BUDGET REFORM AND PERFORMANCE BASED BUDGETING

Muhamad Al gamal, SE.Ak, MA

Executive Director

Center for e-Accountability System (CeAS)

Preface

This article will shortly elaborate the issue in budget reform and the choice of “Performance
Budgeting” as a tool to implement the reform.

The specific objectives of this paper are:

o To briefly explain the budgeting and its process

o To briefly explain the government budgeting, its role and process
o To briefly explain the budget reform and its process
o To briefly explain the Performance Based Budgeting, its process, and experience of
adopted countries

It will consist of four sections, (1) Budgeting (2) Government Budget (3) Budget Reform (4)
Performance Based Budgeting and experience of two adopted countries, and (5) The
Challenge of Performance Based Budgeting

Budgeting

Budgeting is considered as a part of management accounting processes which plays a role as

intermediary between planning and control. The first step in management accounting process
is to set planning of fundamental aims and objectives. Two important things in this step are
formulation of long term goal and strategy of public sector organization which depend on
type of the organization. Generally, public sector organizations should use the public
perspective on setting up their goal. It means that the fundamental aims of public by creating

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these organizations will be a goal for them. In case of government organizations, public
create them through certain political process in order to serve the public interests, so that the
public interests should be a fundamental aim. Unfortunately, sometime the lack of political
process can mislead the stated aim of public sector organizations. It is really different with
private organizations which solely set the profit as their goal. These fundamental goal and
strategy need to be detailed in day to day activities by setting up the operational planning.

After stating its operational planning, organization needs to express it in financial terms. This
is important because every programs or activities in planning statement will consume
resources (input) and will produce products or services as output. Both input and output need
to be measured so that agency management or any interest parties can understand to what
extend the actual results have been achieved compared to expected results. Both of actual and
expected results will be comparable if they are expressed in particular scale of measurement,
in this term is financial term in budgeting. The control stage will take place after
management aware as of what points have been deviate, so that they can take actions to
improve them.

Government Budgeting

Government budgeting is a process that matches resources and needs in an organized and
repetitive way so that collective choices are properly resourced (McCaffery and Jones,
2001). This process results in the budget, an itemized and programmatic estimate of expected
income and operating expenses for a given unit of government over a set time period.
Moreover, government budget will be a tool to plan and to manage the taxes collection, fees
and other revenues as well as its distribution and disbursement to achieve the goal stated in
the budget in certain fiscal year. Parry, as stated in IFAC research report (2004) mentioned
the characteristics of government budget, those are, (1) Constitutional and legal status, (2)
Political significance, (3) Multiple purposes, (4) Budget as driver of financial management
process, (5) Unrequited revenues and expenditures, (6) Budget time periods, (7) Cash based
budget most easily linked to fiscal impact and budget execution process, (8) Multiple
stakeholders

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In democratic countries, the making of a nation‟s budget, usually, initiated by executive
branch of the government. The legislative branch then approves or disapproves the budget
submitted by the executive. From transmittal to execution, it is shaped by the system of
government. Basically, there are three main stages in the budgetary process (IFAC, 2004):
(1) The formulation stages. During this stage, initial budgets and forecasts are developed and
submitted to the legislative bodies for consideration. Spending authority is granted by
legislative bodies based on the political priorities and fiscal policies of government. (2)
Execution stage. This stage reflects implementation of the fiscal policies and is accomplished
through the use of budgetary accounts in the accounting system. (3) Ex-ante and ex-post
public reporting stage. Ex-ante of the initial budgets and forecast budgetary data permits the
government to identify its financial intentions. In the ex-post reporting stage, a comparisons
of the actual results with the final budget permits the government to identify its actual
performance against the approved budget and provide explanations of significant variances.
The matters to be considered in the three stages of budget formulation, execution, and
reporting are identified as follows1:

Stage Possible areas for consideration and guidance

1. Formulation Budget formulation is a policy process and there are important aspects of
the matters in the budget documents that could be addressed by an IPSAS,
e.g.

