Overall Structure and Functions

Transparency in the boundary between the public sector and private economic agents entails development of a well-defined and publicly available policy statement that sets the relative areas of competence and provides limited, if any, scope for private rent seeking in the public domain. Apart from some areas (e.g., education, health care, and public utilities) where public and private providers may operate concurrently, in most industrial countries and some developing countries, the separation between public and private activity has been clarified over the past two decades. While the government has retained responsibility for public administration, internal safety, defense, foreign relations, and macroeconomic policy, the private sector has become the principal actor in commercial and profit-making activities and, in some cases, infrastructure.

Recently, certain industrial countries have taken steps to conduct the remaining government operations by applying more explicit cost and performance indicators and management techniques used by private enterprises.³⁴ But the marked increase in the outsourcing of government operations to large-scale private suppliers or contractors (in areas such as defense, health care, and certain administrative services), whose principal or sole client is the government, may offer scope for nontransparent behavior, even if the transactions are formally subject to open tender.³⁵ Whereas the boundaries between public and private spheres are generally weaker in developing than in industrial countries,³⁶ the demarcation is perhaps least transparent in the economies in transition. In these economies, for the most part, the boundaries have not yet been defined—lacking even conflict-of-interest legislation—to the point where, in some countries, public officials are allowed to engage in transactions for personal profit using public resources, including internal government information.

Freedom-of-information legislation is another fundamental instrument of government transparency and accountability.³⁷ It gives citizens access to government documents without their first having to prove a special interest, and the burden of justifying nondisclosure falls on the government. Although such legislation imposes administrative costs, and exempting highly sensitive issues in certain areas (e.g., defense and foreign affairs) can be justified, experience suggests that it can change the attitude of elected officials and civil servants toward fiscal transparency.

Within the public sector, publicly released information on the assignment of functions among various components of the sector is not always available and, when available, is not always clear, even in some advanced economies. The nexus between the government and public financial institutions or non-financial public enterprises is rather opaque in many cases.³⁸ The paucity of publicly available information on the fiscal costs and the terms of bank rescue operations (Alexander and others, 1997) and of enterprise restructuring has been notable, not only in virtually all economies in transition but also in some industrial and developing countries. In some cases, financial injections were provided in an ad hoc manner, often from off-budget sources.³⁹ The privatization of state-owned enterprises has been conducted with varying degrees of openness across countries. In some countries (e.g., Australia, most EU countries, New Zealand, and United States), there has been nearly full public disclosure on all aspects of enterprise sale.⁴⁰

Notwithstanding the general trend toward managing and operating state-owned enterprises in an increasingly open way along commercial lines (e.g., Australia and New Zealand)—in some cases, in preparation for eventual privatization—state-owned enterprises in a number of countries are still engaged in sizable quasi-fiscal activities, mainly in the form of social benefits, overemployment, and price subsidies without compensation from the budget.⁴¹ Such quasi-fiscal activities are remnants of the widespread provision of implicit subsidies for consumption of loosely defined “merit” goods and services and for employment, not only in the former centrally planned economies but also in many developing countries.⁴² Although the ideal solution would be to phase out such activities over time, transparency requires that estimates of their costs be published in budget documents.

Perhaps less transparent are the quasi-fiscal activities conducted by public financial institutions. These activities take many different forms: multiple exchange rates, exchange rate guarantees, import deposits, preferential credits and loan guarantees (directed, e.g., to exports, and investment in specific activities), deposit guarantees, and selective reserve requirements (Mackenzie and Stella, 1996). Such implicit subsidies and taxes, not explicitly remunerated by the government, can be found especially in developing and transition economies. Again, as a first step, it is necessary to improve the transparency of these operations through the publication of estimates of the costs involved.

A lack of clarity in the division of responsibilities between national and subnational levels of government is a major problem in many developing and transition economies and, to a lesser degree, in some industrial countries. Although revenue sharing has been clarified in some countries, including those with clear formula-based arrangements (e.g., Canada and Denmark), in others, bargaining and ad hoc negotiations persist for intergovernmental transfers. The least transparent distribution of functions and resources can be found, of course, in some economies in transition that have recently evolved from a highly centralized system of government to a federation or confederation.

In principle, extrabudgetary operations can be useful for pursuing certain tasks more efficiently (or for ensuring greater support from users) on a fiduciary basis, in the form of separate funds—though often administered in a manner similar to budget entities—particularly if their spending obligation transcends the annual budget appropriation process. Such is the case for highway funds (established for road construction and maintenance and financed from earmarked user fees and capital transfers), commodity stabilization funds (set up to mitigate the effect of export price fluctuations), or social insurance funds (to protect against unemployment, old age, or disability).⁴³ In a number of countries, however, extrabudgetary funds—for example, to finance export promotion, tourism, housing, and, in particular, military expenditures—have apparently been created, at least in part, to avoid legislative scrutiny. Often, extrabudgetary funds that were originally created for valid reasons have become highly dysfunctional. In some African countries, reserves accumulated in commodity stabilization funds have been diverted to finance consumer subsidies or prestige projects. Instead of relying on active labor-market programs or deregulation, a number of European and Latin American countries (except under defined-contribution schemes) use social security funds as a nontransparent means for alleviating structural unemployment, through easy eligibility for old-age and disability pensions. In some countries, reform efforts are under way to limit early retirement and excessive use of disability benefits and sick pay. Although efforts to do away with such dysfunctional practices should be stepped up, the immediate task is to make the activities of these funds transparent through publication of their operations on a timely basis and in a manner that permits consolidation with budget operations.

One potentially important instrument for ensuring transparency in government operations is a permanent independent review agency that is responsible for conducting studies on selected fiscal issues, performance audits—focusing on the efficiency and effectiveness of government programs—and appraisals of the activities of specific public sector institutions, including state-owned enterprises. Such an agency, accountable to the legislature and the public at large, can be found in most industrial countries, some developing countries, and a few economies in transition.⁴⁴ Occasionally, some governments commission outside experts to prepare special studies—such as white papers on selected policy issues in Commonwealth countries that contain detailed factual assessments and nonbinding recommendations for reform.

Budgetary Practices

The budget process, undertaken under varying degrees of transparency, normally comprises four main stages: formulation and preparation of the draft budget, legislation and approval, budget execution, and audit and review. In some countries (e.g., Germany and Switzerland), including an increasing number of economies in transition, the tasks involved at each stage are detailed in the budget framework law. In others (e.g., United Kingdom), the process has been set by past conventions and rulings. In either case, the process can be said to be transparent if it follows clearly established guidelines rather than an improvised approach, is fully explained, openly debated and enacted, and applied preferably to the entire general government, including extrabudgetary operations and local governments.

The first stage—preparation of the draft budget—involves internal debate and resolution of priorities within the government. Although the actual formulation of budget proposals is an internal matter, the timetable and decision-making process used by the government should be publicly known. Of course, once completed, the budget and the supporting documents (such as the budget speech and various specialized analyses) need to be published and made widely available in an understandable and meaningful format. Clear announcement of the fiscal target embodied in the budget documents is seen as one of the most important aspects of transparency because, by analogy with the inflation targets used in monetary policy, it conditions the expectations of private and public sector participants.⁴⁵

Following formal presentation of the budget, government representatives are responsible for explaining—as openly and in as much detail as necessary—its contents and the underlying rationale and policies, often at legislative hearings. By their nature, the actual legislative debate and authorization are normally open to the public, and the outcome is recorded in public documents that become the foundation for the next stage. The execution stage requires both internal transparency (timely monitoring of information on actual spending and cash movements through the treasury) and external transparency (prompt reporting to the public). Finally, adequate information is to be made available for conducting both financial and performance audits, and the results, including any actions recommended and implemented, are to be disclosed to the public.⁴⁶

Whereas the foregoing transparency criteria are formally met in most countries that have separate executive and legislative branches, the quality of information is often inadequate. Moreover, the specification of fiscal targets, particularly medium-term targets,⁴⁷ incorporated in the annual budget document is in many cases vague. The linkage between these targets and actual policy measures, on the one hand, and ultimate economic goals, on the other, is often unclear. A major problem stems from the reporting on the realization (or nonrealization) of fiscal targets. Many governments, especially in nonindustrial countries, fail to explain fiscal developments in the course of the year; thus, public knowledge of slippages is delayed. Added weaknesses in budget execution transparency stem from information lags and incomplete coverage, mostly in developing countries and economies in transition. It is perhaps most difficult to achieve transparency in budget audit and review. Although a number of Asian countries (e.g., India and Korea) have made considerable strides toward openness, some other countries in the region and in Africa still exhibit nontransparency at various stages of the budget process.⁴⁸ Despite taking some important steps to shed a tradition of secrecy, most economies in transition (with the exception of a few Central European countries) need to make further progress toward transparency in the budget process as a whole.

