CHAPTER 5
Local Government Budgeting: Hungary
Ákos Szalai ■
Ferenc Zay ■
Mihály Hôgye ■
Izabella Barati ■
Ábel Berczik
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LOCAL GOVERNMENT BUDGETING—HUNGARY
Table of Contents
1.
Local Government System ............................................................................ 1.1 Introduction ......................................................................................... 1.2 Basic Issues of the Municipal System ................................................... 1.3 Local Politics and Administration ........................................................ 1.4 Functions of the Municipalities ........................................................... 1.5 Structure of Revenues ........................................................................... 1.5.1 Current Own Source Revenues .................................................. 1.5.2 Intergovernmental Grants to the Current Budget ...................... 1.6 Central Control Over Municipalities ...................................................
333 333 334 336 337 342 342 345 346
2.
Local Government Budgeting ....................................................................... 2.1 Budgeting at the National Level ........................................................... 2.2 Strategic Planning and Short-Term (Annual) Budgeting at the Local Level .................................................................................. 2.3 Basic Structure of the Local Budget ..................................................... 2.3.1 Fund System .............................................................................. 2.3.2 Extra-Budget Funds, Off-Budget Units ..................................... 2.3.3 Classification System .................................................................. 2.4 Budgeting Techniques........................................................................... 2.5 Major Stages of Budgeting ................................................................... 2.6 Participants and Actors in Local Government Planning ...................... 2.7 Information Systems ............................................................................. 2.8 Budget Implementation ....................................................................... 2.9 Auditing System ................................................................................... 2.10 Capital Budgeting ................................................................................
348 349
3.
350 352 352 356 359 361 369 370 371 375 380 382
Issues and Recommendations ....................................................................... 387
Notes ..................................................................................................................... 392 References ............................................................................................................. 395
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List of Tables
Table 5.1: Basic Data on the Size of the Municipalities (1999) .......................... Table 5.2: Total Expenditures by Function, According to the Tiers (1999) ........ Table 5.3: Municipal Current Expenditures by Functions and Cost Type (1996) ................................................... Table 5.4: Sources of Municipality Revenues (1998) .......................................... Table 5.5: Local Tax Revenues, According to the Autonomy of Municipalities (1999) .................................................................... Table 5.6: The Assessment of the Hungarian Municipal Budgeting Techniques Following Meyers’ Criteria for Effective Budgeting ........
332
335 338 340 343 344 387
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Local Government Budgeting—Hungary Ákos Szalai Ferenc Zay Mihály Hôgye Izabella Barati Ábel Berczik ■
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1. LOCAL GOVERNMENT SYSTEM 1.1 Introduction In Central and Eastern Europe, the Hungarian municipal sector is considered to be well developed. The importance of local budgeting is most easily demonstrated by considering three dimensions: (i) the municipalities deliver many public services and fulfill many tasks (especially in the light of their relatively low average size), (ii) their share of public finance is higher than in other countries in the region, and (iii) they have full decisionmaking power, with many constraints well-known in other developed countries being absent in Hungary. Municipal share of public finance: In 1997–98 the municipal revenue was approximately 28% of the revenues of general government and 11% of GDP. On the expenditure side the related figures were 23% and 11%, respectively. In the major fields of municipal activity, this share is much higher. For example, in 1998 in the field of education municipal expenditure was HUF 347 billion, which was 65% of total government spending.1 The municipal share from public sector investment was also extremely high at 70–80%.2 Great autonomy in local decision-making: In Hungary, the local budget is constrained by only very broad centrally defined limits. Many restrictions existing in other countries are absent. For example, there is no: • central approval for any part of the budget, e.g., for major capital expenditure programs or borrowings; • central provision for a compulsory number of staff, although in the field of law there are regulations requiring minimum standards for local public services; • requirement for keeping the municipal account at the treasury or at the National Bank, or for a treasury countersignature for bank contracts. The municipalities are free to choose banks for their accounts or for other financial services.
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The higher tiers are not required to approve the purpose, the currency, the maturity or other conditions of any loan. The most important restriction is that which limits the amount of borrowing based on the amount of own-source revenues. Our research: In light of the broad range of functions provided, of the significant funds involved and of the wide autonomy given, it is clear that the effectiveness and efficiency of the local public management are essential for the success of the whole public (governmental) sector. However, municipal management capacity is one of the least known features of the system. To assess the capacity of municipal financial administration, our research considered budget preparation to be the most important policy tool in the hands of local governments. Owing to time and resource limitations, efforts were focused on the issue of the links between budget preparation and policy-making, so some very important management problems (e.g., procurement and debt management) were ignored completely, and some others (e.g., the accounting, auditing, reporting and implementation process) were evaluated only from the viewpoint of policy-making. For drawing a more or less reliable picture about the current budget preparation practices: (i) the current Hungarian legislation and regulations concerning the municipal budget preparation and financial management process were analyzed, and (ii) the budget preparation process and the fiscal management techniques were evaluated in forty Hungarian municipalities.3 This group of local governments represents all types of Hungarian municipalities and was selected in order to cover three geographic areas (Heves, Komárom-Esztergom and Tolna) so that the information exchange among the neighboring municipalities could be appraised.
