterally by the Finance Minister and the relevant spending minister.

B. Delivering Better Services

Tool 1: Performance Indicators The evolution of public service performance management systems in countries such as Australia, France, Netherlands, the U.K., and the U.S. has been toward the development of high-quality performance indicators underpinned by robust measurement, monitoring and accountability arrangements. Experience in these countries suggests that performance indicators are most effective in driving behavior and improving outcomes when they are: • Focused primarily on outcomes and outputs, rather than inputs and processes.

• Developed in consultation with frontline delivery agents and service users to ensure that their definition, measurement, and delivery reflect their experience and preferences and perverse incentives—such as the incentive to sacrifice the quality of service in favor of increased quantity of service when the targets are set for the latter but the former is not measured—are minimized.

• Subject to effective quality assurance. Both internal control and the external auditor have an important role to play in this respect. Explicit, publicly-available statements of the methodology used for each indicator—as in the U.K.—represent another valuable quality assurance measure.

For the purposes of external users and decision makers, a small number (3 to 5) of key indicators per program should be identified. Managers within the agency will, of course, use a larger set. Central agencies, including the Finance Ministry, should play a key role in agreeing on these key indicators with line ministries, so as to ensure that they meet the needs of central decision-makers. Some examples of performance indicators used in selected countries are in Annex III. Developing a set of performance measures for the whole government that is robust and relevant enough for use in the budget process takes considerable time. Countries that are 13 For example, Australia, Canada, New Zealand, and sometimes the U.K.

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leaders in this field took decades to build the sophisticated systems they have today. While all ministries can be expected to develop some performance indicators from the outset, it should be expected that these will be subject to revision in the light of experience. Also, starting with a small number of measures and expanding the set gradually over time is the only practical strategy. The main function of government officials is the provision of information regarding program performance. This includes identifying options to improve program performance and to meet new priorities identified by ministers, and ensuring agreement on costings with the Finance ministry before the budget submissions are finalized and lodged for ministerial consideration. The Finance ministry provides alternative options for savings when those proposed by spending ministries are found to be inadequate; it also keeps a running score card of how the various decisions are affecting the total for budget outlays

Tool 2: Evaluation As performance measures per se rarely provide conclusive evidence of performance, program evaluation is also critical. Evaluations are analytic assessments typically addressing the cost-effectiveness or appropriateness of expenditure policies. Countries like Chile have had great success in integrating evaluations into their budgeting systems; there is currently a new wave of international interest in evaluation, with many countries—such as, for example, Canada and Australia—working on building useful evaluation systems. International experience shows that evaluation needs to be in a form valuable to policy-makers without being too resource-consuming. This means that most evaluations should be carried out quickly, focus on drawing conclusions of specific value to managers and budgeters, and should not set unrealistically high “scientific” standards of proof in drawing these conclusions. Tool 3: Performance targets Quantitative statements on outputs and/or outcomes have been an important part of performance management regimes in a number of countries. The most effective example of the target-based approach is the UK Public Service Agreement (PSA) system, under which performance targets have been set as part of the spending review process and have been related to the level of funding provided (Box 9).

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Box 9. Public Service Agreements in the United Kingdom

The centerpiece of performance management in the U.K. are Public Service Agreements (PSAs), agreed between the Treasury and 18 departments. Introduced in the 1998 spending review (SR), the aim of PSAs was to focus resources on improving outcomes for the public and strengthen accountability for cost effective service delivery. Published alongside departments’ 3-year allocations, PSAs specify the department’s aim, 5 to 10 supporting objectives, and targets with respect to performance against those objectives. PSA targets, currently 110 in total, are defined primarily in terms of outcomes rather than the inputs or processes, to allow departments the flexibility to find the most effective route to delivering the expected results. Examples include targets to reduce mortality rates from cancer for under 75s by 20 percent by 2010 and to halve the number of children in relative poverty by 2010, on the way to eradication by 2020.

Source: http://www.hm-treasury.gov.uk/spending_review/spend_sr04/psa/spend_sr04_psaindex.cfm

International experience indicates that targets need to be set carefully, in order to minimize perverse effects and to avoid damaging rather than enhancing performance. Arbitrary and inappropriate targets with no relation to the level of resources must be avoided. The implementation of a targeting regime presupposes the existence of well-developed performance measurement and costing. Tool 4: Input Flexibility Many countries have given ministries and managers greatly increased discretion to choose the mix of inputs that will deliver services most efficiently, within the context of a move to program-based budgeting and management. This involves the removal of a large part of the detailed control of budgets by economic classification, internal organizational unit, “chapters” and similar, which characterize traditional budgeting systems. Thus, in the United Kingdom, many ministries are free to use the funding provided for each program in any way they wish, subject to only two minimum restrictions: firstly, that the amount of money provided for employing staff cannot be increased and, secondly, that money cannot be shifted away from capital to current expenditure. In France, only the first of these restrictions applies. More generally, greater freedom to let the managers manage has normally been accompanied by tighter requirements to manage within their budgets. Tool 5: Funding based directly on results Many countries have had considerable success in improving the efficiency of service delivery in sectors such as hospitals and universities, without loss of quality, through the adoption of systems in which funding is based on the services delivered to the community. The effectiveness of the output-based “diagnostic related group” funding

30

system for public hospitals has been particularly clearly demonstrated, and this has led to the adoption of this system by a number of countries, including Portugal (1990), Australia (from 1993), Norway (1997), Singapore (1997), the United Kingdom (2004) and Germany (2006).14

C. Enhancing Accountability for Performance

rol t, and a culture of integrity in the civil service, so as to safeguard against

ossible abuses.

ool 1: Information to Parliament

hes

es

f pending ministers and other enquiries frequently inform future policy developments.

iate

Input flexibility needs to be accompanied by a strong managerial accountability for results—that is, the results (outcomes and outputs) delivered by ministries—and staff withinministries—are scrutinized and those concerned are held accountable for their performance. This needs to be accompanied with a change in civil service remuneration arrangements and other relevant employment conditions to create better incentives for performance. Increasing managerial freedom over the choice of inputs also requires a robust regime of internal contand external audip T The provision of performance information on a program basis allows Parliament to play a significant role in holding the government to account for the results achieved by its policies. The focus on programs and the provision of information that readily establisthe cost of those programs and the results achieved enable parliament to assess the cost effectiveness of each program, and thus to hold the government to account, as well as to reflect such information in budgetary decisions. Ministries or associated groups of ministriare typically oversighted by specific parliamentary committees that are able to enquire in depth into their performance. Over time the findings from parliament’s interrogations os Parliament retains its role to approve the government’s budget proposals, but it also has a major role in holding the government to account for the results achieved by thespending proposals. In order to hold the government fully accountable for its budgetary strategy, in a number of countries, either by convention and/or by law, there is an expectationthat the budget will emerge from parliament intact. The alternative is that the government is defeated by a confidence vote. This requirement means that parliament, as in France, is frequently not able to alter the total of spending from that proposed by the government, nor its broad allocation among functions. In some other countries the budget bills that appropr