In response to unanticipated exogenous developments, most industrial countries follow clear guidelines for using contingency reserves (e.g., Australia and United Kingdom), resorting to cash limits (e.g., formerly in the United Kingdom), or preparing a supplementary budget. By contrast, many economies in transition rely widely on discretionary steps, including sequestration of entitlements, often to contain an unbudgeted widening of the deficit in the course of the fiscal year.

A further test of transparency in budget execution and control involves public procurement, contracting, and employment practices. In the majority of OECD member countries—at the national rather than at sub-national government levels—public tenders are issued for major government contracts, procurement of supplies above a certain threshold are subject to open bidding, and awards are publicly announced.⁴⁹ Overall, there is increasing reliance in these countries on the contracting out of basic government services. Similarly, a number of countries that previously operated closed career systems have introduced open recruitment. Although some progress has also been made in Latin America (e.g., Chile and Venezuela) toward increased transparency in this area, in many developing countries, there is considerable room for discretionary purchasing practices and patronage in the civil service.⁵⁰ The lack of transparency in the economies in transition⁵¹ is not surprising, given a background of completely internal procurement practices—especially during the shortages that prevailed under central planning—and of hiring under the nomenklatura system.

Tax Treatment

In general, a transparent tax system is characterized by relatively small differences between statutory and effective tax rates on transactions, income, and property. The extent of such differences is determined by tax evasion, administrative shortcomings, or tax concessions. Hence, to reduce the differences, the tax base should be well defined, and modifications through preferential treatment should be based on clear statutory criteria of eligibility. Also, tax administration should be conducted in a clear and simple manner, assisted by dissemination of all the necessary information, including instructions for completing tax returns. Discretionary tax relief provided to particular individuals or enterprises (including state-owned enterprises), as practiced in some developing countries and virtually all economies in transition, constitutes a departure from transparency. In these countries as well as in a few industrial countries, taxpayers are able to accumulate substantial tax or social security contribution arrears, or overdue obligations, subject to almost endless litigation—in some cases, even with tacit government approval. Least transparent, however, is the case-by-case negotiation of tax liabilities between tax officials and corporate taxpayers, which has been made available mainly to foreign investors in many developing countries. In some of these countries, however, as well as in economies in transition, this approach has proliferated.

As a step toward transparent tax administration, most of the advanced economies have promulgated laws or statutes specifying taxpayers’ rights and obligations (Organization for Economic Cooperation and Development, 1990). Obligations include filing tax returns and making tax payments by the due date; and filing information returns on wages, interest income, or payments for merchandise made by third parties. Likewise, the authority to impose penalties, including the search and seizure of assets, is legally defined. In many countries, tax officials are obliged to adhere to strictly enforced rules of conduct; taxpayers who have the right to privacy may turn to the administration or to the courts for protection from arbitrary treatment. In some countries, taxpayers may appeal to a tax referee; the legal costs are covered if the taxpayer’s appeal is successful. Such a clear definition and enforcement of rules and regulations are absent in many developing countries and most economies in transition.

Tax preferences can be viewed as tantamount to budgetary outlays benefiting households or specific economic sectors or activities. For this reason, estimates of tax expenditures—that is, loss of revenue compared with the level that would obtain in the absence of tax allowances—can provide valuable information to the legislature and the public, particularly at the time of the annual budget debate or during tax reform, despite the difficulty of defining the reference value for each tax expenditure category. At present, one dozen OECD member countries regularly publish expenditure accounts that show the estimated budgetary cost of tax exemptions, deductions, credits, deferrals, and reduced rates.⁵²

Similarly, useful information about the distributional implications of a country’s tax subsidy system can be gleaned from incidence studies, albeit with some methodological and measurement limitations, including those associated with the underlying household budget surveys. In some industrial countries (e.g., Australia), the government periodically publishes tax subsidy incidence calculations, often prepared under contract by nongovernmental organizations. In addition, of course, it would be informative to occasionally estimate differences among statutory, effective, and realized tax rates—especially for taxes on company income and foreign trade.⁵³

Financing Operations

Besides its adverse monetary and macroeconomic consequences, nonmarket bank financing of government deficits also conceals the true cost of debt servicing. For this reason, in the past two decades, an increasing number of countries have resorted to market-based, nonbank financing of deficits, accompanied by a parallel effort to create an arm’s-length relationship between governments on the one hand and central banks and other financial institutions on the other. Thus, apart from a few economies in transition and some developing countries, public financial institutions are no longer a captive source of deficit financing at below-market interest rates. However, such practices still account at least partially for the domestic borrowing requirement of the public sector in certain large countries.

The trend toward market-based financing operations has enhanced transparency and received the support of financial markets. In fact, governments wishing to access international markets must furnish rating agencies, underwriters, and security market supervisory agencies with considerable data on their debt stock, including guarantees, debt-service capacity, and overall debt-management strategy—as well as information on macroeconomic developments and outlook. For successful domestic financing, governments need to provide information on marketing techniques, the mix of domestic and external maturity structure and other characteristics of securities to be issued, and rules governing public tenders and open market operations.

Nonetheless, certain subtle nontransparent debt-management practices can be found in some industrial and developing countries. For instance, strong moral suasion by the authorities on institutional investors and discretionary selection of underwriters, financing consortiums, and primary dealers are examples of less visible practices. In addition, insufficient or excessively complex public information on the terms of acquisition or sale of various types of government securities, coupled with a lack of adequate retail outlets or secondary markets, may constrain proper risk evaluation and, hence, the development of markets for such instruments. In countries with regulated markets, transparency would be served by providing estimates of the cost of such restraints in budget documents to show the degree of subsidization and consequent resource misallocation introduced by such practices.

In government lending, the least transparent practices prevail in some economies in transition and parts of Asia and the Middle East, where the authorities allocate credit directly.⁵⁴ On-lending by governments or by public (or, in some cases, private) financial institutions, often through government guarantee, can be equally nontransparent.

Regulation

Government regulation is often justified for a variety of objectives: public health, consumer protection, environmental protection, labor protection, and moral hazard prevention. In many countries, however, the complexity, overlapping jurisdictions (between national and subnational levels), frequent changes, and sheer volume of regulations all contribute to a lack of clarity in the regulatory framework. Moreover, regulations are sometimes used as a nontransparent substitute for budget transfers or taxes. For example, rent controls can be viewed as a substitute for transfers to low-income households; zoning regulations, obligatory military service, and training requirements for employers are substitutes for various forms of taxation (Tanzi, 1995). Similar substitution can also arise when a government department or agency (e.g., department of forestry) is responsible for both regulation and budget spending, given that managers may face conflicting pressures to achieve fiscal savings through the use of (less transparent) regulation.

Unlike public services financed from the budget, the costs of complying with regulations, some borne directly by the regulated households and enterprises and some borne indirectly by the rest of the economy, are not transparent. An attempt to assess these costs suggests that the extent of nontransparency in regulation can be considerable, especially in industrial countries.⁵⁵ In developing and transition economies, with greater latitude for evading regulations through the informal sector, these direct costs tend to be offset, at least in part, by costs associated with payoffs to the regulators themselves and to intermediaries who assist in evasion.

In general, the recent—practically worldwide—trend toward deregulation in commodity, labor, and financial markets has contributed to greater transparency in government operations in these areas. Although difficult to quantify, considerable progress toward deregulation has been attained by a number of advanced economies (e.g., Denmark, New Zealand, United Kingdom, and United States).⁵⁶ In some of these countries, however, there is a risk that these gains may be undone by renewed substitution of regulation for fiscal measures. While some developing countries in East Asia and Latin America (e.g., Chile) have embarked on major deregulation efforts, most economies in transition have made an impressive evolution from central planning—arguably the most overregulated system.