1.2 Basic Issues of the Municipal System In Hungary, the local government system contains two tiers: there are 3,100 municipalities and nineteen counties. There are two exceptions to the two-tier system: • The first exception concerns cities with county rights. They perform both municipal and county functions. Although this approach is common in western systems,4 in Hungary the number of cities with county status is exceptionally large (22).5 • The second exception is Budapest, which contains 20% of Hungary's population. The capital is both a municipality and a county, but it is divided into 23 districts.6 With an average population of about 3,200, Hungarian municipalities are smaller than in the most of the OECD countries and are most comparable to the more fragmented western systems (e.g., France and Switzerland). The size of sub-national governments must be appraised solely in conjunction with the issue of their responsibilities. From 334
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this viewpoint, the main problem of the Hungarian municipal system is that the local governments have more functions than in countries with similarly small municipalities. This fact causes problems because the smaller jurisdictions are unable to manage their functions. According to the basic legislation, all local governments regardless of their size have the same rights. However, there are some exceptions to this general rule. There is a concept in Hungary that the larger units should undertake more tasks than the smaller ones. The current system uses this in some fields (e.g., in social care, in firefighting, in building authority, etc.). Before 1990 the local authorities worked mainly as agencies of the central government and the local councils were subordinate to the county councils. In the new system, the intermediate level lost almost every right. Almost every municipal function was transferred to local governments. Moreover, in some fields, the local governments have the option to create extra limitations on the actions of the counties. For example, the functions of the intermediate level depend on a local decision, because the local governments have the right to take over any function from the county level (and can become responsible for institutions where more than half of the users during the previous four years were inhabitants of the municipality). But the local level may also choose to give back any of these functions (or institutions). The county level must accept and carry out the local decision.7 Table 5.1 Basic Data on the Size of the Municipalities (1999) Inhabitants
Number of Municipalities
Population
Total Expenditures [HUF billion]
Per Capita Expenditures [HUF thousands]
Capital Expenditures [HUF billion]
Less than 1,000
1,674
779,405
62.7
80.45
12.6
1,000–5,000
1,180
2,493,565
205.9
82.57
56.1
5,000–10,000
136
952,642
82.5
86.60
21
More than 10,000
118
2,267,353
273.3
120.54
56.2
Cities with county status
22
2,062,207
229.8
111.43
39.5
Counties
19
Districts in Budapest
23
Budapest
1
178 1,844,028
152.7 197.6
20.9 82.81
26.1 39.3
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1.3 Local Politics and Administration Mayor: The Hungarian legislation designates the mayor, who is elected by the local inhabitants, as the head of the local government. He chooses the nominees for the vicemayor(s) who must be ratified by the legislative assembly. According to legislation, this team is responsible for fulfilling and administering the decisions of the local government. The mayor is responsible for submitting, among others, the budget proposal to the municipal body. Practically, many municipalities attempt to involve formally or informally more local politicians in the proposal making process by creating an informal “government” for the municipality, e.g., from the heads of the committees. In Kecskemét, in accordance with the law, the work of the mayor is assisted by six consultants. Each consultant has a special field in which he can support the mayor's decision-making, e.g., civil service, tax policy, economy, technical issues, etc. The mayor, together with these six consultants, works out the economic plan of the town at the start of this political period. But thereafter, this body does not take part in the annual budget preparation.
Committees of the legislative assembly: The Hungarian municipalities are free to form any committees of their choice, with only one requirement. The Hungarian Law concerning Local Self Governments requires municipalities with more than 2,000 inhabitants to set up a financial committee. The tasks of the committee are defined by law. Naturally, the municipalities may give additional functions to the financial committee. For example, in many cities, the financial committee is responsible for assessing the business plans of the municipal companies as well as playing the central role (instead of the financial department or office of the municipalities) in cases where the company requires financial support from the local budget. Another frequent function of the committee is the participation of their members in the budget negotiations with the municipal institutions. In Oroszlány, the mayor, who is a member of FIDESZ, does not have a majority. The head of the committee and two members belong to the Socialist Party. The committee is involved in every stage of the budgeting process, e.g., they participate in negotiations with the institutions. The committee debates each proposal at a minimum of two meetings —initially in a common meeting and secondly in the so-called joint-committee meeting. In this joint meeting, every committee meets at the same time to discuss the budget proposal, so that this can be seen as a municipal meeting extending to all external members of the committees. The effectiveness of this method is proven by the fact that, in 2001, no proposal for modification was submitted at the common municipal meeting. Thanks to the activities of the committees, the municipality approved the budget during the first round.