14 See Chapter IV of Marc Robinson and Jim Brumby, Does Performance Budgeting Work? An Analytical Review of the Empirical Literature, IMF Working Paper WP/05/210 (2005), available at www.imf.org/external/pubs/ft/wp/2005/wp05210.pdf

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funds for the normal functioning of the state cannot be amended. In any event, numerous detailed amendments are normally prevented. However, in most countries all proposals that require changes in legislation have to be agreed by parliament voting. There is normally also time limit imposed for parliament’s consideration of the budget

ool 2: Performance Auditing

e taken

ntability to

dit tors in

to

as

y include assessments of the performance management systems of the agencies under review.

a T One important element in the results-oriented public management reforms which havplace around the world has been the enhancement of the mandates of supreme audit institutions (SAIs). This has seen them transformed from bodies concerned only with financial accountability into bodies with a crucial role to play in respect of accouthe parliament and the public for performance. There are two different types of “performance auditing” that have emerged and that should be carefully distinguished. The first is the auditing of performance indicators—the approach taken by the UK National AuOffice, which reviews the adequacy of the systems generating performance indicaministries, has particular advantages. The second is what is known as “systemic” performance auditing—that is, reviews of the adequacy of management systems—staffing, organizational structures, information systems and other components of internal control, enable the organization to operate effectively and efficiently, rather than on substantive performance measurement. Australia is a country where systemic performance auditing hbeen developed; performance audits carried out by the Australian National Audit Office routinel

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IV. A SHORT-TO-MEDIUM TERM BUDGET REFORM STRATEGY FOR ITALY

A. Current Reform Plans and Steps to Date

Recognizing the weaknesses in the existing budget system, the Italian authorities have initiated a number of reforms. These include the introduction of a program-based budget classification; support to parliament in its efforts to reform the budget approval procedures; and an assessment of public spending in selected ministries through spending reviews. Increasing the transparency of the budget: a new program classification A new program budget classification is under preparation to improve transparency. This effort, led by RGS in close coordination with spending ministries and the Department for the Government Program, will facilitate a more transparent presentation of the budget. The revised structure to be submitted to parliament (bilancio decisionale) will significantly reduce the number of UPBs from the current some 1,500 (see Section II), to about 200, each representing a specific program. In a model based on the French reforms, the intention is to identify a number of broad missions aligned with the government’s strategic objectives, and define a number of programs within each of these missions. Programs will be used as the unit of budget appropriation. As a result, Parliament will be in a better position to focus on strategic priorities and decide resource allocation accordingly.15 The challenge will be, however, to ensure that improved transparency is accompanied by greater operational flexibility for managers to deliver results (bilancio gestionale). A number of crucial issues remained unresolved at the time of the mission: • Structure of programs: how these programs will be concretely defined so as to make

them as relevant as possible for government decisions about strategic expenditure priorities, and more generally to ensure that the program budgeting system will work well.

• Structure of chapters: whether and how the current budget structure by chapters (underlying the newly defined UPBs/programs) will be modified.

• Flexibility within programs: whether the underlying structure by chapters will translate into greater flexibility in the use of resources within the same program—as

15 The existing functional-based classification by missioni istituzionali is used solely for ex-post reporting purposes (to allow international comparisons). It is based on some imputed “ratios” to map out the COFOG, but with apparently little scrutiny or use, as it is not effectively integrated into the budget process.

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about 90 percent of spending by chapters is currently considered mandatory (spesa obbligatoria, as shown in Table 1). In other words, the newly redefined (and significantly fewer) UPBs will aggregate more chapters than the older ones; this in principle should increase the amount that can be reallocated within a specific program. However, the fact that many chapters are encumbered by legislative prescriptions may imply that, in practice, a significantly more flexible use of resources within a program may not be feasible under current legislation.

• Joint responsibility for programs: how programs spanning across different administrative units and ministries will be defined and managed.

• Cost accounting: whether the accounting system will be appropriately adapted to capture the costs of running programs—this will be essential if programs are to be used as the basis for budget appropriations, as currently proposed.

Similarly, auditing by the Audit Court will, at least for the moment, remain based on the “old” classification. Opening dialogue with Parliament on reform of budget approval process The parliamentary budget commissions are working on a proposal to improve the budget approval process. The main purpose of this reform is to allow a more focused parliamentary discussion of the budget, by better defining the content of the DPEF to include broad indications about possible provvedimenti collegati to identify strategic priorities; limiting the content of the finanziaria to make it more homogenous and discernible; and regulating the amendments that can be presented (for example, by requiring that amendments proposed by the executive be subject to the approval of the council of ministers), so as to contain their unruly proliferation. These proposals will require changes to the parliamentary regulations, to be approved by the majority of parliament. It is therefore imperative that these efforts be seen as serving the interest of the whole parliament—and not the government coalition of the day—so as to make its decision-making process more effective and better aligned with the policy priorities. Reviewing and prioritizing central government expenditures

Within the tight margins of discretionary spending, the 2007 Finanziaria aimed to challenge ministries to prioritize spending. Clause 507 effected proportional cuts (by 12 percent) in discretionary spending in identified chapters (accontonamenti lineari);16 it then 16 These cuts amount to some €4.5 billion for 2007 (equivalent to 0.3 percent of GDP).

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allowed these cuts to be redistributed across the affected chapters, by presenting proposals to the RGS by end-March. The spirit of the exercise was to induce ministries to prioritize across activities and choose strategically which ones should be “rewarded” by higher allocations, at the expense of lower-priority ones for which the cuts would be deeper than originally envisaged by the finanziaria. It was also meant to be an innovation from across-the-board cuts seen in previous years. In meetings with the mission, representatives of selected spending ministries noted that:

• The March deadline for submissions was too tight, as a ministry may face “tough” choices later in the year and may not be yet in a position to prioritize early on.

• “Reallocating after cutting” was seen as a “zero-sum game”, where overall cuts would eventually remain unchanged. This reduced incentives to find genuine savings.

• At the same time, it seemed that the cuts were not seen as binding, as ministries could still access special funds to counteract them—thereby negating the sense of prioritization that clause 507 aimed to instill.17

• There was also a feeling that it may be politically easier, within each ministry, to leave the cuts as originally formulated (and seen as being imposed) by the RGS. Shifting their incidence around different responsibility centers (departments/offices) may imply choices that are difficult to implement.