Coverage

In principle, the general government is universally regarded as the most comprehensive definition of the sector that “performs primarily the functions of supplying certain public goods and services and fulfilling certain public purposes not for commercial or financial reasons, or, if of a commercial or financial nature, not on a major basis or not primarily for a profit” (International Monetary Fund, 1986, p. 7). Its coverage encompasses the national (central) government consolidated with all subnational (provincial, municipal, or local) governments, consisting of the budget, as well as social security and other extrabudgetary accounts, at each level of government. Although nearly all countries can supply up-to-date information on the central budget—which for many is the main focus of policy—only in about two-thirds of the member countries of the Organization for Economic Cooperation and Development (OECD) are timely data for the consolidated general government available on a yearly basis.⁵⁷

Many countries, including some major ones, do not provide comprehensive and timely information on extrabudgetary activities. Particular shortcomings include the inconsistency and lags in social security data in countries where such institutions enjoy a high degree of autonomy. Moreover, because the data on the operations of subnational governments have not been compiled and consolidated with those of the central government in a timely fashion, full coverage of the general government has not been possible. For some countries, large and small, the sheer number of subnational governments poses a major problem. For others, consolidation is made difficult by the need to attribute a large number of hard-to-identify intergovernmental fiscal transfers to grantor or recipient levels of governments. Also, data collection may be inhibited by legal restraints or by the complexities associated with the interposition of an additional regional or provincial tier of government in the subnational structure. However, in some developing countries and economies in transition, the main difficulty stems from the lack of consistent recording and from delays in information, which, in turn, can be traced largely to the shortage of well-developed financial management systems at the subnational level.

Further evidence of the difficulty of providing full and timely coverage is that in 1995 only 40 IMF member countries supplied internationally comparable information on consolidated central government accounts for the most recent year; an additional 30 members provided data with a one-year lag; another 32, with a lag of two or more years; and 13 provided recent data covering only the central budget. Of these 115 countries, 45 report timely data on social security institutions, and fewer than 20 provide up-to-date information on subnational government operations.⁵⁸

In practice, even the general government falls short of full coverage of fiscal operations because it excludes quasi-fiscal activities (including the cost of regulations) of public financial institutions and nonfinancial enterprises. To account fully for direct or indirect government ownership of nonfinancial public enterprises, some countries, particularly in South America (e.g., Brazil, Peru, and Venezuela), publicly report data for the nonfinancial public sector; others (e.g., Costa Rica, New Zealand, Portugal, and United Kingdom) have expanded coverage to official financial institutions as well, that is, encompassing the entire public sector.⁵⁹ Albeit a step in the right direction, this broad coverage may be viewed as a rough approximation of the true magnitude of government functions, whether undertaken inside or outside the general government sector. In fact, such coverage cannot be used to identify the source of losses incurred by public enterprises or financial institutions, which may reflect a cyclical downturn or poor business decisions, or, alternatively, the cost of quasi-fiscal activities. However, in a significant number of developing countries and economies in transition, there is little, if any, public reporting of quasi-fiscal activities by the state-owned enterprise sector or financial sector.

The concept of general government activity, proposed in the revised Government Finance Statistics Manual, is intended to accurately capture the cost of all government functions, including quasi-fiscal activities conducted outside the general government.⁶⁰ Although still at a conceptual stage, this coverage would provide a useful complement to institutionally based measures of general government and deserves widespread application in the future. However, the measure does not remove the need to separately cost quasi-fiscal activities whenever possible. If these activities prove impossible to quantify,⁶¹ listing them would aid transparency.

Recording Basis

How government transactions are recorded, namely, on a cash or an accrual basis, is critical for the transparency of fiscal performance. On a cash basis, transactions are recorded when financial receipts or payments actually take place, even if there is no associated real economic flow.⁶² This approach can be useful for two reasons. First, it is preferred for short-run budgetary control and analysis. Whereas it may be difficult to alter budget commitments or payment obligations in the short run, it may be relatively easy to record and monitor cash payments through treasury operations or, for example, to enhance revenue through an accelerated sale of assets. Second, cash-based accounts have been used traditionally to assess the first-order financial impact of the government borrowing requirement, if monetized, on inflation and on the external balance. By contrast, on an accrual basis, all economic transactions are recorded as they occur, regardless of whether the transaction is an in-kind or a for-cash payment.⁶³ Because transactions are recorded when they reflect changes in government assets and/or liabilities, including depreciation of plant and equipment, this approach permits full consistency between the government’s income statement and balance sheet.⁶⁴ Accordingly, accrual-based accounts are indispensable for gauging the macroeconomic repercussions of fiscal policy—as well as the resource implications for the management of specific government programs—especially over the medium to long term.

In practice, neither the cash nor the accrual method needs to be adopted in a pure form; indeed, some countries find it attractive to pursue a modified cash or a modified accrual approach.⁶⁵ In countries that rely on the cash approach alone, the recording of certain important government transactions can be either distorted or nonexistent. Major areas where nontransparency may arise would be the exclusion of information on the accumulation of arrears, transactions in kind, and the cost of borrowing at a discount.

Measurement of revenue and expenditure arrears has become a problem, especially in countries where the tax or social security administration may face legal or political impediments in collecting taxes or payroll contributions, or where cash limits or sequestration of funds is used to contain expenditures.⁶⁶ Exclusion of expenditure (tax) arrears leads to an understatement (overstatement) of government deficits.⁶⁷ Cash-based recording can, of course, be supplemented with memorandum items showing changes in floating debt that account for the difference between payment orders (tax liabilities incurred) and cash or checks issued (collected). However, payment orders issued often do not cover the full range of commitments made, and it may not be feasible to eliminate normal lags in processing checks; hence, floating debt cannot be regarded as a measure of genuine arrears.

Transactions in kind include certain grants and loans extended by one country to another and, sometimes, by one level of government to another; grants are more important in developing countries, and loans are more important in transition economies. Through such operations, a donor country may purchase goods and services and then pass them directly to the recipient or pay an outside commercial supplier to provide goods and services on its behalf.⁶⁸ In addition, barter transactions, which were frequent among former centrally planned economies (and vis-à-vis their free market trading partners), still occur occasionally in some economies in transition. Other noncash transactions include the issuance of government obligations—often in the form of securities—as payment for services received from suppliers, which, in turn, can be used to offset tax arrears or for tax refunds due to taxpayers; in a different context, tax arrears were written off with the transfer of equity to the government. In each case, the immediate effect of the transaction is an understatement of the true deficit.

A nontransparent accounting practice may arise in connection with noncash issuance of government debt, particularly in bank restructuring. Regardless of the recording basis, all interest payments involved in the bank recapitalization are to be shown as government expenditures. But under the accrual approach, the principal component of transferred government paper (less the market value of any nonperforming loans assumed by the government), if it is not accompanied by an increase in government equity, should also be recorded as expenditure. In either case, the net value of the transfer would contribute to an increase in government net debt. While always recording interest payments as expenditure, a number of countries have failed to show the principal component of the net value of bond transfers as expenditure. (For a review of country experiences, see Alexander and others, 1997.) Under this principle, any government debt issued in exchange for previous outstanding doubtful liabilities, including arrears, should be recorded as an expenditure in the amount of the difference in value between the new debt and the old debt.⁶⁹

Several governments issue discount securities, with a zero or a low coupon rate of interest. The transparency implications of these securities under cash recording depend on the exact formulation of interest and repayment terms. In most cases, governments can permanently reduce the cash measure of interest payments. The cost of the borrowing is instead placed “below the line” as amortization payments. In some formulations, amortization can also be delayed by requiring a “bullet” repayment at maturity. A similar understatement of interest cost may take place with bonds that carry a fixed interest rate, although the principal is indexed to inflation with the effect of understating cash expenditures.⁷⁰ In all these situations, under accrual-based recording, all interest charges, including the indexation component, whether paid at maturity or not, would be shown continuously during the life of the instrument.

Accrual-based recording has some potential shortcomings, above and beyond the limitations mentioned above. An often-cited deficiency involves the measurement of accrued tax liabilities so overdue that they can no longer be regarded as collectible because the liable enterprise may already have been liquidated or declared bankrupt. Such overdue taxes or payroll contributions for social security, often subject to unending litigation, cannot reasonably qualify as arrears. The preferred solution on a modified accrual basis is to measure all tax and contribution revenue on a cash basis.

