June 14, 2012Doug Hadden
Part 1: PI-1 to PI-14
Doug Hadden, VP Products
I suggested in my previous post, What Canada can learn from Developing Countries on Public Financial Management sustainability, [Part 5], that we could learn more about holistic public financial management. In particular, the PEFA assessment methodology.
Norway is the only developed country to have completed a PEFA assessment. This was an interesting exercise by the Norwegian development agency, NORAD. The assessment showed that Norway has stellar public financial management, yet there are 11 C’s and D’s.
Fortunately, there has been some academic work to evaluate PFM in Canada such as How Do Canadian Budget Forecasts Compare with Those of Other Industrial Countries from Martin Mühleisen, Stephan Danninger, David Hauner, Kornélia Krajnyák, and Bennett Sutton from an IMF paper in 2005. It would be helpful if Canada was evaluated as part of the Open Budget Index and Revenue Watch Index.
As has Marco Cangiano of the IMF noted in a recent ICGFM presentation, not all developed countries operate with PFM “best practices”.
PEFA scores seem to be somewhat aligned to Human Development Index and World Governance Indicators for Government Effectiveness. Norway has the highest average PEFA score with the highest HDI and government effectiveness rating. The graphs show that many countries have PFM systems that are operating far better than expected from the country condition.
My sense is that the federal government would achieve a good PEFA assessment similar to Norway. I have some familiarity with PEFA. We use PEFA as part of our governance valuation process. And, I’ve attended some workshops and have a PEFA pen – but I’m not certified to complete an assessment. That doesn’t mean that I can’t offer and opinion of the 28 criteria – PI-1 to PI-28. (There are 3 donor criteria that aren’t relevant because Canada does not receive donor funds). Here are the first 14.
PI-1. Aggregate expenditure out-turn compared to original approved budget
The difference between actual primary expenditure and the originally budgeted primary expenditure (i.e. excluding debt service charges, but also excluding externally financed project expenditure).
The federal government produces conservative estimates. The current Conservative government and the previous Liberal government revealed better than estimated results. This was often accomplished by expending less than planned. It’s good politics, but it’s not clear whether the government could achieve an A.
According to the 2005 IMF study:
fiscal forecasting in Canada is governed by one of the strongest institutional frameworks relative to benchmark countries. Although Canada has no formal fiscal rule, the policy of “balance or better” has evolved into a de facto fiscal target. In support of this objective, Canada has adopted a conservative approach to budgeting, with explicit prudence and contingency factors
This “prudent” nature for budget estimates from 2005 continues in 2012 as “analysts said Ottawa could easily close the budget gap one year earlier due to a better-than-expected fiscal performance this year, an improved economic outlook and a contingency cushion built into the numbers.” The 2005 IMF study that benchmarked Canada with other developed countries concluded: “even when scaled by the size of GDP, Canadian fiscal forecasts appear unusually conservative.”
PI-2 Composition of expenditure out-turn compared to original approved budget
(i) Extent of the variance in expenditure composition during the last three years, excluding contingency items
(ii) The average amount of expenditure actually charged to the contingency vote over the last three years.
There has rarely been significant contingency spending by the federal government with the exception of the stimulus problem. As described above, there is “a contingency cushion built into the numbers.” The 2005 IMF study found that “deviations on the expenditure side appear partly driven by smaller than expected debt servicing costs.”
PI-3 Aggregate revenue out-turn compared to original approved budget
Actual domestic revenue compared to domestic revenue in the originally approved budget.
As Ian Lienert pointed out in 2009:
“With regard to revenue forecasting, Canada stands out as the country with the most consistent and largest underestimation of budget revenues. Canada’s GDP forecasts were deliberately conservative during 1995-2003: actual economic growth was on average ½ percentage point higher than that assumed in budget projections. Inflation (the GDP deflator) was also underestimated, by 0.2 percentage points. All tax and nontax revenue components were underestimated (the forecasting records of four different taxes were analyzed).”
The 2005 IMF study found that “economic growth in Canada has on average been ½ percentage point higher than budget projections in recent years” and “forecasters also underestimated GDP inflation by 0.2 percentage points on average.” The study also found that “on the revenue side, projections of personal income tax and GST/MST revenue have contributed most to the overall forecast error.”
PI-4. Stock and monitoring of expenditure payment arrears
(i) Stock of expenditure payment arrears (as a percentage of actual total expenditure for the corresponding fiscal year) and any recent change in the stock.
(ii) Availability of data for monitoring the stock of expenditure payment arrears.
The federal government operates on a modified accrual basis. Therefore, arrears are visible to financial managers. There is significant attention to handling arrears when closing the year.
PI-5. Classification of the budget
The classification system used for formulation, execution and reporting of the central government‟s budget.
Financial management is decentralized in the federal government. There is a consolidated chart of accounts. Departments and agencies have custom elements. Many experts believe that the budget classification should be more standardized. PI-5 requires the support of Government Financial Statistics (GFS) and Common Functions of Government (COFOG). This is not currently supported, but there is a plan, according to Statistics Canada:
statistical system underlying government finance statistics must also change. Statistics Canada has decided to move towards reporting government finance statistics on a Government Finance Statistics 2001 basis. The GFS 2001 is an international accepted accrual accounting framework for government finance statistics. The GFS 2001 is also fully integrated with the United Nation’s System of National Accounts framework.