Therefore, this initial “seed” of spending review may not be as successful as it was intended to be, especially in those ministries that are not yet well equipped to assess trade-offs and strategic priorities. The government also initiated pilot spending reviews in five ministries, which should yield more lasting results. Clause 480 of 2007 Finanziaria called for a new program to analyze and review government spending in order to improve its efficiency and effectiveness. The pilot ministries, identified on the basis of their preparedness and/or strategic importance, are: Education, Interior, Justice, Infrastructure, and Transport. Their portfolio represents less than 20 percent of total central government spending (Table 4). The review has two principal components: • Review programs and classify them according to: (i) programs to be discontinued;

(ii) programs where efficiency gains may be possible; (iii) programs for which greater

17 For example, the Ministry of Justice indicated that about €200 million cuts effected by clause 507 would be “financed” by making recourse to a reserve fund, assigned to the Justice ministry by clause 1304 of the 2007 finanziaria (€200 million for each year during 2007-09), to finance purchases of goods and services.

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resources would be necessary; and (iv) programs for which cooperation across various spending centers would be desirable.

• Establish a specific set of performance indicators (by September 30, 2007). These indicators should be measurable and verifiable ex post (in terms of public service delivery) and include a timeline. They would serve as benchmarks for subsequent analysis and assessment. This process is to be linked to the work on identifying missions, programs, and objectives for each ministry.18

Table 4. Spending by Ministries Selected for the Spending Review 1/

Spending 2/In euro billions In percent of total

spending

"Spending Review" ministries: 82.7 18.2Ministry of Education 42.2 9.3Ministry of the Interior 24.7 5.4Ministry of Justice 7.8 1.7Ministry of Infrastructure 4.1 0.9Ministry of Transport 3.9 0.9

Memorandum itemsMinistry of Economy and Finance 2/ 252.9 55.5Ministry of Labor and Social Sec. 56 12.3Total state spending 2/ 455.3 100.0

Source: 2007 Budget Law (published on Official Gazette 28-12-2006 (Suppl. Ordinario N1/ This represents only state spending, including transfers to local governments.2/ Excludes Euro 189 billion for amortization, which is allocated to MEF; it assumed that all "regolazioni debitorie" are done at the Ministry of Economy level.

As this is a new initiative, attempting to achieve tangible results in all five ministries in the next few months may prove too ambitious. The Ministries of Education and Transport seem more advanced in their preparation, and should be in a position to report on their analysis by mid-year, in time for findings and recommendations to be reflected in the preparation of the DPEF, or for the budget cycle starting in September (Box 10).

18 The Treasury Department of the MEF is also working on a set of performance indicators related to the implementation of the Lisbon agenda, which are being coordinated with other EU member countries.

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Box 10. Initial Steps with Spending Review in Italy

Five ministries were selected to participate in the initial round of spending reviews: Education, Interior, Justice, Infrastructure, and Transport—which represent core state functions. In their meetings with the mission, it became evident that all these ministries have:

• proposed a structure of missions and programs, in cooperation with RGS, for the new budget classification;

• prepared a proposal for an administrative reorganization that would better align their functions with the budget programs being identified; and

• started work on identifying performance indicators.

The Ministry of Education has set up a working group that provides a good example of a spending review process. The group was actually created before the spending review reforms were initiated; it includes staff from the ministries of Economy, Education, and Economic Development, and the Bank of Italy. Its objective was twofold: (i) explore ways to use education as a lever to boost productivity, and (ii) identify why, despite spending ratios comparable to other OECD countries, educational attainment has fared poorly in the context of international surveys. In line with best practice, the exercise attempts to trace links between inputs and outcomes. The main input from the Ministry of Education budget is teachers’ salaries (accounting for some €38 billion out of a total of some €40 billion). However, although Italy’s teacher/student ratio is higher than in many countries, teachers’ salaries are lower. The information base for this exercise is largely available, both nationally and internationally, and is being further refined. The aim is to issue a white paper in early June outlining possible scenarios and policy options (for example, projecting the number of teachers depending on varying policy parameters such as class size, the number of taught subjects, and the like). This paper will inform the DPEF strategy on education. The Transport ministry is quite advanced in its restructuring plans. It had already prepared a proposal for the 2007 budget along functional lines, which allowed the number of UPBs to be reduced (this was done in conjunction with its separation from the ministry of infrastructure). The ministry is collecting a number of performance indicators linked to its objectives; and has appointed an eminent transport expert as an adviser to provide support to its internal control unit. The other selected ministries—Justice, Interior, and Infrastructure—are at different stages in the spending review process. They all have some performance information available that will provide a good basis to build upon; and the preparation of the new program classification is forcing a rethinking of their overall objectives and how to achieve them. As to the scope of the spending review, the Ministry of Interior noted that more than half of its budget (equal to some €14 billion in 2007) represents transfers to local governments as specified by law—these transfers are therefore viewed as not suitable to a spending review unless the law that regulates them can be modified. Overall, these ministries displayed a clear willingness to gear up to participate in the spending review exercise, for which they will be mainly responsible and which is seen as an opportunity to gain more managerial flexibility, currently reported as lacking.

Source: Based on the mission’s meetings with these ministries.

The 2007 Finanziaria also foresees important, although initial, steps to strengthen the institutional capacity to analyze and evaluate spending. More specifically:

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• A new public finance commission (Commissione Tecnica per la Finanza Pubblica, CTFP), mainly comprising technical experts, was recently appointed. Its main tasks include assessing issues related to, and preparing proposals on: implementation of fiscal federalism reforms; coordination of budgetary reforms; providing support for the spending reviews described above; and advising on the transparency and reliability of fiscal accounts. While this broad mandate appears daunting for a 10-member commission, many of its members have previously served on similar commissions and can therefore draw upon a significant body of earlier studies and proposals. It was also noted that, differently from previous commissions, the CTFP will have specific operational responsibilities.

• A research unit (Servizio Studi) at the RGS will provide operational support to the CTFP (clause 476); and a council of five experts (comitato di consulenza) will be established to provide strategic guidance and analytical support to the RGS.

• Discussions are underway for the creation of a bicameral budget service for Parliament, to better monitor public spending—an area where Parliament feels it has not succeeded in exercising adequate scrutiny.