Although cash is the predominant basis of recording worldwide, a number of countries have sought to complement it with, or shift altogether to, a modified accrual basis, broadly consistent with international accounting standards.⁷¹ So far, only New Zealand has moved to a comprehensive system of accrual-based budgeting, management, and recording; a few others have adopted at least partial accrual recording (e.g., France, Greece, Iceland, Mali, Spain, and Sweden) or intend to move to a full or partial accrual-based approach (e.g., Canada and United Kingdom).⁷² More generally, there is increased interest in accrual-based recording, including steps to reconcile existing cash accounts to an accrual basis, partly for greater transparency.⁷³

Valuation and Recognition

Accrual-based recording prescribes certain standards for valuation and recognition of assets and liabilities, with implications for the transparency of government financial statements. In this context, the treatment of capital assets and contingent liabilities deserves discussion.

The valuation and recognition of capital assets may be subject to varying treatment depending on the analytical purpose at hand. Accounting fully for investment spending when it is incurred captures the impact on aggregate demand, the focus of macroeconomic stabilization. By contrast, from the standpoint of resource use, only capital depreciation during the period should be shown, regardless of when the acquisition of fixed assets takes place.⁷⁴ However, this perspective—in line with the so-called generally accepted accounting practices applicable in the private sector, with full consistency in the calculation of the operating balance and changes in net worth—is limited for the government because of the difficulty of measuring the depreciation of fixed assets in an economically meaningful way.⁷⁵ Indeed, reliable measurement of the value of government assets in infrastructure, given, at best, a rather thin secondary market for such assets, is likely to pose a major difficulty in most countries. Hence, in some cases, it may be necessary to resort to somewhat arbitrary solutions.⁷⁶

In view of the unsolved valuation difficulties—besides the obvious distinction between government and private enterprises, whose objective function is to maximize net worth—the reluctance to prepare full government balance sheets is not surprising. The advanced economies, some developing economies in Asia and Latin America, plus a few economies in transition (Czech Republic, Hungary, and Poland) prepare timely data on gross public debt. Although practically all IMF member countries report data on their official international reserves, only 42 countries report up-to-date information on gross public debt. Most of these countries limit the compilation of government debt to financial obligations serviced through the central budget.⁷⁷ (Net government liabilities can then be calculated by deducting financial assets, in the form of securities and foreign assets, from gross debt.) In a few countries (New Zealand and United States), an effort is under way to publish a comprehensive balance sheet for the public sector as a whole. For these and other countries, the measurement of balance sheet information has been influenced by both the generally accepted accounting practices issued by private accounting bodies⁷⁸ and by the national accounting standards.⁷⁹

Besides correcting the market value of actual liabilities for inflation, public sector balance sheets are affected by the recognition and valuation of commitments and contingent liabilities. The importance of accumulating such liabilities as a vehicle for spending is underscored when they are substituted for actual government expenditures but not reflected in the fiscal accounts. Most governments undertake commitments (e.g., to multilateral institutions) and provide guarantees for credits extended by financial institutions (e.g., for business investment, commodity sales or purchases, and exports) for direct investment overseas and for bank deposits. Often, however, the motive for extending investment or loan guarantees—mainly to industries in difficulty—is the nontransparent postponement of budget outlays. In addition, governments provide social insurance for old age, unemployment, and health care—in most countries, against payroll-based contribution payments.

Although these liabilities represent a potential future obligation for the government, contingent on the realization of the insured occurrence—and thus the need to estimate their unfunded portion—they are not comparable or additive to actual government debt. In general, neither the funded nor the unfunded portions of contingent liabilities relating to social entitlement schemes should be included in the government balance sheet; likewise, changes in such liabilities should not be entered in an accrual-based income statement of the government. However, despite some measurement problems, the actuarial value of net unfunded liabilities for government employees’ pensions should normally be included in the calculation of government liabilities in the balance sheet—much like for private enterprises—because they represent a strictly enforceable contractual obligation. This practice, however, is not always followed, even in some major industrial countries. Leaving the arguments for estimating net unfunded government liabilities to Appendix III, it is worth noting here that the measurement of such liabilities is subject to certain technical limitations.⁸⁰

Many countries that compile government debt statistics show separate data on the unfunded portion of contingent liabilities and commitments other than those related to entitlements, specifying the nature of the commitments and contingent liabilities. However, these data are not formally included in a statement of government liabilities outstanding unless they can be quantified and definitely identified as requiring future expenditure. Although most commitments can be quantified, contingent liabilities are more difficult to measure, especially when they are not incurred with the expectation that they will have to be met at some future date. Rather, they are a form of indemnity for the entity receiving the guarantee, which may not be realized. Including the value of such guarantees in the balance sheet requires an assessment of the likelihood of default or some other event likely to require realization of the liability, which in many cases can be done with acceptable accuracy.⁸¹

Classification

Fiscal transparency requires that data on government operations be classified into analytically useful categories of flows and stocks. Short of an exhaustive discussion of classification issues, some areas where nontransparency is most prevalent are examined.

First, the breakdown of debt service between interest and amortization payments—and less frequently of certain nontax revenue flows between unrequited transfers and borrowing—is not always available in published government financial statements. Given the indistinguishable nature of such transactions, especially between unrequited transfers and financing, and the ambiguous nature of debt servicing under the former system of central planning, it is still difficult to draw the distinction between “below the line” and “above the line” in a number of countries in transition. There are also some developing countries that traditionally classify certain financing items above the line. An important distortion in measuring fiscal policy, in countries engaged in large-scale privatization of state-owned enterprises, is the inclusion of gross receipts from privatization with other nontax revenue in national presentations.⁸²

Second, separation of tax and nontax revenue can be a contentious issue, as is the occasional misclassification of revenue from capital taxation as a form of capital revenue, especially in some economies in transition. Misclassification of revenue by type of tax is rare, except for various types of income taxation, which, at times, is ambiguous. More frequent, however, is the unintended failure to disaggregate revenue at the subnational level of government. Of 83 countries reporting up-to-date revenue data to the IMF, only one-third provided any disaggregation at the subnational level.

Third, deficiencies abound in the classification of government expenditure. Without an adequate breakdown of spending, it is difficult to undertake a meaningful fiscal adjustment plan in terms of the composition of adjustment. Nearly all countries rely primarily on an institutional classification of spending⁸³ for purposes of budget preparation, legislation, and execution. Only for broad policy planning and analysis do most industrial countries and some developing and transition economies use an economic classification—largely subject to the shortcomings of cash-based accounting. Again, of the countries that reported up-to-date information on government expenditure by economic category, only about one-third did so at the subnational level. Deficiencies in this classification were especially evident in some economies in transition.⁸⁴ However, finer distinctions between current and capital outlays tend to be arbitrary even in the most advanced countries, some of which have traditionally failed to separate out capital expenditures in budget statements. Difficulties can also be found in the classification of the wage bill as distinct from other payments for services.

Far more problematic for most countries is to move from an institutional classification to a truly functional disaggregation of outlays. As an example, although education and cultural spending may be grouped under the same ministry for legislative purposes, these two categories should be shown under separate functions. Relatively few countries are able to approximate satisfactory international standards in this regard, especially at the subnational level. Only 66 countries were able to supply the IMF with such a classification at the central budget or government level, and about 20 countries at the subnational level. Particularly helpful are ongoing reforms in some member countries (e.g., Italy and United Kingdom) to align the management and control of government operations on the basis of a functional classification of expenditures. For analytical purposes, it is useful to separate discretionary spending from expenditure under mandatory programs, insofar as the latter may be altered only through structural reform over the medium to long term.

Finally, disaggregation of financing flows and the corresponding debt stocks by currency denomination, maturity of (securitized) instrument, and source (domestic bank, nonbank, external) is available for only a limited number of countries. Of particular difficulty is establishing consistency between financing flows and the stock of outstanding debt classified on a uniform basis and between financing and revenue and expenditure above the line. Part of the difficulty stems from the diversity of data sources. Whereas below-the-line data on financing are derived mainly from monetary and balance of payments accounts, compiled (for the calendar year) by the central bank or the statistical office, the above-the-line data on government operations are usually recorded (for the fiscal year)—sometimes using a different recording base—by the responsible fiscal authority. Only 40 countries were able to provide timely data on financing flows and corresponding debt stock by type of instrument and creditor at the central government level; of these countries, only a few did so at the sub-national level.