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Administration: In Hungary, the notary is the head of the mayor's office. This office is responsible for administering the decisions of the local government, but it has many functions delegated from the central level through different laws. Therefore, the notary is the head of the municipal bureaucracy and of the local state administration at the same time. According to the Law on Public Finance, the notary is responsible for preparing the budget proposal that the mayor must submit to the legislative assembly.8 The internal structure of the mayor's office is not regulated—this depends fully on the decision of the notary. Within the field of financial issues, the cities with a small office typically form a single financial department (or financial office) which includes: (i) the budget team (dealing with budget, accounting and financial issues) and (ii) the tax administration. In large municipalities where both fields require large teams, these two functions are separated into different departments and offices. Although the Hungarian municipal system does not define special functions for the city managers, in many cases, the head of the financial department (financial bureau) naturally has a special place within the office. Informally, he is the second person in the mayor's office because of his special knowledge and skill.9
1.4 Functions of the Municipalities
Local Discretion In Hungary, the Law on Local Government defines a very broad range of functions residing with the local governments. However, the definitions are not clear and there are inconsistencies between this act and later ones. According to the Law on Local Government, the principal duties of the local governments are as follows: 10 township development; environmental protection (protection of important local natural sites, etc.); local housing; water supply, drainage, flood prevention; liquid waste disposal; maintenance of public roads and other public areas; local public transportation; public cleaning; local government fire brigade as well as local defense and civil defense duties; participation in the local energy supply; participation in the handling of local unemployment; nursery and primary school education; basic health and social services; support for local child programs; provision of local public facilities, general education, culture and sciences; support of local sport; ensuring the rights of the national and ethnic minorities and ensuring the opportunity for healthy life. In another paragraph, the law defines the following functions in addition to the previous ones: the provision of potable water; maintenance of public cemeteries; public lighting; support for local civic organizations.11
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Table 5.2 Total Expenditures by Function, According to the Tiers (1999) [HUF millions] Local Government
1.
General public services
2.
Defense
3.
Public order and safety
4.
Total Public Spending (Consolidated)*
173,033
366,198.1
556
98,319.5
14,140
198,609.0
Education
393,397
594,091.7
5.
Healthcare
224,583
513,095.2
6.
Social security and welfare
194,037
1,746,477.1
7.
Housing and community services
103,811
92,318.0
8.
Recreational, cultural and religious facilities
55,830
120,036.8
9.
Fuel and energy
0
2,647.4
10.
Agriculture, forestry, fishing and hunting
8,200
157,872.7
11.
Mining, manufacturing and construction, except fuel and energy
900
7,064.2
12.
Transportation and telecommunication
14,612
119,812.3
13.
Other economic affairs
11,648
109,920.8
14.
Other functions (including debt management)
10,066
967,140.3
15.
Total
1,205,813
5,093,603.1
*
Social security contribution paid by government units are included.
SOURCE: OECD (2000).