 Basis on which budget revenues and expenditures are estimated and

time periods to which budgeted amounts are allocated (linked to
accounting base for financial reporting)
 Information to be included to achieve transparency, including need to
facilitate analysis by external stakeholders
 Classification of items – as defined in the chart of accounts
 Presentation and aggregation of data – linked to concepts of
transparency
 Incorporation of non-financial targets
 When the accrual is the basis for budgeting, inclusion of cash flow

1
Adapted from IFAC. Research Report. May 2004

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 data to be able to assess fiscal impact of budget decision

2. Execution This tends to be „internal‟ government process and not subject to external
reporting as indicated below. However, there is a need to consider how
„virements‟ and supplementary budgets will be reported to external
stakeholders

3. Reporting Ex- ante and Ex-post budget reporting should be an important part of
financial statements. There are many issues to be considered, e.g.

 Consistency of definitions between accounting and budget figures

 What figures are used as comparators when budgets are adjusted
through virements and supplementaries
 Incorporation of non-financial information
 Achieving transparency and accountabililty

Budgeting process in U.S. Federal Government could be an example for government

budgetary process. At least three budget years are in play at any one time. First is the budget
under execution; it has various reporting dates and deadlines, quarterly plans, and report to
both the Office of Management and Budget (OMB) and congress. It could also include
responses to the Appropriations Committees and to the Governmental Accounting Office
(GAO) audits made on the prior year. Second is the budget under review in Congress. This
includes hearings at several committee venues. To some extent what these committees say
about the budget proposal under discussion must be considered by the agency as it begins
preparation of its budget for the coming year. Hearings usually begin late in February and
feature the Department Secretary and bureau chiefs. In most cases, key bureaus are heard on
separate days. In most cases, key bureaus are heard on separate days. These hearings last
until early May and may be understood to be part of the negotiation process noted above. In
May, the Departments review their Congressional testimony and prepare written answers for
questions asked at the hearings. As the appropriation bills progress through Congress, the
Department begins to prepare its initial obligation plan for OMB in mid-August with the final
plan due October 1 or within 10 days of passage of the bill. Agencies within the department

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also have to prepare a departmental financial and staffing plan for the coming fiscal year for
the Department Budget Office; the final plans are due two weeks after enactment of the bill.
Thirdly, the budget preparation process for the following fiscal year is running concurrently
with the execution of the current budget and testimony on the next budget. Budget
preparation begins with a Guidance letter and topline allowances from OMB in the winter, is
followed up with a Spring Preview session where the Department and OMB may work
certain issues at dispute and concludes with the routines of budget preparation as dictated in
OMB circular A-11, the budget preparation circular.

Here are some of the key factors, which contribute to making the budget process effective in
practice2.

Transparency The budget documents should provide a clear link between objective
and expenditures;

All participants in the budget process should be clear about their roles
and responsibilities;

Simple well documented procedures;

Well defined basis of budgeting e.g., incremental, zero based etc

Departmental targets and resources allocated, clearly indicated and

explained.
Management Effective budgeting involves more than simply preparing annual
budgets; the management and monitoring of the budget is equally
important.
Decentralization It is potentially inefficient and may undermine the budget system for all
decision to be made at the center.
Co-ordination and Between all those involved in the budget process is required to ensure
Co-operation links between recurrent and development budgets and the remainder of
the process of the financial management system.

2
Based on The United Nations Development Program. Appendix 3, The Draft Country Assessment in
Accountability & Transparaency Report

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Integration Of recurrent and development budgets; the recurrent cost arising from
development projects need to be built into recurrent expenditure
planning and the trade-offs between recurrent and development
expenditure considered.
Flexibility The system should allow responses to changing circumstances: these
responses should be built into the system, so that implication of any
changes are sufficiently analyzed and still fit within government‟s
overall objectives and priorities.
Discipline Although the system should provide flexibility, there should also be
effective control over expenditures;

Any changes to the budgets should be carefully analyzed and justified;

Only limited use of Supplementary Estimates;

Penalties for breach of rules and regulations.