Direct Indicators

The most commonly available fiscal indicator is the overall balance of government operations, published by nearly all IMF member countries on a routine (at least yearly) basis. As a first approximation of the impact of the budget on domestic demand, this indicator is subject to all the distortions in coverage, recording, and classification found in each country’s fiscal accounts discussed in Appendix II. Among these distortions, the most prevalent and significant is the exclusion of extrabudgetary operations—particularly social security accounts—and of quasi-fiscal activities. Apart from the above nontransparencies in measurement, some countries present the budget balance by excluding or misclassifying some or all of the economic flows associated with the external sector. Others tend to significantly understate the true deficit and fail to report data on deficit financing. For purposes of policy formulation, certain countries (e.g., Australia and European Union (EU) members) intend to follow the more transparent definition of an “underlying balance,” which excludes one-off transactions, especially privatization, even if they otherwise rely on cash-based recording.⁸⁵

Measurement of subsets of the overall balance depends mainly on the adequacy of economic classification, as discussed above. Calculation of the current balance as an indicator of the government’s contribution to national saving requires a clear separation of capital and current transactions, which is difficult to achieve without a satisfactory measurement of government investment expenditure. Furthermore, if conventionally measured, government investment may not provide a meaningful gauge of the long-term effect of public spending insofar as it includes some nonproductive capital structures (e.g., executive palaces and monuments) yet excludes current expenditures on human capital through education and health care. Notwithstanding these caveats, many developing countries show separately a capital or development budget balance in the context of their development plans.

Similarly, the primary balance, calculated to determine the fiscal policy effort necessary to stabilize or reduce public debt, requires that net interest payments be excluded from the overall balance. In some countries, interest payments cannot be readily separated from capital transactions or from financing flows. A number of countries (e.g., Argentina, Italy, and United States) include calculations of the primary balance in budget documents. Measurement of the operational balance entails both identification of interest payments and deduction of the corresponding inflationary component of those payments from the overall balance. Notwithstanding some potential measurement problems,⁸⁶ the operational balance is routinely calculated, as a supplement to the overall balance, in countries that have experienced high inflation and large domestic indebtedness (e.g., Brazil and Israel). However, some advocates of the operational balance concept argue that even countries with moderate inflation should apply this concept to avoid adopting an inappropriate fiscal policy stance.⁸⁷

Some countries with a traditionally large public enterprise sector (e.g., Italy, Portugal, and United Kingdom) report the public sector borrowing requirement on a cash basis to assess the net impact of the public sector on financial markets, implicitly taking into account the net effect of quasi-fiscal activities of state-owned enterprises and financial institutions, but without revealing the underlying gross flows. Although occasionally subject to debate and to varying treatment, for consistency, privatization receipts are often removed from the public sector borrowing requirement.

Given the difficulties of valuing government assets with precision, gross debt is widely regarded as a more reliable and internationally comparable indicator.⁸⁸ Alternatively, by subtracting only negotiable financial assets—mainly domestic securities, gold, and foreign exchange reserves—the net debt ratio could be an acceptable variant.⁸⁹ The most ambitious refinement, of course, is the calculation of government net worth. Perhaps because of the ambiguities in valuation and recognition of certain assets and liabilities, only New Zealand has begun to publish a comprehensive and consistent set of statements of the operating budget balance and net worth for the public sector, following the generally accepted accounting practices. (See New Zealand Treasury, 1996.)

Analytical Indicators

Measures of actual government balance and debt, or their variants, as a proportion of GDP may be useful as a first approximation of ex ante fiscal stance and sustainability or of ex post fiscal performance. However, given the inherent limitations of such direct indicators, some countries have adopted a number of more focused analytical indicators, either as a permanent feature or at least on an experimental basis.

To ascertain whether fiscal policy is expansionary, contractionary, or neutral, various summary indicators of fiscal policy stance have been developed by removing the effect of cyclical fluctuations or exogenous shocks from the direct measures of budget balance. The simplest analytical measures of fiscal stance are those based on the full employment surplus (developed in the United States) or the cyclically neutral balance (Germany) and, alternatively, of fiscal impulse, measured by the change in the cyclically adjusted effect of the budget (as originally published by the Netherlands). All are compatible with virtually any macroeconomic model and impose rather modest additional data requirements. They require information on the natural rate of unemployment or on a satisfactory measure of the level of potential output. Calculation of the structural balance requires, in addition, estimates of the elasticity of each major tax and transfer category with respect to GDP, which under the cyclically neutral balance are constrained to unity (see Heller, Haas, and Mansur, 1986). Because of the uncertainties surrounding these parameters and estimates of potential output underlying the level of the structural balance, it is preferable to look at the yearly change in the structural balance as indicative of the discretionary thrust of fiscal policy. When the influence of inflation is removed, the operational structural balance provides a useful indicator of discretionary policy in times of inflation. Meanwhile, measures of the primary structural balance abstract the combined influence of interest rates and the debt stock, on the one hand, and of cyclical factors, on the other.

Selection of the appropriate indicator for a given country depends on its stage of development, depth of financial intermediation, tradition, and, perhaps most important, computational convenience. A few governments, or their advisory agencies or councils, publish regularly (Canada, Denmark, Germany, and United States) or occasionally (France) an analytical indicator of fiscal stance, whereas others prefer to calculate such an indicator only for internal purposes.⁹⁰ No comparable official calculations can be found in developing countries, because structural shifts preclude reliable time-series estimates of potential output and GDP elasticities of tax revenue or transfer expenditure. Of course, this problem is compounded for economies in transition, where the extraordinary contraction experienced in the first half of the 1990s reflects the radical shift from a centrally planned level of output to a market-determined level of output.

Beyond the short term, it is of much interest to policymakers and financial markets to ascertain whether fiscal policies or, rather, fiscal institutions—including public pension and health care programs—are sustainable well into the future. There are only general definitions of what constitutes sustainable fiscal policy, and economic theory provides little guidance about the optimal or desirable level and path of the ratio of public debt to GDP.⁹¹ Only the actual prospect of insolvency and debt default signals a clear indication of unsustainability of the public sector. It is, however, useful to determine for any country, even with relatively limited data availability, whether its indebtedness is stable or explosive over the medium term.⁹²

A comprehensive indicator of sustainability should include the present value of net unfunded liabilities as a ratio of GDP, particularly liabilities consisting of the future stream of defined benefits for public pension and health care programs, net of existing assets and future contributions to these programs. However, calculating the actuarial value of unfunded liabilities requires long-term projections of social security benefits and contributions, as discussed below. At present, few countries (Canada, United Kingdom, and United States) regularly publish a transparent statement of all actual, as well as funded and unfunded, contingent government liabilities for social entitlement schemes. Recently, the present value of net unfunded public pension liabilities ratio has been calculated for most member countries of the Organization for Economic Cooperation and Development (OECD).⁹³ The ratio of contingent liabilities to GDP is neither comparable nor additive to the actual debt ratio of the public sector for purposes of determining sustainability. Rather, the ratio of net unfunded government liabilities to GDP should be interpreted as an indicator of the magnitude of the necessary structural reform of the public pension, health care, and other programs—by raising taxes or contributions or by rationalizing benefits—to restore financial viability to the social security system.⁹⁴ An alternative approach to evaluating the necessary adjustment involves calculating the contribution gap.⁹⁵

Whereas the foregoing indicators transparently show whether fiscal policy meets the intertemporal budget constraint, they convey limited information on the intergenerational equity of fiscal benefits and burdens. Increasing concern with not only fiscal sustainability, but also the intergenerational distributional implications, of the existing fiscal structure has spawned the construction of generational accounts, especially in countries with rapidly aging populations. In essence, generational accounts are aimed at calculating the difference between the transfers and services received and the tax payments (in net present value terms and adjusted for productivity growth) of a generation, given the eventual need to satisfy an intertemporal budget constraint.

Notwithstanding some proposals to substitute generational accounts for conventional budget balance measures,⁹⁶ the empirical implementation of the former imposes heavy data demands and relies on specific behavioral assumptions derived from the one-good, two-period, life-cycle model. The calculations are highly sensitive to the assumed determination of private savings (with most calculations denying liquidity constraints or a bequest motive); to the selected discount rate and productivity growth; to stylized assumptions about a range of taxes, including those on capital; and to the assumed absence of intergenerational benefit from public consumption or capital spending.

So far, only two countries (Norway and United States) are known to have published official calculations of generational accounts, whereas the OECD has prepared such accounts for five member countries (Germany, Italy, Norway, Sweden, and United States). These calculations suggest that, with unchanged fiscal policies, generations born in the mid-1990s can expect to face significantly higher tax burdens than present generations in most of these countries.⁹⁷ Although, clearly, it would be difficult to prepare such estimates over a wide range of countries, private researchers have attempted similar calculations for a number of other industrial countries (Australia, Denmark, New Zealand, and United Kingdom). As with the estimates of unfunded liabilities, generational accounts should be regarded merely as a broad indicator of the structural adjustment required to avoid aggravating the inequities among generations.