Aligning staff resources to strategic objectives Ministries and central agencies are also preparing reorganization plans that would better align their staffing structure to their respective strategic mission. These efforts reflect provisions in the 2007 Finanziaria, which require: (i) rationalization and streamlining of support and administrative services, so as to avoid duplication of tasks within services (clause 404 and following); (ii) geographical reorganization (through the elimination of provincial offices, where applicable, and their consolidation into regional-level offices). For example, the MEF is planning to concentrate all its support services into the Department of General Administration (DAG), which will significantly reduce support staff in the other three departments (Treasury, RGS, and Taxes) and allow them to focus on their core functions; and it will close 40 provincial offices, in a way that would not undermine services provided by these offices and with careful consideration for negative implications for existing staff. Similar plans are being developed in other ministries.19 These efforts are part of a broader and deeper civil service reform at the central level. A memorandum of understanding (signed on January 18, 2007 with the main union representatives) acknowledges that there is a need to increase the quality of public services,

19 For example, the Ministry of Transport has well advanced restructuring plans, as noted above.

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and necessary resources will come also from elimination of inefficiencies. There is also an explicit recognition that the availability of performance indicators, as indicated above, will allow increased accountability vis-à-vis users and promote transparency. Improving the information base Significant efforts in recent years to implement a computerized system for cash transactions (SIOPE) are starting to bear fruit.20 This system, which is based on a standardized codification of all cash operations across government levels and agencies, will allow real-time monitoring of cashflows—this is particularly relevant for capturing the sizeable local governments’ spending activities—an area that has remained rather impenetrable to date on a timely basis. Sustained progress on this project will require continued cooperation across the parties involved; progressive extension to include all cash operations (currently, central government revenue are not covered); and its access, in a suitable format that does not undermine confidentiality, by outside agencies. The government believes that SIOPE will represent a powerful monitoring tool for tracking spending. While a significant step in the right direction, SIOPE will need to be complemented by additional information bases, also covering all the prior steps of the spending process (commitments and verifications) as outlined below.

B. Main Components of a Further Reform Strategy

The mission considers that a sustained budget reform effort over the medium term in Italy should focus on improving budgetary resource allocation and the quality of public services by: • strengthening the strategic decision content and role of the budget;

• increasing transparency of both the policy priorities in budgetary resource allocation, and the performance of spending programs;

• strengthening the medium-term focus in the budget;

• improving the system of controls, to focus on spending aggregates consistent with macroeconomic objectives and fiscal sustainability, and with sectoral policy priorities, rather than on inputs; and

20 The database is owned by RGS and managed by the Bank of Italy.

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• promoting, for spending managers, a culture of accountability for results, rather than solely or primarily for legal compliance.

The reforms announced by the government are an important step towards a budgeting system focused on the delivery of efficient and effective services to the Italian people. To be successful, these measures will need to be implemented fully, which will require the cooperation of the parliament and key elements of the civil service. They will also require a series of complementary and supporting measures.

In the view of the mission a successful budget reform strategy in Italy would need to:

• promote effective, sustained progress towards the medium-term objectives outlined above;

• include tangible gains for the main stake-holders:

the government, in terms of strengthened fiscal discipline and credibility, and simultaneously increased scope to fund new spending priorities;

the Parliament, in terms of improved transparency of the budget, and scrutiny over strategic policy choices;

the Ministry of Finance (and RGS in particular), in terms of a more effective and modern role in program formulation and management;

the Audit Court (Corte dei Conti) in terms of more substantive and outcome-focused control over budget outturns;

managers of spending programs in ministries, in terms of greater freedom in optimizing the input mix, to deliver results; and

society at large, in terms of increased budget transparency and improved quality and timeliness of public services;

• be implemented at a pace that is sufficiently ambitious to deliver visible results in the relatively near term, but not unrealistic so as to make them unachievable and breed political opposition, with clearly specified and monitorable milestones; and

• identify main foreseeable legal, institutional, cultural, and human resource obstacles to progress, and devise practical strategies to address them as effectively as possible.

What follows outlines the main elements of a reform package that could begin to address these challenging desiderata.

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Reforms of the Budget Structure

Rapid, but realistic, progress in the development of a sound program-based budget classification should be a high priority, as this is a key vehicle for the articulation of policy priorities, and their reflection in the allocation of budgetary resources.

Full involvement of spending ministries, as well as the MEF, in the definition of programs (and sub-programs/activities) is crucial, since the line ministries are ultimately responsible for the implementation of the relevant sectoral policies.

The authorities should ensure that accounting systems measure program costs with an acceptable degree of accuracy. Since programs are to be the basis for budgeting and management—rather than simply a mechanism for ex-post reporting—it is essential that program costs are captured on a continuous basis. End-of-the-year estimates (the method used for the present missioni istituzionali) will not suffice. It is not clear that management accounting is currently in an advanced state of development across the central government, so this may be a substantial task. It will be necessary:

• firstly to implement any necessary enhancements of the functionality of the accounting systems; and then

• following the determination of the program structure, to map cost objects to the new program structure.

The completion of the task of defining programs does not need to wait until the capacity of the accounting system to handle programs is assured. However, budget appropriation by parliament based on programs should await appropriate retooling of the accounting system, for this reform to lead to meaningful results.

To make the implementation task more manageable in the short run, administration programs should be designated in each ministry to cover overhead and other indirect costs which are difficult to allocate to outcome-based programs. Over time, with the development of improvement management accounting, these programs should be phased out.

The breadth of these implementation tasks should not be underestimated. Even if the accounting system is technically fully capable of recording program costs on a continuous basis, the task of mapping cost objects to programs is a substantial one, and should in any event only be carried out once there is confidence that the program classification which has been developed is reasonably satisfactory. Regarding the development of the program classification, it is the mission’s impression, based on its brief contacts with selected

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spending ministries, that some are more advanced than others in the identification of meaningful spending programs.

All these are indications for proceeding with caution with full-fledged implementation of the budget classification reform, as steaming ahead without the necessary preparations may be riskier than proceeding at a slower (but safer) pace.

Spending Reviews A systematic process of periodic spending reviews should become an integral part of the budget system in Italy. The primary purpose of such reviews would be to identify programs to be redesigned to achieve savings, or eliminated; and programs to be expanded or initiated. Spending reviews should cover all expenditure, including spese obbligatorie, as well as tax expenditure. Spese obbligatorie should not be considered as untouchable—it is the purpose of meaningful spending reviews to point to any needed revision of the legislation underlying such spending programs, which is required if the programs concerned are ineffective or of low priority. Table 5 includes a summary outline of a potential spending review process.

The information generated by the spending reviews should feed into the budget preparation process, including at the ministerial level, leading to decisions to change existing expenditure policies and, consequently, to revisions of baseline budget estimates (see below), and into the preparation of the legge finanziaria, as appropriate.