Link to Medium Link between the resource framework of the National Development
term Framework Plan and the annual budget
(National
Link between the policies and priorities of the National Development
Development Plan)
Plan and budget allocations
Accountability and Political involvement: good links between politicians and civil
Credibility servants;

Involvement and accountability of senior managers in all stages of the

process;

If ministries do not believe that they will be held t their ceilings, or if

they can easily by pass normal procedures, the whole process of
budgeting can be undermined;

Budgets should be reliably close to the actual out-term.

Comprehensive The budget process and documents need to include all revenues and

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 expenditures, including all aid funds;

The budget should also contain information on previous year‟s and

current year‟s expenditures;

Measuring the impact of the budget through output performance

indicators for recurrent and development expenditures.

Budget Reform

Current budget practice in many countries was produced from the evolution processes (or
revolution process) in government system. Budgeting theory and practice changes in
response to changes in the national mood because budgeting is an “open system”. Budgeting
is not an independent path toward technical refinement or analytical sophistication
independent of the political environment. It fashions and re-fashions itself to reflect that
environment (Kelly, 2003). As open system, budget will response the changes in the broader
system in a country, such as political system and economic system.

In a country system, government and citizens enter into social and legal contract, whereby
government responsible to serve public needs by allocating resources trough budget. These
resources are used to produce goods and services that will enhance public welfare. Normally,
the changes in government related systems is intended to improve the way government could
serve the public in order to fulfill the contract. Sometime, the changes are controllable and
sometime are not controllable, that is, because of the pressure of the environment. For
example, the changes in economic system because of the political crisis. Regarding to the
changes in economic system, whereby government manages production, distribution and
consumption of a country trough it, will likely influence government budget as well. This is
because government plans the resources allocation to public, as well as to themselves,
through budget. Moreover, Budget allocation has been classical problem in government
budgeting, that is, how much resources will be allocated to certain sector based on the proper
assumptions.

Budget reform is an effort of government to find out the best way in linking budget input
and its result. In many countries, the reform became one of the economic reform agenda of

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improving the production, distribution and consumption systems. Many studies of budget
reform used United States (US) system as background and might inspired other countries to
reform their budget system as well (Gill. 2001, McCaffery. 2001, Ott. 2002, Kelly. 2003,
IFAC. 2004, etc). Regarding to the budget reform in US in 20th century, Kelly (2003) argued
that budget reform has been emerged into two stages. The early reforms were functional, and
reflected two important features of the American Political system, accountability and
responsiveness. The later reform was process oriented. She explained further, in first part of
the century, budgeting was recognized as a function of public administration but a distinct
subfield. Public administration it self was being defined in the early part of century, so
budgeting has to considered in the context of the social forces that were shaping the concept
of public administration and public management. Therefore, changes in budgeting reflected
big ideas. However, in the later half of the century, budgeting emerged as a sub-field and
began to go through it own transformation independent from public administration as a
whole. American presidents began to use changes to the budget process to reflect their
personal philosophies about the role of government in the society, thus defining the budget
process as something much more than an orderly consideration of how to finance
government activities.

The United States General Accountant Office (1997) presents a historical review of Budget
Reform. It argued that since 1950, the federal government has attempted four government-
wide initiatives designed to better align spending decisions with expected performance. First
was the effort of Hoover Commission in 1949. The second was in the era of President
Johnson in 1965, that is, the planning-programming-budgeting system. The third was
management by objectives (MBO) initiated in 1973 by President Nixon. The last was the
President Carter initiative, that is, zero-base budgeting (ZBB). Moreover, all have led to the
current budget system in US based on Government Performance and Result Act (GPRA).
Because all of the initiatives were linking input and the resulted performance, it commonly
known as “Performance Budgeting”. However, still in the same report, GAO mentioned that
there was a consensus with regard the failure to shift the focus of the federal budget process
from its long-standing concentration on the items of government spending to the results of its
programs.