In addition to these functions, the municipalities have two main options for extending the range of their functions. 1) The Hungarian municipalities are free to undertake any functions not prohibited by law. 2) According to the law, the county should undertake any functions and should maintain any institutions (secondary schools, hospitals, etc.), the effects of which extend beyond any single local community. But by way of the aforementioned process, the local governments may take over or return any of these functions. Sectorial laws and regulations: Refinement (defining the exact meaning of local services, setting up standards for local services, etc.) is the task of the sectorial laws. For example, they define the compulsory number of workers, their working hours (e.g.,
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weekly teaching hours for teachers), the professional parameters of the institutions and the minimum values for the various supplementary income grants. Naturally, these sectorial laws and other legal regulations limit the decision-making freedom for the provision of compulsory public services. However, many of these regulations are not enacted by parliament (but instead, by a decree of the ministers or of the government) and therefore can be passed with only a simple majority (a two-thirds majority is not required as in case of a constitutional modification or an amendment to the Law on Local Government). As a result, the municipalities and many politicians (the opposition parties in every parliament) criticize such laws and regulations in every case because they are seen as attempts both to avoid the modification of the basic legislation (with a two-thirds majority) and to reduce local autonomy. Healthcare: It is worth presenting the municipal role in the Hungarian health sector separately, because this is a convoluted system with many players and with a very complex financing structure. As mentioned, the Law on Local Government declared that local governments are responsible for organizing basic health services. Basically, at the beginning of the 1990s, the municipalities became the owner of the facilities used for basic health as well as in- and out-patient services. The doctors and other staff of the health institutions were public employees. According to the basic principles, the health system was financed from two sources: the central level (health fund) financed operations and the owner (the municipalities) had to make the necessary investments. (The central government did set up some funding for the investments in local health facilities.) The central level transferred money for local health based on defined performance measures— e.g., the number of patients, the number of different diseases treated, the hours of services—but only for the services in those institutions having contracts with the Health Insurance Fund. The local government treated the transfers from the Health Insurance Fund as an earmarked fund which merely flowed through the local budget. During the past ten years most general practitioners became entrepreneurs, and some health services were also privatized. These services received a transfer directly from the Health Insurance Fund. But the municipalities remained the owner of the facilities, so they had to continue financing the necessary investments, which are also needed for the service of the private doctors. Most municipalities view their health services as an independent institution (similarly to the municipal companies analyzed below)—normally they must operate using their own revenues (i.e., the transfer from Health Insurance Fund), and the municipality becomes involved only in case of insolvency or of a major investment program. The mayor's office as an administrative agent of the central government: Most municipal systems, including the Hungarian system, are not able to separate clearly the functions of central and local governments. In Hungary, the central government delegates many functions to the local level. The notaries are both the heads of the municipal office as well
339
340 120
Fuel and energy
9.
12,260
11. Mining, manufacturing and construction, except fuel and energy
Recreational, cultural and religious facilities
8.
7,117
952
Housing and community services
7.
23,761
18,856
10. Agriculture, forestry, fishing, and hunting
Social security and welfare
Other medical and dental operations
4,193
37,051
Hospital operation and services
Family physicians and paediatrician services
61,186
Healthcare
6.
5.
126,815
31,229
Education
4.
4,471
Secondary school
Public order and safety
3.
56
79,088
Defense
2.
40,912
50
413
4,871
3,112
11,621
8,276
1,778
16,592
27,235
13,785
35,322
56,413
1,827
23
15,971
Purchase
345
1,605
6,238
16,266
10,203
5,040
930
18,906
256,654
5,326
12,114
26,259
526
62
4,019
of Goods
Purchase
415
1,926
7,487
19,518
12,243
6,047
1,116
22,682
30,792
5,960
13,557
30,100
631
74
8,069
of Services
104
482
1,873
4,880
3,060
1,512
279
5,677
7,706
1,395
3,173
7,213
158
19
1,341
VAT
0
0
52
9,632
52,469
0
0
5
89
843
950
1,998
0
0
26,316
Subsidies
0
0
0
0
0
0
0
0
0
0
0
0
0
0
6,479
Others
1,034
5,378
0
32,781
60,525
113,267
39,461
8,296
100,913
152,673
58,538
144,204
248,798
7,613
234
103,109
Total
••
Preparatory and primary school
General public services
1.
Employer's Contribution
Wages & Salaries
Table 5.3 Municipal Current Expenditures by Functions and Cost Type (1996) [HUF millions]
LOCAL GOVERNMENT BUDGETING PART II
SOURCE: OECD (1999)
15. Total
279,469
781
13. Other economic affairs
14. Other functions
410
12. Transportation and telecommunications
Wages & Salaries
122,336
319
166
Employer's Contribution
101,701
1,699
1,673
3,616
Purchase of Goods
123,872
2,039
2,008
4,339
Purchase of Services
29,989
509
502
1,084
VAT
91,706
0
0
0
Subsidies
Table 5.3 (continued) Municipal Current Expenditures by Functions and Cost Type (1996) [HUF millions]
0
0
18,606
12,127
Others
767,679
16,374
5,283
9,615
Total
LOCAL GOVERNMENT BUDGETING—HUNGARY
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as the representatives of the state administration at the local level. This is useful especially in cases where the number of clients is so high that the administrative or compliance costs of the program are minimized by local administration. Naturally, creating a parallel central administration at local level would be very costly, so the cheapest solution is to delegate the function to the local governments. But in these cases, the incentive problem arises from the fact that the local assemblies appoint a notary as the local officer, which is treated by the state administration as if independent of local interests.12 While the central government regulates these functions in more detail, the administration depends mainly on local decisions—e.g., how the mayor's office is organized, whether the local budget includes appropriate funds for these functions.