The active engagement of the relevant ministries is key to the effectiveness of spending reviews. One important way of doing this is to give ministries an incentive to identify options for savings by permitting them to retain, and reapply for higher-priority purpose, a portion of any savings which they themselves identify from the elimination or cut back of programs, or productivity-enhancing steps. Appropriate criteria governing such retention should be defined in advance.

Spending reviews should also make a contribution to the task of identifying efficiency gains. However, it should be recognized that it is in general more difficult for reviewers from outside any given ministry to identify potential productivity-improving measures than it is for those “at the coal face” within the ministry. For this reason, spending reviews are usually better at identifying ineffective and low priority programs than they are at identifying efficiency gains. This does not mean that spending reviews cannot play a useful role with respect to efficiency. It does, however, make it essential that other pressures and incentives are created for ministries and other government agencies to identify and act on opportunities to redesign their business processes to improve productivity. One such incentive is the savings retention mechanism referred to in the previous paragraph.

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Table 5. Possible Outline of a Spending Review Process in Italy

Process Comments

Council of Ministers, Tesoro

Council of Ministers, Line MinistriesMEF Process

underway

Program 1 Program 2 Program 3 .... New Program Council of Ministers, Line MinistriesMEF

Policy tools Policy tools

Law 1 Cost

Law 2 Cost

Law 3 Cost SR processFocus SR

etc. Cost on robustbilancio est.

Total prog cost conducted byragioneria w/ Strategic documentline ministries; presented to Parliamentchecked by to explain overall aimcommittees in of budget lawsParliament (Bilancio + Finanziaria)

What type of legislation? Are estimates robust?Still relevant for program? Necessary for objective?Consolidation possible? Savings identified by ministry? CostIs it better suited to annual If so, ministry can retain for estimate forappropriation in finanziaria? new spending programs new programs

Finanziaria

Setting overall fiscal objectives (DPEF)

Setting out government strategy and overall program

Legislative and Budgetary Agenda for Finanziaria

Estimate for Bilancio

Review laws Review costs

Spending reviews should include both reviews of individual ministries and “cross-cutting” reviews focused on expenditure in an important area of services spanning a number of ministries, or on generic management (including productivity-related) issues. Examples of areas which have been the subject of such cross-cutting reviews in other countries have included family assistance measures and aged-person related expenditure.

Given the time involved in carrying out effectively such reviews, and the current state of preparation of the selected ministries, the mission would recommend to aim to conclude initial reviews for at least two ministries (Education and Transport) in time for the 2008 budget; and for at least three other ministries (Interior, Justice and Infrastructure), and possibly others, including the MEF, in time for the 2009 budget. Consideration should also be given to undertaking in the course of 2008 one cross-cutting review, for example a review of main types of tax expenditures.

Reforms of the Budget Preparation Process

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Consideration should be given to whether processes for reviewing and agreeing on expenditure priorities in the Council of Ministers might be further enhanced. The SR process will result in more options for expenditure reallocations being presented to the Government’s political leadership, and it is likely that the Council of Ministers will need to devote time and energy to considering these options. It may then be useful to consider the establishment of a small “priorities” or “expenditure review” committee of cabinet (or to expand the role of a current committee, such as CIPE) to give such options detailed consideration, and advise the Council of Ministers as a whole.

The mission would favor a strengthened role of the Documento di Programmazione Economica e Finanziaria (DPEF) in setting the framework for budget discussions in the Council of Ministers, and subsequently in Parliament. This could be achieved by including in the DPEF both an aggregate spending ceiling, and quantified targets for major areas of spending of the central government. This could promote better budget discipline, and would likely facilitate an increased focus of policy makers on key budget priorities and trade-offs. Once the fiscal federalism reform is completed, ceilings for broader spending aggregates of the general government could be considered.

The Relazione Previsionale e Programmatica (RPP) would subsequently summarize the results of the spending review and outline how the broad sectoral priorities are articulated into budgetary allocations to individual spending programs. Issuing the two sections of the RPP together would also contribute to enhanced transparency.

In the view of the mission, the three-year budget estimates (bilancio pluriennale a legislazione vigente) should be substantially recast, to provide transparent, reliable, and regularly updates estimates of the cost of delivering the policy objectives embedded in existing legislation. An improved forward estimates system would project the costs of maintaining existing spending programs using clearly specified and objectively determined cost drivers (e.g. forecast price movements and projected changes in the program target population). This would replace the current expenditure projection methodology, which is too subjective, negotiable and which fails to fully distinguish policy changes (e.g., in respect of staffing levels) from the costs of running programs on the basis of current policy. Such a system would enable budget preparation to focus primarily on policy changes, including spending priorities, rather than on haggling about the costs of delivering current policy. This would then facilitate the identification of the legislative changes (to be included in the legge finanziaria or the related legislation, provvedimenti collegati) needed to shift budgetary resources from lower priority programs to higher priority or new ones.

To promote transparency with respect to the proposed allocation of resources between competing objectives, within the context of legal system which requires that budget measures be split between the baseline budget and the proposed legge finanziaria, it would be desirable

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to include in the budget documentation provided to Parliament a consolidated picture of the program allocation of expenditure, detailing how the baseline budget and the proposed legge finanziaria map into the final budget estimates by program.

Reforms of the Budget Approval Process An important element of the reform package would be to use the program classification as basis for budget authorization by Parliament. The government’s plan to redefine UPBs as programs is aimed to achieve this without requiring changes to the existing accounting law (law 468/1978). Consideration by Parliament of a much reduced number of spending programs (compared to the 1,500 or so UPBs currently included in the budget) would allow the legislative to focus and deepen its discussion of the strategic policy priorities and trade-offs, and of the adequacy of budget appropriations to meet such priorities.

It is, however, important that accounting system enhancements to handle program budgeting (see below) take place prior to the appropriations being placed on a program basis. This is because moving to appropriations by programs means that the budget has to be executed on a program basis, and it will therefore necessary for both ministries and Ragioneria to be able to monitor program costs on a continuous basis with a reasonable degree of accuracy.

It may not be possible to do this in time for the 2008 budget. If this is the case, an option would be to present to the parliament an illustrative program budget showing, with as much accuracy as possible, what the budget submitted to them would look if it had been presented in program terms.