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Reformation in budgeting system not only happened in US, but also in many countries
through out the world. In Europe countries, Finland, French, Germany, Netherlands, Italia,
Spain, Sweden, Switzerland and United Kingdom have reformed their budget system as well
as in African countries such as Ghana, Kenya, Nigeria, South Africa and Zambia. Several
countries in Asia were also in reforming of their budget system for instances Cambodia,
Indonesia, Japan, and Korea. Last but not least, Australia and several countries in South
America have also been reformed their budget system. The study has been done by OECD,
Word Bank, Inter-American Development Bank and IMF by using 60 pooled countries,
concluded that growing civil society and legislative demand for transparency, access and
better results were shown in the countries. Given the shift in the political climate towards
democratization, the study argued that now is a fortuitous time for budget reforms, provided
that the pay attention to principles of transparency and participation. In conjunction with
above, these two reflected the effort of government in linking input consumed with the
program results, that is performance based budget system.

Performance Based Budgeting (PBB)

The classical issue in public sector is the lack of suitable output measurement, therefore
inputs consumed are often used as a measure of effectiveness, but it is not satisfaction. Why?
Because the input measurement will tend to omit how effective agency can fulfill and satisfy
the public needs as the ultimate goal of government agencies.

The measurement problem in public sector has motivated the management scholars to find
out the best way of linking the public needs to the resources have to be consumed by public
sector organizations in order to satisfy them. Performance Based Budgeting (PBB) or
Performance Budgeting (PB) is one of the ways where initiated by government agencies in
United States as a solution to solve the measurement problem.

Basically, Performance Budgeting is a general terminology that can be applied in some

techniques. The fundamental process is to link expected result/ performance to budget
levels, so that the focus will be on expected result of programs rather than input consumed.
By applying Performance Budgeting, organizations can set up and allocate the resources
based on priorities of the performance goal will be expected. Performance goal is derived

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from strategic goal of organization which is an ultimate target should be achieved to satisfy
the public needs in long term. In PB terminologies, outcome is used to state public
satisfaction from output delivered by public sector organizations whereby output is goods or
services produced or rendered by government to public. Input is resources consumed to
produce output in order to achieve outcome and the process of linking input, output and
outcome is performance

In general, the steps to implement PB are started from translating of missions, fundamental
aims and strategy into performance goal. Then, organization will set up KPIs for any
programs or activities. Last but not least is determining the money amount should be spent to
conduct the programs or activities. In practice, many organizations realize the performance
goal through Key Performance Indicators (KPIs) format. Those are some short term targets
stated in kinds of number scale, so that management can use them as a measurement tool. By
assessing KPIs, public sector organizations can enhance their accountability trough
improvement of their performance that refers to public interest.

The important question with regard to adopt performance based budgeting (PBB) is, What
needs to be done to ensure meaningful adoption?. This question is relevant to all
governments attempting to introduce the budget reform, whether these are national or sub-
national entities in developing or in developed countries. Andrews (2004) emphasized three
factors influencing PBB adoption in order to make it meaningful: Ability, authority and
acceptance. The ability consists of performance evaluation ability, personnel ability and
technical ability. The authority consists of legal authority, procedural authority and
organizational authority. The acceptance consists of political acceptance, managerial
acceptance and incentive compatibility.