While it will take a number of years to be able to derive detailed GFS-based statistics directly from government financial information (Statistics Canada will begin publishing public sector statistics based on the GFS 2001 manual in calendar year 2014), Statistics Canada has decided to release quarterly GFS data using Canadian System of National Accounts (CSNA) government sector data and a bridging model that maps these data to the GFS framework. The CSNA (consistent with the United Nations’ System) already compiles some government data on an accrual basis and therefore offers the foundation to produce preliminary estimates of government data on a GFS basis.
This is good news because the GFS standard is ideal for comparing the economic purpose of programs over time and for comparing with other governments. For example, many government agencies can be involved in educational programs or environmental protection. These standards can provide the type of clarity that policy makers need. However, it appears that, unlike in developing countries, GFS will not be baked into the budget classifications. Rather, some kind of meta survey of financial information will be accomplished to re-create GFS information. As we have found in developing countries, GFS is easy to support within the financial chart of accounts in a Government Resource Planning (GRP) system.
The 2005 IMF study found some issues with budget classifications: “expenditure subcategories appears particularly difficult. For example, the distinction between discretionary and mandatory spending components”
My sense is that not all federal government organizations use best practices in program classifications. These departments and agencies place programs as part of the organizational structure. (My information might be out-of-date.)
PI-6. Comprehensiveness of information included in budget documentation
1. Macro-economic assumptions, including at least estimates of aggregate growth, inflation and exchange rate.
2. Fiscal deficit, defined according to GFS or other internationally recognized standard.
3. Deficit financing, describing anticipated composition.
4. Debt stock, including details at least for the beginning of the current year.
5. Financial Assets, including details at least for the beginning of the current year.
6. Prior year’s budget outturn, presented in the same format as the budget proposal.
7. Current year’s budget (either the revised budget or the estimated outturn), presented in the same format as the budget proposal.
8. Summarized budget data for both revenue and expenditure according to the main heads of the classifications used (ref. PI-5), including data for the current and previous year.
9. Explanation of budget implications of new policy initiatives, with estimates of the budgetary impact of all major revenue policy changes and/or some major changes to expenditure programs.
Budget plans and speeches from the Throne make for interesting reading, but may not satisfy all the PEFA criteria. The 2012 budget plan is a compelling political document and covers some of the criteria for PI-6. My sense is that more factors are covered during budget preparation but are not presented in the budget plan. For example, the 2012 Budget: Canada’s Economic Action Plan shows the fiscal output, describes deficit and debt. GDP is forecasted. But, the rationale for macroeconomic conclusions such as industrial indicators is not shown. The potential effects of material changes to cost drivers like oil prices on government revenue and expenditures are not described. Only the revenue and expenditure impact of GDP changes are described. Examples of meeting good practices in budgeting from the 2012 budget plan include the following images:
The 2005 IMF study suggested that “Canada could enhance the understanding of budgetary forecasts by providing more information on the assumptions and methods underlying the translation of the macroeconomic outlook into fiscal projections.”
It’s not clear whether government department are using multiple year planning to enable “bottom-up” forecasting for future years or whether the rolling budget estimates provided in the document are “top-down” forecasts.
Major revenue and expenditure initiatives are costed at an aggregate level, so it’s not clear how the estimates were developed.
The government financial position and risk are well described. The new policy initiatives by the government are detailed such as Supporting Entrepreneurs, Innovators and World-Class Research and Expanding Trade and Opening New Markets for Canadian Businesses. Expected tax revenue is projected as are the effects of some entitlement programs.
PI-7. Extent of unreported government operations
(i) The level of extra-budgetary expenditure (other than donor funded projects) which is unreported i.e. not included in fiscal reports.
(ii) Income/expenditure information on donor-funded projects which is included in fiscal reports.
My sense is that the federal government does not have any material unreported government operations.
PI-8. Transparency of Inter-Governmental Fiscal Relations
(i) Transparent and rules based systems in the horizontal allocation among SN governments of unconditional and conditional transfers from central government (both budgeted and actual allocations)
(ii) Timeliness of reliable information to SN governments on their allocations from central government for the coming year
(iii) Extent to which consolidated fiscal data (at least on revenue and expenditure) is collected and reported for general government according to sectoral categories.
Canada does well with federal – provincial transparency in fiscal relations (SN= ‘sub-national’). Although, the 2005 IMF study claimed that “data on transfers to other levels of government are not provided on a consistent basis.” The formula for transfer payments is well documented. The budget document shows transfer payments for:
- Canada Health Transfer Canada Social Transfer
- Other health and social transfers
- Fiscal arrangements
- Canada’s cities and communities
- Other transfers
- Alternative Payments for Standing programs
The federal nature of government in Canada means that provincial governments have no obligation to report to the federal government. (Territories have that obligation.) However, Canadian Provinces provide financial information to citizens so some of factor iii can be achieved.