It appears desirable to strengthen the role of the parliamentary Budget Committees in the consideration of the budget, and in weeding out amendments catering to narrow interests, as mandated by Article 11 of the accounting law. To facilitate careful design and debate of the substantive legislation underpinning spending measures authorized by the legge finanziaria (the so-called provvedimenti collegati), it would also seem appropriate to allow a time-bound “window of opportunity” (say, three months after the budget approval) for fast-track approval of such legislation, within the amounts established in the legge finanziaria for the corresponding programs. Reforms of budget execution, monitoring and control, and reporting

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To promote needed flexibility in the management of budgetary resources, while at the same time ensuring strengthened accountability of spending managers, a set of interrelated reforms appears highly desirable. To encourage productivity gains and realize the full benefits of a program-based budgeting system, there should be over time a substantial reduction of ex-ante controls during budget execution. This would involve both a review of the plethora of budget chapters, to consolidate them as much as possible within the constraints of existing legislation, and leaving to the responsibility of the program managers the allocation of funds within each chapter (subject of course to strengthened ex-post accountability for legal compliance, financial propriety and performance in term of results). Over time, the results of spending reviews should be also reflected in the consolidation and simplification of the legislative basis of spending programs.

The ultimate objective should be to provide a large degree of flexibility to program managers in the use of the budgetary resources appropriated for each program, enabling program managers to shift funds among the input line items included under the program (for example, by trading the filling of a staff vacancy for contractual professional services or the purchases of office equipment). In this respect, the approach taken in France and the U.K. should serve as a model.

In line with international experience, it may be desirable to allow limited virements across programs with approval of the Minister of Economy and Finance. Allowing small reallocations between programs—say of up to 5 percent, as in France—is a means of providing some flexibility to meet unexpected challenges during the financial year without going back to parliament. At the same time, because only small reallocations would be permitted, the essential right of parliament to determine spending priorities would be preserved. Such a provision would also help keep required contingency reserves low. Such virement provisions would not apply to entitlement programs (such as social security benefits). This may require a change in the accounting law 468 of 1978.

Considerable effort should be directed towards the progressive development of output and outcome indicators for spending programs. The choice of such indicators would benefit from the inputs of spending ministries, the MEF, outside experts, and international experiences. The indicators would utilize existing statistical information, as well as, in some instance, new one (e.g., derived from users’ surveys). It would be preferable to focus initially on a few indicators for selected programs, and to expand gradually their scope, as well as revise the initial ones, as experience is gained with them.

The development of performance indicators should be monitored, and periodically published, and an annual report on their evolution should become part of the annual budget

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documentation. While international experience does not support mechanical linkages of budget allocations to developments in such indicators, the latter should be taken into account in budget decision-making.

The use of performance targets as a means of placing pressure on ministries—along the lines of the UK Public Service Agreements system—is a desirable objective towards which Italy should move. However, a prerequisite for such a reform is a somewhat more developed system of performance measurement than Italy appears to have at the present time. In addition to good indicators, target-setting requires considerable understanding of the relationship between resources and results. Such understanding can often only come from the conduct of a spending review of the program concerned. In the absence of such an understanding, target-setting will inevitably be arbitrary, and it is worse to set arbitrary targets than to set no targets at all. For these reasons, Italy should not rush to establish a PSA-style performance targets regime.

Other elements of an improved monitoring and reporting system which would strengthen performance accountability in Italy are:

• The further development of SIOPE: The system should be extended to cover revenues of the state budget, and to include the program classification, once it is introduced in the budget. The information generated by the system should be reflected in periodic summary reports to Parliament (e.g., in the quarterly Relazioni di cassa). It should also complement (and at cruising speed it may replace) information generated by other current systems (covering all stages of the expenditure process—commitments and verifications—prior to payments), to allow a more timely and accurate monitoring of the execution of spending programs by the spending ministries and the RGS;

• The development of the Audit Court’s role beyond financial compliance into the field of “performance auditing”, both in respect of the auditing of performance indicators and so-called “systemic” performance auditing (see Section III). This type of performance auditing represents a very large change of role for a national audit body. It is, nevertheless, a change which has taken place in many countries around the world.

The reforms outlined above are predicated on the existing legislative framework—the working assumption of the Italian authorities in carrying out current plans. However, were the legislative framework to prove a stumbling block in the implementation of the needed reforms, it would be eventually necessary to seek its modification, to align it with the requirements of a modern budget process.

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Finally, these reforms would have substantial human resource implications. In particular, they would require: increased geographic and functional mobility of civil servants; investment in retraining personnel to facilitate such mobility; and a range of actions to strengthen the preparedness and capacity of line ministries to effectively manage spending programs. At the same time, it would require investment into strengthening the capacity of MEF (and in particular the RGS) to monitor and evaluate the performance of spending programs, and to reflect this information in subsequent budget decisions. These are obviously complex issues, which are beyond the mission’s remit and expertise. The mission is encouraged by the fact that significant reflection on these and dialogue with relevant stake-holders have already been initiated by the Italian authorities.

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ANNEX I. Program Costing In a program budgeting system, ministries and managers within ministries are expected to manage budgets in program terms. Parliament usually also approves budgets for ministries expressed in programmatic terms. This means that, in order to comply with its legal budget authorization, each ministry is required to control budget execution on a program basis. In order to manage its budget on a program basis, the ministry must have ongoing information on program expenditure, and this program cost information must have an acceptable degree of accuracy. More precisely, managers must receive information on program expenditure with at least the same frequency (whether that be weekly, daily or real time) that, prior to the introduction of program budgeting, they used to receive information on expenditure by input, organizational unit, and other costs objects. To have information on program costing available on a continuing basis, it is necessary that program costing be built into the accounting system employed by ministries. The requirements for program costing are fundamentally different from those involved when the sole purpose is statistical or financial reporting, where the relevant data might only need to be produced annually and it is therefore feasible to use a process of manual adjustment of accounting data. In order to build robust costing and cost control systems based upon the programs—that is, upon the intended outcomes of expenditure—the accounting system must be modified and extended to make it capable of allocating expenditure on input or other cost objects to programs.21 One aspect of the challenge of program costing concerns direct costs. In the context of program costing, a direct cost is the cost of an input or other cost object which is wholly devoted to the delivery of a particular program. For example, if the environment ministry has a pollution control program and a nature conservation program, the costs of employment of staff who inspect factories for compliance with pollution regulations is a direct cost which is wholly attributable to the former program, while the costs of rangers whose job is to prevent the hunting and poaching of protected species is a direct cost wholly attributable to the latter program. Similarly, if a car is used exclusively by the factory inspectors, it is a direct cost (whereas if it is shared between rangers and factory inspectors it is not). In order to deal with direct costs, it is necessary that such costs are identified in the accounting system with the program they serve. There is nothing technically complicated about this task of direct cost attribution. However, the task of matching such direct costs to the relevant programs can

21 The question of accrual versus cash accounting is not considered here, and the term “expenditure” is therefore used in a general sense, without any implication that the budgeting system is necessarily on a cash basis (although this is usually the case).