PBB – Experience of Some Countries

It is important to highlight the experiences of several countries in adopting PBB before

examining budget reform in certain country. This is because by comparing the experiences,
national issues, such as government system, political and economic situation as well as
geography and demography condition, and their impact to budget reform in certain country
will be more visible to be elaborated. McGill (2001) studied the adoption of PBB in Tanzania

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and India, using Andhra Pradesh as a sample. Tanzania has around 26 million people. It has a
three-tier government structure; national, regional and local. The national government is the
dominant force. The regional government is essentially an administrative service, with and
inherited political over-tone (regional commissioners). Local governments are essentially
urban and rural. The over-riding commitment of government is to decentralize itself to the
lowest level of competent administration.

Andhra Pradesh (AP) has over 70 million people. Twenty-seven percent of the population is
classed as urban (1). The average household size is 4.77. Thirty million people are classed as
working; 18.7 million are men, 11.3 are women. The dominant economic activity is
agriculture and associated enterprises, with almost 20 million people involved (67 percent of
the population). The next largest segment is manufacturing, with 2.5 million people. Trade
activity absorbs another 2 million. Several conclusions of the comparative study as follows;

General Tanzania India (Andhra Pradesh)

principles in PB
Shifting from The move from input to output- The required shift is was explicit at
input to output- based budgeting was clear and both national and state level,
based budgeting explicit. In practical terms, it declared in its budget manual.
was driven by its PB operations
manual
A strategic The strategic context was The new Vision 2020 has still to be
context to defined explicitly in terms of translated into objectives and
condition the organizational intentions related targets
resource followed by quantified
allocating process objectives, three- year and
annual targets, conditioned by a
performance review.
The strategic The annual report and service No such public document is
context for PB is improvement plan is an explicit required. Therefore no explicit
being satisfied precondition for the submission annual planning and review cycle
increasingly of annual estimates. It includes exists

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through public output and impact tests
annual reporting
The real test is of Tanzania‟s limited PB There was no explicit assessment of
resource experience determined its objectives and program targets
allocation against budgeting against planning because no such objectives, three-
future intentions intentions. It would take three year and annual targets existed
(plan), tempered years to move to a full
by recent performance review cycle
performance
PB require all The format and structure for Any prioritization was implied in
priorities to be in priority settings was made the sense of the amount of
ranked sequence explicit in terms of objectives, resources being allocated to any
so that difficult three-year and annual targets programs.
choices are
impossible to
avoid
PB‟s key unit of The program was not used in AP had highly structured definition
planning and PB. Instead, the key units of of the program in relation to other
budgeting analysis were the vote (a modes of service delivery and in
analysis is the ministry) and its sub-votes (its relation to an organization‟s budget
programs departments). In turn, the and accounting structure
department equated to a
function. Any section referred to
a task. The specific activities
referred to „scheduled officers‟.
Tanzania later introduced
programs between votes and
sub-votes. However, they had no
practical budgeting or reporting
impact
PB is the Tanzania was Moving towards a No such agreements exist in AP,

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foundation for system of performance despite the fact that programs are
performance agreements. led by identified posts (normally
agreements with commissioners)
any agency‟s
senior (program)
manager
PB requires four Tanzania‟s input test centered on AP‟s PB structure encouraged such
basic performance variance analysis for each sub- analysis but there was no means for
tests to exist; vote. Output analysis was the doing so as an automatic part of the
inputs, outputs, tests had not been established. PB process. Separate sectoral
efficiency tests Impact assessment was an review had to be established
and impact explicit requirement, to be set
assessment against three-year target
achievement and wider
objectives testing, with
community-based assessment
format also developed.

The Challenge

Although many public sector organizations in any countries are trying to implement
Performance Budgeting in order to improve their management process, there is still a doubt
about its effectiveness. The ongoing issues are:

• Is PB able to avoid negative impacts of political process, then concentrate on what

public really need, how much resources will really be consumed and rational
management process?
• Can PB improve the government and public paradigm? Ideally, the government must
serve the public with the best effort of their obligation and the public should impose
the government for their rights have to be served with the most responsible and
accountable process.

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McCaffery, J.L and Jones, L.R. 2001. Public Budgeting and Financial Management in the
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