Differences According to Municipality Size or Type The Hungarian Law on Local Government states that each municipality has the same rights, but it is not necessary for each municipality to undertake the same tasks. It is possible to assign different functions to different types of municipality. This concept appears in the Law on Local Government where some special municipality forms (cities with county rank and Budapest) are defined. Some sectorial regulations differentiate further among the local governments according to their size. For example, the social assistance system requires the larger localities to be responsible for more social institutions. The larger municipalities (the towns) have some additional special functions, e.g., they organize: (i) fire stations, (ii) the prevention of cruelty to children and (iii) the building authority serving their small regions.
1.5 Structure of Revenues
1.5.1 Current Own Source Revenues According to many textbooks, the main indicator of municipality independence is the share of own source revenue (a small share of central transfers) in the local budget. In Hungary, more than 70% of the municipal operating revenues comes from the central budget.13 Local taxes: The most important feature of the Hungarian local tax system is the absence of the compulsory tax. The Law on Local Taxation only defines the options and the municipalities are free to decide which taxes, if any, they levy. The other special
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feature of the Hungarian local tax system is the predominant share of the local business tax, which is basically a sales tax. The main advantage of this form is that it is consistent with the concept of benefit taxation. However, the tax on production can be passed on if the local taxpayer has great market power, so the tax burden can be transferred to the consumers. Therefore, inhabitants of other localities pay a portion of the local tax. The other negative effect is that this tax is very dependent on the economic cycle, so that planning with revenue from this source is more difficult than with a tax with a more stable tax base such as a property tax. Moreover, the fiscal federalism (decentralization) literature frequently mentions the problems arising from harmful tax competition: differing tax rates on a mobile tax base (capital, income, etc.) encourage a movement to municipalities with lower tax rates. The result is a misallocation of factors or an establishment of efficiently low rates and public services if the local government reduces tax rates because of this intergovernmental competition. Table 5.4 Sources of Municipality Revenues (1998) [HUF millions] Local Government
Own source
339,018
Of which Local taxes
145,825
Tax sharing on contingent basis
98,387
Current transfers from central government and tax sharing on non-contingent basis
739,744
Of which unconditional transfers
356,703
conditional transfers*
371,888
matching transfers
3,415
ad hoc transfers
7,738
Other revenues Total
20,831 1,197,980
* including transfers from the Health Insurance Fund
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Table 5.5 Local Tax Revenues, According to the Autonomy of Municipalities (1999) [HUF millions] Category
a
b
1000 Taxes on income, profits and capital gains
c
d1
d2
d3
d4
e
179,090
1100 Individuals*
179,090
1200 Corporations 2000 Social security contributions 3000 Taxes on payroll and workforce** 4000 Taxes on wealth and property 4100 Recurring taxes on real property***
1,161 27,044
21,528
18,202
N/A
4200 Recurring wealth taxes
N/A
4300 Estate, inheritance and gift taxes
N/A
4400 Taxes on financial and capital transactions
N/A
4500 Other non-recurring taxes on property
N/A
4600 Other recurring taxes on property**** 5000 Other taxes on consumption*****
8,842
N/A
126,463
6000 Other taxes Total
154,668
200,618
NOTES: * ** ***
PIT (Personal Income Tax). Municipal tax on business. In category (b): sum of (i) land tax, (ii) building tax, (iii) municipal personal tax, (iv) tourist tax (on recreational property); in category (d3): duties. **** Vehicle tax. ***** Business turnover tax and tourist tax.
The table does not include revenue from duty (HUF 21,527 million in 1998) because it is not known what portion comes from duties on gifts and inheritance and what portion is from fees for public administration. (a) Municipalities set the tax rates and tax base. (b) Municipalities set the tax rates only. (c) Municipalities set the tax base only. (d) Revenues are split. (d1) Municipalities determine the revenue split. (d2) The revenue split can only be changed with the consent of the municipalities. (d3) The revenue split is fixed in legislation and may be changed unilaterally by the central government. (d4) The revenue split is determined by the central government as part of the annual budget. (e) The central government sets the rate and base of municipal taxes.
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The base of this tax is very unequally distributed among the municipalities. According to a calculation of the Ministry of Finance, the gap in the per capita tax base of the local business tax between the rich and poor municipalities is much wider than it would be, e.g., in the case of a property tax—the price of properties is more comparable in different municipalities than the local business revenues. The other important feature of the Hungarian local tax system is that the counties have no taxing power. Their tax revenues come solely from taxes the rate of which is set by the central government. User charges: The other main form of municipal revenues is the user charges (including administration fees). In 1996 revenues other than taxes made up some 60% of current own source revenues in the Hungarian municipal system. The business function in local governments: In Hungary, the option of the “entrepreneur municipalities” was refused at the beginning of the 1990s: the local governments were only granted those properties necessary for the provision of public services and for the operation of public institutions. So in place of the own source revenue from property, the central funds transfers played a significant role on the revenue side of municipal budget. With respect to investments, Hungarian municipalities are free to act like private companies. The only constraint is that municipalities are not allowed to participate in any companies where their liability would be unlimited. Naturally, the largest part of municipal assets is property, but about one-fourth of the invested capital is in shares. But most of these investments are in public utilities or in public service companies. As a result, entrepreneurial and property income was only about HUF 19 billion in 1996 at the same time that the value of the municipal property was HUF 1,299 billion (and the value of the shares was HUF 496 billion).