Projections

The formulation of fiscal policy as well as the concomitant public debate are usually predicated on projections of future trends in government finances and in overall economic performance. The more transparent the projections, the more informed the public debate and the more credible and sustainable the resulting fiscal policy decisions. Broadly speaking, explicit, realistic, timely, and internally consistent projections—whether model-based or judgmental—can be regarded as transparent. But transparency in the underlying macroeconomic projections does not necessarily ensure transparent fiscal projections. Transparency needs to be examined separately under different time frames: short- to medium-term forecasts, as distinct from long-term scenarios.

Short- to Medium-Term Forecasts

With the exception of the economies in transition and the least developed market economies, most IMF member countries have come a long way in developing and improving their ability to prepare macroeconomic forecasts through some combination of econometric or computational models and judgment.⁹⁸ The resulting macroeconomic forecasts provide the framework for forecasting fiscal aggregates. Although virtually all governments disclose forecasts of key macroeconomic indicators (growth, inflation, unemployment, interest rates, and key commodity prices), they may be reluctant to reveal the methods they use to derive them, including behavioral and technological parameters.⁹⁹ However, most advanced economies and some developing economies disclose the detailed macroeconomic forecasts they use as the basis of fiscal forecasting.¹⁰⁰

In the past, governments often adopted assumptions that were difficult to justify, especially about interest rates, unemployment rates, and output and income growth, so as to understate government expenditure forecasts and overstate revenue forecasts. The propensity for such practices—often based on assertions rather than on transparent measurement using empirical relationships—was particularly high when governments felt compelled to meet short- or medium-term fiscal targets. In recent years, however, many countries have become more realistic, open, and consistent in their forecasts, realizing that they are likely to be evaluated and challenged by their legislatures, the public, and financial markets. Under one approach (e.g., Canada), the government relies on consensual macroeconomic forecasts for the preparation of fiscal projections.¹⁰¹ Following another approach, country authorities deliberately use conservative macroeconomic assumptions (e.g., Chile and Netherlands).¹⁰² In a number of countries (e.g., Austria, Germany, Sweden, and United Kingdom), transparency has been enhanced by open debate with independent forecasting agencies or panels, created to assist governments in selecting realistic forecast values.

In preparing fiscal forecasts and the accompanying macroeconomic forecasts, policymakers should provide, separately, baseline projections that assume unchanged policies and alternative projections incorporating the impact of major (anticipated or recommended) policy changes. In most countries, official projections usually include policy measures, with the net budgetary impact of the measures—in terms of the value of revenue and expenditure measures—shown separately. Under the circumstances, the scope for nontransparent practices is rather ample. For example, poorly documented, pessimistic baseline projections may give a misleading impression of the size of the required fiscal adjustment.¹⁰³ A less obvious distortion involves reliance on rather opaque implicit tax or expenditure parameters. Instead, a fully documented set of baseline and policy projections, including feedback effects, should be published.¹⁰⁴

Preparation of comprehensive forecasts is, of course, beyond the reach of many nonindustrial countries, particularly economies in transition that are undergoing rapid structural change and lack adequate databases. In the interest of transparency, these countries should offer a public explanation of even rudimentary forecasting methods and assumptions used, so that users can gain some perception of the risks—both upside and downside—inherent in the forecasts. Although a significant number of member countries possess a modest forecasting capacity, the authorities seldom publish a note explaining the forecasts.

Quite apart from a rather uneven disclosure of the methodology and basic assumptions, nearly all IMF member governments provide fairly detailed forecasts for the annual central budget, subject to deficiencies in classification (Appendix II), as part of the draft budget bill they submit for legislative enactment for the upcoming fiscal year. Particularly enlightening for users of fiscal forecasts—lacking sufficient information on methods—is the publication of (1) a sensitivity analysis showing the response of fiscal aggregates to a marginal change in key macroeconomic variables, (2) a breakdown between discretionary and mandatory spending, and (3) supporting forecasts of “cost drivers,” such as the number of government employees and the number of beneficiaries of entitlements (e.g., Australia, Canada, and United States).

Detailed and open documentation of microeconomic linkages and assumptions (e.g., effective tax rates, tax bases, and parameters, including compliance coefficients or collection lags, used for each revenue category) underlying the fiscal forecasts is not readily available in most countries. As a result, it is difficult to assess any deviations of outcome from forecasts for specific revenue or expenditure categories.¹⁰⁵ Yet, logically, initial budget forecasts should be followed with periodic updates and an evaluation of how outcomes deviate from forecasts. In fact, several OECD member countries (Australia, New Zealand, United Kingdom, and United States) publish within-year updates, even in the absence of supplementary budget legislation. Such updates should be accompanied, if possible, by a public explanation of the reasons for significant deviations from forecasts.¹⁰⁶

With increasing concern for sustainability, in the 1980s, some industrial countries (Italy, Netherlands, Sweden, and United States) began developing multiyear budget projections—often contrasted with baseline projections—in the context of medium-term fiscal consolidation plans. At present, in some countries, these forecasts are simply meant to provide top-down guidance on the need for discretionary fiscal action beyond the current one-year budget period, that is, the baseline for formulating medium-term budget priorities. In some countries (France and Japan), the multiyear projections provide the context for the medium-term outlook for only the broadest fiscal aggregates, without necessarily spelling out the actual policy measures to be used for attaining the fiscal target.¹⁰⁷ Nevertheless, a number of countries (Australia, Germany, Italy, Netherlands, New Zealand, Switzerland, United Kingdom, and United States) provide detailed medium-term fiscal forecasts incorporating the authorities’ policy intentions.¹⁰⁸ Regardless of the approach used, the message of such exercises is that the built-in momentum of existing programs—especially mandatory entitlement programs—measured against the revenue yield of existing tax policies leaves a narrow, if any, margin for new program initiatives.¹⁰⁹

Long-Run Scenarios

A growing concern with long-term financial sustainability in view of rapidly aging populations, the rising cost of health care, and the rigidity of most social entitlements prompted some governments in industrial countries to prepare long-term scenarios showing the annual fiscal balance over a period of up to seven decades. They have carried out these calculations, mostly on an occasional basis, to examine the sustainability of existing public pension systems.¹¹⁰ There are, however, a few countries where social security agencies are legally required to publish each year long-term projections separately for each retirement fund (Canada and United States) and each health care fund (United States)¹¹¹ under alternative sets of general assumptions regarding economic growth, wage growth, interest rates, inflation, unemployment, fertility, net migration, and mortality, as well as under specific assumptions about disability, hospital, and medical costs. On the basis of these baseline projections, it is possible to test the effect of alternative reform options, such as tightening eligibility criteria for specific pension benefits or various cost-containment measures in health care programs.¹¹²

Overall, these scenarios contain considerable information, particularly regarding the path of financial balance over a prolonged period, and can be used to simulate in a transparent manner the effect of corrective reform measures.¹¹³ Furthermore, these scenario results can be summarized, using the present value of net unfunded government liabilities to choose an appropriate discount rate, as discussed above. Expressed as a percentage of GDP, the former can be interpreted as an indicator of fiscal sustainability, comparable across countries and over time. In view of the acknowledged uncertainties about the underlying macroeconomic and demographic projections and assumptions, presentation of scenario results should always be accompanied by a sensitivity test with respect to changes in key assumptions.

Botswana

Within Africa, Botswana has achieved a substantial degree of fiscal transparency. Factors that have contributed to transparency include a prudent and open budget process and a high level of competence in the civil service.

The government’s fiscal policy strategy is set down in published five-year development plans. However, these plans are revised periodically to take into account the evolving economic situation. Thus, in the published midterm review of the current plan, expected revenue shortfalls were identified, along with intended measures to reduce current expenditure and improve project implementation. Successive budget surpluses, driven by strong growth in mining revenues, contributed to a large accumulation of government deposits with the banking system and associated foreign exchange reserves.

The Seventh Development Plan, covering the period 1991/92 to 1996/97, announced publicly that the country intended to run down cash deposits to fund a revenue shortfall as mineral revenues slowed and current expenditures increased. During the preparation of the Eighth Development Plan, the Ministry of Finance and Planning released to the public a policy paper setting down the thrust of fiscal policies over the period to 2002/2003. Given the anticipated slowdown in revenues, particularly from the mining sector, the paper prudently highlighted the options to curtail the growth of government expenditure.