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involve considerable effort and can be expected to take some time. This is particularly true to the extent that it is not possible to simply map the cost categories of the pre-existing accounting system (i.e. by economic classification, organizational unit) to programs. To take the environment ministry example, suppose the ministry has small regional offices which (because they are small) are multi-functional and have within them some factory pollution inspectors and some park rangers. The accounting system would no doubt record the staff costs of each regional office, but to determine program costings it would be necessary to code the salary costs of the different types of staff within the regional office to their respective programs. More technically difficult is the allocation of indirect costs. In the context of costing programs, indirect costs refer to the costs of inputs or activities which contribute to more than one program. The rent of an office building which is shared between two programs is an obvious example of an indirect cost. To handle indirect costs, more is required than simply identifying the expenditure of the input or other cost object within a program. It is also necessary to allocate the expenditure on particular inputs or activities between two or more programs. Thus, in the case of the office building, it is necessary to determine and record in the accounting system the respective portions of the building’s rental costs which are attributable to each of the programs concerned. As stressed in the main report, in a well-designed and mature program budgeting system, programs should be—in all but a handful of exceptional cases—defined in terms of outcomes and outputs. That is, they should be defined as groups of services to the public (or other clients external to the ministry) which are united by the fact that they aim to achieve a common impact on society. The application of this principle has significant implications for the magnitude of the indirect cost allocation task: it makes all “overhead” costs of the ministry indirect costs which must be allocated between programs by the accounting system. Overhead costs are the costs of ministry-wide support services and infrastructure (such as human resources management, internal financial management, and the IT network) together with other items such as the salaries of the chief executive and other top ministry-wide managers. Such overhead costs contribute to all of the outcomes which the ministry aims to achieve, and cannot be uniquely attributed to any particular outcome. If all programs are to be outcome-based, it is therefore necessary to allocate overhead costs between programs. If, for example, the environment ministry comprises the two programs identified above, it would be necessary to determine what portion of the costs of the ministry human resources unit, IT services etc was attributable respectively to the anti-pollution effort, and what portion to the nature conservation effort. Accountants use the term “allocation basis” to refer to the formula or principle used to allocate a specific indirect cost between two or more programs. The allocation basis used for each indirect cost should reflect that indirect cost’s contribution to each program, which

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will often require the collection of relevant data (e.g. on the usage made of human resources services—in respect of recruitment etc—made by different program areas). To allocate indirect costs, the accounting system needs to be supplemented with a management accounting module which pools together relevant indirect costs and then allocates them to programs using an appropriate allocation basis. Relevant data to provide a proper allocation basis also need to be routinely collected and used by this management accounting system. It follows that the enhancements of the accounting system necessary to handle indirect costs can be particularly demanding and time consuming. Moreover, the more sophisticated and accurate the methodology used for costs allocation, the greater the costs and human capital requirements of the management costing system.22 It is therefore not difficult to understand why the allocation of indirect costs is often done rather poorly after the introduction of a program budgeting system, with indirect costs being allocated between programs on a more or less arbitrary basis. The problem is that measures of program costs derived from such arbitrary cost allocations are worse than useless—they are positively misleading and will lead to worse, rather than better, decision-making. For these reasons, many countries chose to make use of “administrative cost” or “corporate services” programs grouping together ministry overhead costs, when they first introduced program budgeting. Such a pragmatic approach makes it possible to move to program budgeting without having immediately the capacity to allocate indirect costs. Even when this approach is adopted, however, the task of adapting accounting systems to handle the task of accurately allocating direct costs will remain something which will take serious efforts and adequate time to achieve. The use of administrative programs is legitimate—even desirable-- in the early stages of program budgeting. However, this should be regarded only as a temporary solution. The expressed intention should be to move over time to eliminating these programs and absorbing overhead costs into outcomes-based programs. The appropriate timetable for this will depend on a country’s financial and human resources; in the case of an OECD country such as Italy, this task should be relatively rapid (less than, say, five years). It is also important that administrative programs be only used for overhead costs, and do not end up as a “recepient” for direct costs which have not been allocated to appropriate programs. Experience indicates that there is a considerable danger that administrative programs will be used for “placing on hold” costs so as to artificially reduce the apparent cost of some outcome-based programs which might otherwise appear unduly high. 22 This is particularly relevant for governments considering the use of Activity-Based Costing (ABC), which aims to develop a particularly accurate two-stage costing process. ABC is expensive and demanding of skilled human resources—which helps to explain why, even in the richest countries, ABC tends to be used selectively rather than across-the-board.

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ANNEX II. Australia: Reconciliation of Expense Estimates

2005-06 2006-07 2007-08 2008-09$m $m $m $m

2005-06 Budget fiscal balance 206,081 214,806 225,400 236,568

Changes between 2005-06 Budget and MYEFO 1/Effects of policy decisions 2/ 1,525 1,229 1099.0 1,115Effects of economic parameter variations Unemployment benefits 151 281 312 355 Prices and wages 243.0 1,221 1,141 971 Interest and exchange rates 64 93 64 97Total economic parameter variations 458.0 1,595 1,516 1,423Public debt interest 29 37 89 145Program specific parameter variations -1,332 -594 -576 -422Slippage in 2005-06 budget decisions 1 0 0 0Other variations 277 -214 -264 -985Total Variations 957 2,052 1,863 1,2752005-06 MYEFO expenses 207,038 216,858 227,263 237,843Changes between MYEFO and 2006-07 Budget 1/Effect of policy decisions 2/ 2,032 4,271 4,836 5,254Effect of economic parameter variations Unemployment benefits -23 172 132 165 Prices and wages -139 -220 62 -50 Interest and exchange rates -4 -172 90 73Total economic parameter variations -167 -220 284 188Public debt interest -14 -55 -167 -190Program specific parameter variations -1,458 -1,316 -1,648 -1,574Slippage in 2005-06 budget decisions -2 -4 -8 -39Other variations -1,412 195 -3 -571Total Variations -1,020 2,871 3,293 3,0672006-07 Budget expenses 206,018 219,730 230,556 240,9101/ MYEFO: Mid-year Economic and Fiscal Outlook.2/ Excludes the public debt net interest effect of policy measures.

Estimates Projections

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ANNEX III. Selected Performance Indicators – New York City, U.K., Australia

New York City: Preliminary Fiscal 2007 Mayor's Management Report Description of Selected Police Indicators: http://www.nyc.gov/html/ops/html/mmr/mmr_sub.shtml

Indicator name: Major felony crime Description: Total number of major felony crimes within seven categories, corresponding to New

York State Penal Law: murder and non-negligent manslaughter, forcible rape, robbery, felonious assault, burglary, grand larceny, and grand larceny auto. Figures are also listed separately for each category of major felony. The Department's Fiscal 2002 felony crime data does not include the victims of the September 11, 2001 attacks on the World Trade Center.