1.5.2 Intergovernmental Grants to the Current Budget Unconditional (general) grants: The basis of the Hungarian grant system is a formulabased grant. In 2000 there were 26 normative titles that included about 60–65 targets or formulas, each of which consisted of an index and a per unit cost element. Most indices reflect the load of the municipal institutions (e.g., how many children study in the schools, how many elderly persons live in hospices, etc.). A few of them are based on characteristics of the local community, e.g., in the case of the so-called “social norms”—the number of children, pensioners, unemployed people. The per unit cost element is the same for each municipality. The municipalities receive support according to these criteria, but they are free to allocate the funds as they desire—the central fund transfers are not earmarked. One of the main criticisms of this system is that it consists of many grants based on capacity and not on performance or need. Local governments have no incentive to set 345
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up new and perhaps more efficient systems to provide alternative approaches to meeting local requirements. The second difficulty is that the Hungarian equalization system (especially the cost element) does not deal with differences in tax and revenue potential. The system has been criticized as unfair, because the resources available to finance the “own expenditures” can be quite unequal among communities. Beginning in 1998, the central government created a fund from the shared-tax revenue for equalization purposes. The calculation of local tax capacity is based on the tax base of: (i) the local business tax, (ii) the company tax of the local firms and (iii) the personal income tax (for assessing the income of those small entrepreneurs who are not subject to the company tax). Conditional non-matching: The Hungarian public finance system contains many funds earmarked for specific programs.14 Matching. The Hungarian system contains two main matching grants (investment subsidies): the targeted and the addressed grant. The targeted grant is distributed normatively. The central acts define the targeted areas of this grant and divide the fund into subfunds for these fields.15 All municipal projects in these fields are eligible, but only the most important projects will receive a subsidy in cases where the central sub-fund is not sufficient to finance every project.16 On the other hand, the addressed grant is distributed based on the municipal application. Separate laws allocate this grant, with the responsible line ministry revising the allocation system to take into account total costs—and, in recent years, the local government's own source revenues. This grant is mainly used for local government investments in healthcare (hospitals), culture (theaters) and reconstruction linked to large-area tasks. According to the law, these investments must be above HUF 200 million. The regional development councils can decide on the support of smaller investments from their fund, and from the target-type decentralized fund serving to support local governments deemed as having unfavourable conditions. Vis major grants: In Hungary this grant plays a small role in the municipal finance system, although most municipalities apply for this fund. Therefore most municipalities prepare their budget to meet the criteria of this grant.
1.6 Central Control Over Municipalities Macro-economic control: The Hungarian municipalities are relatively autonomous. • There is no superior external control on borrowing. No approval needs to be sought in order to borrow or issue bonds. There is no central restriction on the maturity of any loan and borrowing does not come under any separate regulation. • The only limitation is the restriction on local borrowing: the Law on Local Governments limits the amount of loans to 70% of the sum of the principal own source revenues of the local government. However, there is no golden rule about the use of the loan. The loan can be used for current expenditures as well. 346
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•
Local governments may borrow from any financial institution, in accordance with market conditions. In general, an invitation to tender precedes borrowing. Usually the bank maintaining the municipality's bank account offers the loan on the most favorable terms.