Tax legislation clearly specifies the rates and taxable bases. The authorities have resisted pressure to expand the extensive investment and other concessions available under the tax system. Tax administrators have limited discretion, and appeals are possible. At this time, the main problem in tax administration is the buildup of tax arrears, on which only limited information is available.

Operations of the central budget are recorded on a cash basis, with a clear breakdown of tax and nontax revenues and a functional and economic classification of expenditures, which accord with international standards. Although no balance sheet is prepared, accurate up-to-date records of gross internal and external government debt are published. Detailed annual data on the central budget are normally published with a lag of two to three months. Nonfinancial public enterprises and public financial institutions are required to publish annual reports. No comprehensive data on local government operations are available.

Although Botswana has an extensive range of financial and nonfinancial public enterprises, the authorities have largely avoided using these enterprises to engage in quasi-fiscal activities.

Chile

In the mid-1970s, Chile formulated an economic strategy to facilitate private sector development by reducing the size and role of government. It has maintained this strategy over time, and the scope of government activities has shrunk significantly. Subsequently, priority has shifted to improving efficiency in government activities, to ensuring that fiscal management is consistent with broader macroeconomic and social objectives, and to enhancing the overall transparency of public finances.

The role of the government has been reshaped through privatization of state-owned enterprises; decentralization of government activities (e.g., in primary and secondary education); shifting of traditional government services to the private sector (including health care insurance and management of pension funds); increasing of private sector ownership or participation in the construction, operation, and maintenance of public infrastructure (including electricity generation and distribution, harbors, and transport projects); and effective operation of the copper fund. The government budget has been in surplus over the last decade, partly as a result of these reforms.

The budget process has been designed to achieve transparent control over public finances and to ensure consistency of fiscal policy with the announced macroeconomic objectives. Each year, the draft budget submitted to the legislature contains policy statements on macroeconomic targets, supported by relatively conservative assumptions for key macro variables (including the export price of copper). It includes detailed operating plans for each spending agency and detailed revenue estimates by tax category. The draft budget is subject to review by specialized legislative committees; since 1995, budget execution has been monitored on the basis of quarterly statements submitted by the Budget Office of the Ministry of Finance with a lag of 60–90 days. The quarterly reports are widely available through publications and the electronic media (Internet).

Although operated outside the budget, the copper stabilization fund has played an important role in the budget process since its creation in 1981. The fund is required to deposit the revenues that exceed an established benchmark in a special account at the central bank. Use of the fund was initially restricted to debt service and subsequently to prepayment of public debt. In 1986, legislation formally establishing the Copper Compensation Fund provided clear rules for deposits and withdrawals on the basis of the difference between a medium-term reference price and the actual export price of copper. Changes in operating procedures for this fund must be jointly agreed to by four institutions: the central bank, CODELCO (the state-owned copper corporation), the treasury, and the budget office. Prudent management of the Copper Compensation Fund under transparent rules has lessened the impact of external shocks and allowed for a buildup of foreign exchange reserves. However, less transparent is the allocation of 10 percent of gross copper exports by CODELCO—equivalent to 0.6 percent of GDP during the 1990s—for military expenditures to a fund operating outside the budget. This allocation is in addition to the regular budgetary allocations to the Ministry of Defense.

Tax reform has resulted in a simple system, by international standards, with comparatively low rates and transparent bases. Tax administration has become broadly transparent, although some past exemptions have been grandfathered under various statutes, making it difficult to assess their full implications; also, these exemptions follow a variety of less than clearly defined objectives. The authorities have yet to develop a tax expenditure budget.

Reports on budgetary accounts, recorded on a cash basis, include consolidated central government operations and the operations of state-owned enterprises, but exclude those of the local governments. Government expenditures are classified by economic, functional, and institutional categories, and revenues are classified by tax categories, consistent with international standards. Chile subscribes to the IMF’s Special Data Dissemination Standard.

For a limited number of decentralized agencies (such as institutions of higher education), only budgetary transfers are recorded, whereas for the public financial institutions, comprehensive reports are published on a regular basis. The central bank’s balance sheet contains aggregate data on quasi-fiscal operations associated with schemes to support the banking system during the crisis of the early 1980s and with the placement of promissory notes for sterilization purposes. State-owned enterprises are operated transparently without hidden subsidies or preferential credits.

As part of the process of increasing the efficiency and transparency of government operations, the authorities are developing selective performance indicators for spending agencies. Recently, they adopted a pilot project and are expanding it to 65 specialized agencies by 1997, covering areas such as public works, mining, education, health care, and finance.

Denmark

Significant efforts have been made to improve the transparency of government operations in Denmark to strengthen financial discipline and to enhance oversight by the electorate. The driving force for these reforms has been the large size of the general government (total expenditures amount to 60 percent of GDP) and the high degree of decentralization (more than half of government expenditures are at the subnational level). The reforms included major legislative changes and deregulation in various areas, including financial and labor markets.

One of the key measures enhancing fiscal transparency was the harmonization of the budgetary systems of the central and local governments, which facilitated the publication of the annual consolidated general government budget. This entailed prescribing common budget standards, adopting a meaningful system of classification, and laying down a strict timetable for the preparation and legislative approval of the budgets at all levels. Current legislative provisions require all governments to disseminate clear information on their operations (in the form of pamphlets) prior to the budget debates in the national and subnational legislatures.

The government budget has been transformed from a mere accounting and monitoring device to an information vehicle to assist political decision making. The introduction of compulsory multiyear budgeting at all government levels has strengthened the budget as an instrument for medium-term policy planning by shifting the emphasis from short-term fiscal management to setting strategic priorities and longer-term objectives. Its introduction has been underpinned by comprehensive analyses of consolidated multiyear public investment programs for all levels of government. Government operations are now reviewed regularly by specialized bodies of fiscal audit, which publish their findings to further increase the accountability of government entities. The central and local governments are also required to monitor budgetary developments closely during the budget year and to prepare supplementary budgets if necessary.

In recent years, considerable efforts have been made to simplify the tax system. As a result, a large number of personal income tax payers need not file tax returns; tax authorities rely instead on administrative records for information on incomes, which are sent to taxpayers for verification. A system of advance rulings has been introduced to facilitate taxpayer awareness of compliance requirements, while a comprehensive statute protects taxpayers from discretionary action.

Denmark subscribes to the Special Data Dissemination Standard. The fiscal accounts, prepared annually, have a broad coverage that extends to the consolidated general government. This presentation typically forms the basis for the budget process and the determination of intergovernmental fiscal transfers for the forthcoming year (e.g., grants for new tasks to be performed at the subnational level). Although the accounts follow a cash-based recording, this approach has been supplemented in recent years by accrual-based recording for some items. The classification of expenditures and revenues closely follows international standards. Although no balance sheets are published, aggregate information on the value of public sector assets and liabilities (including a detailed breakdown of gross central government debt) is published on a regular basis.

Denmark regularly publishes official estimates of the fiscal impulse and the structural deficit for the general government sector, which the Ministry of Finance updates at least four times a year. Quasi-fiscal activities are virtually nonexistent. There has been considerable privatization; the public enterprises that remain are required to meet commercial criteria.

Hungary

Hungary has evolved from a country with secretive and nontransparent fiscal practices—including misreporting to the IMF—under socialist central planning to the one with probably the highest level of transparency among economies in transition as it becomes an emerging financial market. This transformation has been assisted by an active legislative and institution-building process. However, like other economies in transition, Hungary has yet to reach a level comparable to that of most industrial countries.

Since the early 1990s, Hungary has operated a highly decentralized and complex budget system, with the central budget receiving the revenue from the major tax categories and then making transfers to autonomous central budgetary institutions, extra-budgetary funds, and local governments. Although the Ministry of Finance exercised overall control over budget transfers, the system conferred considerable freedom of action on the various participants, many of whom retained some own-source revenue (mainly user fees) and were not subject to detailed monitoring of expenditure. The implementation of a centralized treasury system in 1996—with a single bank account through which all central budget revenues and expenditures are effected under the scrutiny of the Ministry of Finance—has contributed to both improved central budget control and transparency. However, the social security funds retain considerable independence, and reporting deficiencies make monitoring the funds’ activities difficult.