PI-9. Oversight of aggregate fiscal risk from other public sector entities
(i) Extent of central government monitoring of AGAs and PEs.
(ii) Extent of central government monitoring of SN governments‟ fiscal position.
(SN – subnational, AGA – autonomous government agencies, PE – public enterprises)
Canada is a federal state. Sub-national fiscal risk is not rolled up to give a notion of fiscal risk for governments across the country. There are constitutional issues that are not easily overcome for Canada to achieve more than a D.
PI-10. Public Access to key fiscal information
(i) Annual budget documentation: A complete set of documents can be obtained by the public through appropriate means when it is submitted to the legislature.
(ii) In-year budget execution reports: The reports are routinely made available to the public through appropriate means within one month of their completion.
(iii) Year-end financial statements: The statements are made available to the public through appropriate means within six months of completed audit.
(iv) External audit reports: All reports on central government consolidated operations are made available to the public through appropriate means within six months of completed audit.
(v) Contract awards: Award of all contracts with value above approx. USD 100,000 equiv. are published at least quarterly through appropriate means. Resources available to primary service units:
(vi) Information is publicized through appropriate means at least annually, or available upon request, for primary service units with national coverage in at least two sectors (such as elementary schools or primary health clinics).
The federal government will rate well on fiscal information on 4 or 5 of the factors. According to the 2005 IMF study: “The Canadian public has relatively broad access to budgetary information…However, the closed nature of the budget compilation process implies that forecast risks may not be widely understood, limiting public debate on this aspect.” The study suggests:
Canada could benefit from further improving the transparency of its budgetary forecasts. Given the importance of restoring public confidence in government finances in the mid- 1990s, the consequences of running into deficit were considerably higher than those of achieving a surplus. As Canada’s fiscal situation has improved, it is unclear to what extent the relative costs of missing budget targets have changed. However, Canada could benefit from opening up the forecasting process, e.g., by involving private forecasters in producing revenue estimates. Equally important, providing more information about critical parts of the forecasting process—in particular the assumptions and methods used for transforming macroeconomic forecasts into fiscal projections—would invite greater outside scrutiny, helping to improve forecast quality and bolster public confidence in budget projections.
PI-11. Orderliness and participation in the annual budget process
(i) Existence of and adherence to a fixed budget calendar;
(ii) Clarity/comprehensiveness of and political involvement in the guidance on the preparation of budget submissions (budget circular or equivalent);
(iii) Timely budget approval by the legislature or similarly mandated body (within the last three years)
The federal government may have some difficulty with the third criteria. The 2005 IMF study suggests that there is not sufficient time provided to Parliament to evaluate the budget:
In Canada, the legislature has largely been focused on optimizing the budget process, as opposed to taking an active role in the formulation of the budget…
Parliament receives the budget relatively late, less than two months before the start of the new fiscal year. A quarter of the fiscal year has typically elapsed by the time the budget is approved. In contrast, legislatures of other countries receive the budget two to six months before the new fiscal year, and even earlier in the United States…
As in many parliamentary systems, the Canadian legislature has limited powers to change the submitted budget. Parliament can reduce, but not increase, funding for line items, but has otherwise only the choice of approving or rejecting the government’s spending proposals.
The previous budget bill was defeated rapidly. As I described in a previous post comparing Canada and the United States:
Yet here we are, with budget theatre in two G7 countries: Canada and the United States. In Canada, the opposition parties announced, within minutes of budget release, that they could not support the budget. No debate. The government fell three days later on a confidence motion. Perhaps the budget was designed by the governing party to generate an election: an election budget.
PI-12. Multi-year perspective in fiscal planning, expenditure policy and budgeting
(i) Preparation of multi -year fiscal forecasts and functional allocations;
(ii) Scope and frequency of debt sustainability analysis
(iii) Existence of sector strategies with multi-year costing of recurrent & investment expenditure;
(iv) Linkages between investment budgets and forward expenditure estimates.
It does not appear that federal government follows “medium term expenditure frameworks” or uses a process similar to Australia for forward estimates. The federal budget shows expected revenue and expenditures but with only a linkage to GDP, not a full macroeconomic and financial framework aligned to programs. The future year budget implications become less credible based on the 2005 IMF study that found that “Canadian budgets generally adopted a conservative view of macroeconomic developments over the past 10 years” and that “Canada has experienced greater macroeconomic volatility than many other countries.”
PI-13. Transparency of Taxpayer Obligations and Liabilities
(i) Clarity and comprehensiveness of tax liabilities
(ii) Taxpayer access to information on tax liabilities and administrative procedures.
(iii) Existence and functioning of a tax appeals mechanism.
My sense is that these three factors are handled well in the federal government.
PI-14. Effectiveness of measures for taxpayer registration and tax assessment
(i) Controls in the taxpayer registration system.
(ii) Effectiveness of penalties for non-compliance with registration and declaration obligations
(iii) Planning and monitoring of tax audit and fraud investigation programs.
A 2004 OECD study showed that the tax regime in Canada is at a par with other developed countries. Research by Sylvain Fleury and Mark Mahabir conclude that “various factors in Canada’s tax system contribute to making avoidance and evasion easier.”
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