This weak regulation of municipal borrowing indicates that the Hungarian system relies on market discipline: the financial market should assess the municipality's need for credit, as well as the need of private firms. This system strengthened in 1995, when Hungary adopted a very strict Law on Municipal Bankruptcy, which was the first in Europe. The Law on Municipal Bankruptcy regulates the process in case of insolvency. The insolvency criteria are the same and the process is very similar to the regulation of bankruptcy in the private sector. It is worth noting that in this law a new view about the municipalities appeared. While the previous acts stressed that municipalities, as public sector organizations, need special financial regulation (e.g., in the accounting system), this new municipal bankruptcy regulation currently exists only in countries where most municipal activities are under the financial regulation of private companies. Legal control: The central government continues to keep some control over the municipalities. This control can be analyzed in two dimensions: (i) the target of the control and (ii) the institutional form. This study concentrates only on the control over the municipal budget and the budget preparation process. (i) Targets. The Hungarian municipal control system concentrates almost exclusively on the issues of legality. Often only the local finance committee attempts to make any efficiency analysis and the other partners do not help in this effort. If a municipality wants to evaluate the operation of one of its institutions, it must hire an external (often expensive) consulting firm. (ii) Institutions. The Hungarian system is a typical agency system. Almost every ministry has field offices, but the most important is the County Public Administration Office, which is the agency of the Prime Minister's Office. This office has the responsibility for investigating the legality and regularity of local decisions. If decisions on minor issues are against the law, they can overturn them. However, in the case of a municipal decree, the office must petition the municipality to change the decree. If the local government does not follow such a request, the Administration Office may turn to the constitutional courts. In the field of budget preparation, the most important field office is the Territorial Public Finance Office (TÁH) which belongs to the Ministry of Finance. These offices both collect budget data from local governments as well as provide information to them. In addition, they calculate and account for salaries and other personal payments made by the municipalities.
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The State Audit Office (SAO) carries out external auditing. However, the organizational system of the SAO and its staff size are not sufficient to inspect the entire management process of the local governments with the necessary frequency (every three years) with regard to expedience, efficiency and legal compliance. The relevant legal regulations do not specify the frequency of full-scale audits of each local government. According to the OECD (1999), at the current SAO capacity, a comprehensive audit can take place at each local government, on average, every 50–60 years. Each local government with an annual budget above HUF 100 million must hire an external auditor to control the legality of the finance operations and municipal accounts. In countries with a state treasury, this generally has a large effect on the local budget preparation. In Hungary, the state treasury does not include the municipalities. But after the formation of the state treasury, a so-called net financing was introduced: municipalities receive contributions and grants from the treasury, the amount of which is reduced by the total of taxes and contributions related to personal allowances. Thus, municipal cash management requirements are reduced.
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Our research analyzes municipal budgeting from two aspects. 1. Meyers (1996) defined the key characteristics of an effective budget in eleven points: (i) accountability, (ii) comprehensiveness, (iii) constraint, (iv) cooperation, (v) honesty, (vi) judgment, (vii) legitimacy, (viii) perception, (ix) responsiveness, (x) timeliness and (xi) transparency. The first goal of this paper is to assess whether the current municipal budgets fulfill these requirements. 2. The budgeting papers and analysis issued by international organizations (OECD, World Bank) indicate that there are two main trends in the budgeting practice of developed countries.17 The governments attempt: (i) to allocate resources based on outputs/outcomes rather than on controlling inputs (performance budgeting), and (ii) to make budgets with a multi-year horizon. Therefore, the second goal of this paper is to study whether or not Hungarian municipalities employ such techniques. If these are not employed, the goal is to examine whether the current municipal budget preparation and financial management techniques are appropriate to introduce these new budgeting methods. We will concentrate on the key management practices required by these new budgeting methods: accrual budgeting and accounting, global (vs. line-item) budgeting, and performance measurement.
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2.1 Budgeting at the National Level Although the main focus of this paper is on local budgets, it is recognized that the central government could influence the local methods in many ways, especially through: (i) regulation and (ii) central examples. The following pages will present the effects of the central legislation in detail. This chapter deals briefly with four issues: (i) the role of the Ministry of Finance, (ii) off-budget activities, (iii) the negotiation process and (iv) political debates. (i) The Role of the Ministry of Finance The key institution of the Hungarian budgeting process is the Ministry of Finance. All core functions are concentrated here. It is responsible for creating the budget proposal and for controlling the execution process. The Ministry controls the treasury. (The treasury is an independent institution in the central budget.) The most frequently debated point in the system is macro-economic planning. Every new government has tried to shift this function away from the Ministry of Finance in order to create a center for macro-economic planning and to “terminate the bias toward short-term, fiscal issues.” But every experiment has failed. While the Economic Ministry also plays a major role in this field, the Ministry of Finance has kept its central position. (ii) Off-budget activities In the recent past, one of the main issues in the Hungarian public finance system was the move toward a unified and comprehensive budget at the central level. The first goal was to eliminate the great number of extra-budget funds (in the early 1990s more than ten funds existed). Most of them were merged into the line ministries, and only four of them have survived: the two social security (health and pension) funds, the labor fund and the nuclear fund. The distribution of the activities between the central government and the National Bank was also clarified and the quasi-fiscal activities of the bank were terminated, with, for example, the Ministry of Finance becoming responsible for managing the public debt. However, an opposite trend has appeared in the field of investment projects. The government has attempted to find a cheaper and more flexible way for financing major investments (especially in infrastructure), so the development bank has been strengthened in order to outsource some investment functions with the necessary funds. Naturally, this method is widely criticized as a step back toward a less comprehensiveness public finance system. (The companies and banks owned by the state were never part of the public finance system in Hungary.) (iii) Budget negotiations Over the years, the main constraint against “fiscal dictatorship” has been the interest reconciliation process. After preparing the budget proposal, the government had to have it accepted in two forums: in parliament and in the Interest 349
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Reconciliation Council, which was composed of representatives from both employers and employees. Due to its composition, the council dealt mainly with the issues of taxation, social policy, welfare and salaries in the public sector which had a great influence on salaries in the private sector. Parliament, despite the frequent criticisms expressed in political and constitutional debates, was politically forced to approve the results of the council agreement. Two years ago, this method changed. The new central government, as the part of its strategy against the power of the trade unions, limited the options of this council to the budget process and attempted to communicate the budget issues directly to the citizens. (iv) Political debates Besides some cultural issues (e.g., the functions of the Church, financing the cultural institutions, regulating the media), the most intensive political debate at the central level concerns the budget. The vote for or against the budget proposal of the government is the main indicator of the stability of the government, with the ruling and opposition parties being defined according to their vote on the budget. This political sensitivity toward budget issues appears only at central level, with most municipal bodies approving the local budget with near unanimity.