Timely data on general government operations are not yet available. For operational purposes, the authorities rely on information on the consolidated central government, which encompasses the central budget (including the operations of the central budgetary institutions partly financed by own revenues) and extrabudgetary funds (including social security funds). Data on over 3,000 subnational governments are available only with a significant time lag. Although subject to legislative approval, the operations of the privatization agency are excluded from the coverage of the consolidated central government (e.g., as in Germany). In 1996, the bulk of privatization receipts were earmarked in a transparent manner for debt reduction, although some allocations (partly in the form of loan guarantees) were made directly to state-owned enterprises (notably, the Borsod steel complex) and local governments.

Although all transactions are recorded on a cash basis, up-to-date information is made available for social security contribution arrears and contingent liabilities. Institutional and economic classification of expenditures is published for the consolidated central government, and a comprehensive functional classification is under development within the recently formed treasury.

Considerable progress has been made in compiling comprehensive data on financing flows for the consolidated central government, largely from balance sheet information prepared by the National Bank of Hungary. Indeed, gross debt data for the consolidated central government are published annually. Until recently, the task of compiling such information had been complicated by the unique public sector debt-management arrangements, whereby the National Bank of Hungary acted as the sovereign borrower abroad while the Ministry of Finance managed domestic debt. This arrangement was discontinued in 1997, and the Ministry of Finance assumed responsibility for managing all government debt and publishing comprehensive data on government liabilities. Information on new guaranteed debt to non-financial public enterprises is now published in the budget each year.

Like all former centrally planned economies, in the past, Hungary conducted a large number of quasi-fiscal activities through state-owned enterprises and financial institutions, although not to the extent of some of its neighbor countries, and the ongoing reforms and large-scale privatization have reduced the extent of quasi-fiscal activities still further. Although some nontransparent subsidies remain, the authorities have replaced most with explicit transfers from the budget. A legacy in this area is the large nonperforming loans—mainly to bankrupt state-owned enterprises—held by several state-owned banks. By 1995, the issuance of government paper to finance capital injections to these banks had been completed, with the servicing of the debt subsequently assumed by, and shown transparently in, the central budget. The remaining tasks of rationalization (including debt workouts and downsizing of a redundant workforce) and privatization are under way.

Although all the major taxes have been codified in tax laws—Hungary was the first former centrally planned economy to introduce fairly transparent tax rates and bases in the late 1980s—some remain excessively complex and are impaired by frequent regulatory changes. During the transition, a number of largely ad hoc exemptions and deductions were granted to private, especially foreign-owned, companies. Although the effect of past arrangements still persists, the ad hoc granting of new tax concessions was discontinued in 1994. The budget documents provide only fragmentary information on tax expenditures.

The State Audit Office, established in 1992, is fulfilling a mandate to prepare and publish reports on the performance of budgetary institutions, social security agencies, and selected state-owned enterprises.

Jordan

In recent years, Jordan has made substantial progress toward transparency. Historically, Jordan did not formulate a fiscal strategy. The need for a more concerted approach to fiscal restraint was clearly underscored by the explosion of government deficits and debt in the late 1980s. Since then, Jordan has publicly announced a medium-term fiscal strategy, supported by an Extended Arrangement with the IMF.

The budget law is enacted by the end of each year in accordance with comprehensive arrangements for the conduct of fiscal policy: the Ministry of Finance has the primary responsibility for preparing and executing the budget. The draft budget is reviewed by a parliamentary finance committee before it is submitted for legislative action.

Comprehensive information is available monthly and annually for the central government budget, which covers all departments and the Jordan Valley Authority. Budget coverage has improved substantially since 1990; it now includes within its ambit all extrabudgetary operations, except defense. A portion of defense spending is handled through an extrabudgetary fund that is financed through foreign loans. Military wages and operating costs are on-budget, but from published data it is difficult to determine the split between the two components. Earmarked revenues (in particular, a portion of import duties) are channeled directly to municipalities and universities and do not appear in the budget. Limited information is available on a number of decentralized government agencies (such as universities, institutes, marketing authorities, and other agencies) that, besides their own revenue sources, are also supported to varying degrees by budget transfers and state-owned financial and nonfinancial entities.

Government accounts are recorded on a cash basis and published with a two-month lag. The classification used in the annual budget follows a largely institutional format, but the authorities compile data for the Fund’s Government Finance Statistics Yearbook, reclassifying revenues, expenditures (both by functional and by economic type), and financing transactions according to international standards. Comprehensive data are also compiled on both external and internal gross public debt. Although no separate information is available on the large and accumulating unfunded liabilities of the public pension system, data on loan guarantees are published by the Central Bank of Jordan.

Jordan has a large state-owned enterprise sector, and the government owns shares in some private enterprises through its holding company, the Jordan Investment Corporation. Although these enterprises can borrow domestically, guarantees must be approved by the legislature. Overall, it is difficult to assess the relationship between the enterprises and the government. An annual report on public enterprises includes a consolidated balance sheet; however, no information is available on the extent of their quasi-fiscal activities. To improve the monitoring of public finances and increase transparency, public enterprises will be required to submit monthly financial statements and quarterly projections of revenue and expenditure to the Ministry of Finance.

The tax system has been simplified and modernized. The principal objective of the reforms has been to lower marginal rates, reduce the number of rates, and broaden tax bases. In principle, the degree of discretion in tax administration has been reduced. Tariff rates have been reduced and unified and customs procedures simplified. However, multiple rates and extensive exemptions and deductions remain, and the determination of tax liabilities is still often subject to considerable negotiation and administrative interpretation. Taxpayer rights and responsibilities are clearly specified.

New Zealand

New Zealand represents a benchmark for public sector transparency. The Fiscal Responsibility Act of 1994, which contains a set of principles for fiscal management and transparency, is the culmination of a decade of reform designed to improve the efficiency, effectiveness, and accountability of what had been a large and interventionist public sector.¹¹⁴ Until the mid-1980s, economic performance in New Zealand was disappointing because of inadequate adjustment to changes in the world economy. Since then, the government has made solid progress in downsizing the public sector, moving the budget into surplus, and reducing public debt. The measures to increase fiscal transparency may be seen partly as a means of assuring domestic and overseas investors that the government, regardless of political orientation, is committed to behaving responsibly.

The government is required to follow the fiscal management principles established in the Fiscal Responsibility Act, whose goals consist in reducing and maintaining debt at prudent levels; aiming for a balanced operating budget within a reasonable time frame, with allowance for cyclically induced deficits or surpluses; providing a buffer against possible adverse developments by maintaining adequate levels of net worth in the government balance sheet; and ensuring a reasonable degree of predictability about the level and stability of taxes. (The government is allowed to depart temporarily from these principles provided it explains its reasons and indicates how, and within what time frame, it plans to return to them.) In addition, the legislation obliges the government to publish the following: a budget policy statement setting down its strategic priorities for the coming fiscal year as well as its long-term objectives regarding revenue, expenditure, deficit and debt levels, and net worth; an economic and fiscal update containing economic and fiscal forecasts for the current budget year and the following two fiscal years; and a fiscal strategy report that explains whether the update is consistent with the government’s previously stated intentions and that projects the path of all relevant fiscal variables for at least 10 years. A separate preelection economic and fiscal update must be published two to six weeks before an election. The government is required to disclose all items involving fiscal costs or gains and to identify potential risks.¹¹⁵

The tax system is simple and contains clearly specified tax rates and bases. The Inland Revenue Department has limited administrative discretion in the application of the tax laws. The department assists taxpayers by publishing technical information on specific points of interpretation. Since 1992, the department can also issue legally binding rulings. Estimates of tax expenditures are not published—the substantial curtailment of tax deductions and concessions has rendered this task unnecessary. The law specifies taxpayer rights and obligations.

Public accounts are reported on a whole-of-government basis, which covers the consolidated central government (including decentralized entities) as well as nonfinancial public enterprises and public financial institutions (including the central bank). Subnational governments are not included in these accounts, but information on this relatively small sector is now collected in a timely fashion by the statistical agency. Quasi-fiscal activities are not separately identified, but their net impact is implicitly captured in the whole-of-government data. New Zealand’s accounting statements are accrual-based, but cash accounts continue to be published. Scope for creative accounting is constrained by the requirement to conform to standards set by the independent Accounting Standards Review Board. Detailed classifications of revenues and expenditures follow international standards. Comprehensive national balance sheets are produced semiannually. The statements attached to the balance sheets explain revaluation changes and contain comprehensive listings and estimates (where quantifiable) of all measurable commitments and contingent liabilities.