Performance budgeting is an important instrument for improving expenditure prioritization, effectiveness and efficiency. Its relevance is greater than ever today given the tougher fiscal circumstances that face many countries. Reaping the benefits of performance budgeting requires that the performance budgeting systems be properly designed and that they are accompanied by the right types of complementary reforms.
But what sort of performance budgeting works best at the government-wide level? What, on the other hand, does not work? What implementation strategies are required? These questions are the main focus of a chapter I have written for the recently published International Handbook of Public Financial Management. The chapter also identifies key supporting reforms required for performance budgeting to succeed, and addresses the special challenges of designing and implementing performance budgeting in developing countries.
The chapter emphasizes the central importance of designing the performance budgeting system properly, and in this context of avoiding the mistakes so often made of misconceived and unduly complex systems. Its key conclusions on system design are as follows:
Program budgeting is the most useful and relevant form of government-wide performance budgeting.
To succeed, program budgeting must be seen not as an isolated reform in budget classification but as part of a wider set of reforms. Developing the right type of program performance information – including evaluation as well as good indicators – is essential. So also are complementary reforms, including the development of better expenditure prioritization processes during budget preparation (spending review is particularly important here) and the reduction of expenditure inflexibilities. More generally, performance budgeting should be pursued within the context of a wider “managing-for-results” reform program.
The attempt to go beyond program budgeting with government-wide performance budgeting systems based on the across-the-board use of formula funding, purchaser-provider or bonus funding are misguided and doomed to failure. This is true both of attempts to replace program budgeting with these mechanisms (e.g., accrual output budgeting) and of attempts to combine these mechanisms with program budgeting (e.g., output-cost-based program budgeting). Reform blueprints along these lines simply waste effort and resources and lead to disillusionment.
Government-wide performance budgeting systems based on output unit costs – including output-cost-based program budgeting – do not work because there are many types of government outputs for which expenditure cannot be calculated by multiplying planned output quantity by unit cost. The problem is not just that the complexity of unit cost budgeting tends to be too great for developing countries – although this also is true.
Formula funding, purchaser-provider and bonus funding mechanisms work only on a selective basis and should therefore be applied only selectively (e.g. to school and hospitals) and in countries with sufficient capacity and resources to cope with their added complexity. Where these mechanisms can work, they provide a powerful means of promoting better performance, and should therefore be encouraged.
Integrating the setting of key performance targets into the budget preparation process can strengthen the government-wide performance budgeting system – but only if the right approach is taken to target setting. This means, amongst other things, selectivity in choosing targets and effective monitoring and follow-up of performance against targets. Target setting can be readily incorporated within the structure of a program budgeting system.
The chapter points out that performance budgeting has an important role to play in the support of good aggregate fiscal management under the current difficult post-crisis circumstances. The main reason for this is the close connection between improved expenditure prioritization and the control of aggregate expenditure. By helping government to identify and cut spending on ineffective and low-priority programs, performance budgeting helps to make fiscal space for new programs which address emerging challenges and thereby reduces upward pressure on aggregate expenditure. From this it follows that program budgeting – which focuses particularly on improving expenditure prioritization – has a particularly important role to play.
The new Handbook is of encyclopaedic dimensions (over 900 pages), and contains a wealth of other material of great practical use to PFM practitioners. It is, unfortunately, only available in physical book form (no Kindle or iBooks version), and is not cheap.