Source: NYPD CompStat Report. Indicator name: Narcotics Arrests Description: Felony, misdemeanor and violation arrests effected citywide for the sale, possession

or use of narcotics or marijuana. Source: NYPD On Line Booking System. Indicator name: Guns seized by arrest Description: The number of illegally possessed pistols, revolvers, shotguns, rifles or assault

weapons confiscated incidental to an arrest. Does not include air pistols, air rifles, blank pistols, replicas, black powder firearms, toys, antiques or BB guns.

Source: NYPD Office of Management Analysis and Planning. Indicator name: Traffic fatalities (motorists/passengers) Description: Motor vehicle operators or passengers killed in vehicle accidents. Source: NYPD Chief of Transportation. Indicator name: Traffic fatalities (bicyclists/pedestrians) Description: Bicyclists and pedestrians killed in vehicle accidents. Source: NYPD Chief of Transportation. K C I T Y P O L I C E D E P A R T M E N T Indicator name: ` Total civilian complaints against members of the service Description: The number of complaints made by civilians against members of the Department,

investigated by the Civilian Complaint Review Board, for allegations of excessive force, abuse of authority, discourtesy and offensive language.

Source: Civilian Complaint Review Board. Indicator name: Average response time to all crimes in progress (minutes) Description: The average response time to all critical crimes (such as shots fired, robbery, assault

with a weapon), serious crimes (such as larceny from a person, assault not involving a weapon, larceny of an auto) and noncritical crimes (those crimes not involving an imminent threat of personal injury). Response time is measured from the receipt of a call to the time officers arrive on the scene.

Source: NYPD Office of Management Analysis and Planning – Resource Analysis

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United Kingdom: Department for Education and Skills Selected targets, indicators and technical notes from the 2004 Spending Review http://www.hm-treasury.gov.uk/documents/public_spending_and_services/publicservice_performance/pss_perf_table.cfm

Indicator: Levels of attainment in English and math by 11 year olds

Technical Note: The source data are the results of the National Curriculum end of Key Stage 2 assessment tests, which pupils sit in May of each year.

Data on English and math indicators are first published as National Statistics in a Statistical First Release of provisional national results in August/September. Final results – including all late review outcomes and amendments requested by schools as part of the primary performance tables checking exercise—are published in a Statistical First Release the following June. Both provisional and final national results are unadjusted. i.e., overseas pupils are included.

All pupils who will move onto the next Key Stage program of study in the next school year are regarded as being in the final year of that Key Stage. All children in this final year of a Key Stage must be assessed. The expected standard for a pupil at the end of Key Stage 2 is Level 4.

Those pupils who attain Level 4 or 5 are counted towards achieving the level 4 target. These are measured as a percentage against all pupils who returned valid Key Stage 2 test results including those dis-applied from the National Curriculum under section 364/365 of the Education Act 1996, those pupils working below the level of the tests, those pupils who were absent from the tests and those who sat the test but failed to gain enough marks to register a level.

The national and school results are rounded to the nearest whole number. Progress towards the targets is therefore measured in integer steps. The rounding convention is: any fractions of 0.5 and above will be rounded up; anything less than 0.5 will be rounded down.

As part of achieving wider Government objectives on racial equality, DfES will monitor progress in narrowing race equality disparities in educational attainment. Progress will be reported annually in the Government’s Race Equality and Community Cohesion Strategy.

Indicator: Levels of school attendance: “School absence” refers to the sum of authorized and unauthorized absence, for which the 2003 national figure is 6.83 percent. The equivalent figures for maintained primary and secondary schools are 5.81 percent and 8.28 percent respectively.

Technical note: Up until 2001, the data were released in the National Pupil Absence Tables, published at the same time as the Performance Tables. From 2002, the provisional data for LEAs have been released in an Early Statistics Statistical First Release (as National Statistics), in the autumn.

From 2003 data are published to two decimal places. The rounding convention used is: any fractions of 0.005 and above will be rounded up, anything less than 0.005 will be rounded down.

Revised figures for LEAs are published as a National Statistics product in a Statistical First Release in December of each year.

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Australia: Australian Institute of Health and Welfare Selected health sector performance indicators http://www.aihw.gov.au/publications/index.cfm/title/10085

Description: Incidence of acute coronary heart disease events (“heart attacks”). Numerator: The sum of (a) the number of deaths recorded as CHD deaths and (b) the number of non-fatal

hospital separations for heart attack recorded as acute myocardial infarction (AMI), for people aged 40–90 years.

Denominator: People aged 40–90 years. Presentation: Age-standardized rate per 100,000 population, standardized to the June 2001 Australian

population. Description: Incidence rates for cancer. Numerator: New cases of registrable cancer. Denominator: Total population. Presentation: Age-standardized rate per 100,000 population, standardized to the June 2001 Australian

population. Description: Severe or profound core activity limitation by age and sex. Numerator: Those people who experience severe or profound activity limitations, such that they always or

sometimes need assistance with particular activities. Denominator: The population aged 5 years and over, 1988, 1993 and 1998. Presentation: Age-standardized percentage, standardized to the June 2001 Australian population. Disability

data have been adjusted using criteria common to the three Disability surveys. Description: Life expectancy at birth. Presentation: Life expectancy represents the number of years a person born now could expect to live if they

experienced mortality rates at each age that are currently experienced by the total (male or female) population.

Description: Percentage of adults 65 years and over who received an influenza vaccination for the previous

winter. Numerator: Number of adults aged 65 years and over sampled through the national Computer Aided

Telephone Interview survey who self-report having received an influenza vaccine for the previous winter.

Denominator: Number of adults aged 65 years and over sampled in the national Computer Aided Telephone Interview survey.

Presentation: Proportion of adults aged 65 years and over who have received an influenza vaccine. Description: Admissions to hospital that could have potentially been prevented through the provision of

appropriate non-hospital health services. Numerator: Potentially preventable hospital separations. Vaccine-preventable conditions include

influenza, bacterial pneumonia, tetanus, measles, mumps, rubella, pertussis and polio. Potentially preventable acute conditions include dehydration/gastroenteritis; kidney infection; perforated ulcer; cellulites; pelvic inflammatory disease; ear, nose and throat infections and dental conditions. Potentially preventable chronic conditions include diabetes, asthma, angina, hypertension, congestive heart failure and chronic obstructive pulmonary disease.

Denominator: Total population. Presentation: Age-standardized rate per 1,000 population, standardized to the June 2001 Australian

population by geographical remoteness regions.