2.2 Strategic Planning and Short-Term (Annual) Budgeting at the Local Level The planning process is one of the weakest points in the Hungarian municipal budgeting process. Although central legislation requires that the local governments approve many sectorial local plans, these typically only list the “dreams” without assessing their (financial) reality. The lack of planning first appeared as a bequest of the 1990s when the rapidly changing economic situation impeded accurate planning. In addition to this, the frequent modification of the municipal financing system (especially in the central grants) also strengthened the resistance of the local politicians to spend much time on creating reliable plans. Currently, at the end of the great economic transition, planning has become the key point of the budgeting process, but the professional skills needed for planning are still missing at the municipal level. Moreover, in the former period, Socialism discredited the word “planning” because the socialist five-year plans were only a very voluntaristic and basically politically motivated document. Naturally, EU accession will create great incentives for the Hungarian public finance system to change current practices and to learn to make realistic plans that are also assessed at the end of the planning period. Hungary is among those countries where the central legislation contains requirements to create long- or medium-term sectorial programs (either in the form of general programs or of development plans for the given sectors). The Law on Local Governments states that
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the municipalities have to accept the given economic program (i.e., the four-year economic conception of the newly elected bodies). Other laws and regulations require the municipalities to prepare concepts for long- and medium-term plans in almost every sector. But there is no standard for the data content of these concepts, e.g., what information has to be included and presented. There is no requirement that the costeffects of the programs be compared to the expected revenues. This leads to the situation where the financial constraints are not taken into account during the preparation phase. The result is that the approved tasks cannot be fulfilled owing to a lack of funds. The Hungarian municipalities employ two methods during the creation of such programs to ensure that the annual budget will have sufficient financial resources. • Most local governments approve these programs without financial information, and the financial department becomes responsible for having the necessary financial resources for the program. Naturally, in this case the local politicians are aware that in case of a shortage of funds, the program will not be financed in the annual budget and it will be modified or delayed to the next budget preparation period. • The other—far rarer—method is the fiscal analysis of the plans at the time of their approval. Naturally, this also causes problems. At the time the program is set, only project expenditures can be assessed with some certainty, but revenues are very uncertain. And in case the program is approved based on “fiscal information,” it is far more problematic to modify the approved programs as a result of a lack of revenues. In Oroszlány, some strategies are presented together with their budget consequences, but some others are approved without this information. In these cases, the municipal body employs the so-called “contingent approval”—the financial department must search for funds to finance the program, with the municipal body understanding that implementation is contingent on the identification of these funds.. In Dorog, the committee system and its working method also emphasize the importance of the budget process. The financial committee, which is responsible for the budget and financial issues, holds its meeting after all the other committees have met. Its members evaluate the decisions and the proposals coming from the other committees and, in case they have budget impacts, they assess the financial consequences of the proposals. The municipal body debates the proposals of the committees (Economic, City Development and Environmental Committee, Social and Healthcare Committee, Education, Cultural, Sport and Foreign Affairs Committee) only if they appear to be appropriate. If the financial committee feels that the municipal budget will not be able to finance the program, the municipal body omits the debate of the issue. The other option is that the municipality guarantees only “theoretical approval” to programs with uncertain financial resources and declares that the actual implementation will depend on the financial situation of the municipality.
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2.3 The Basic Structure of the Local Budget This chapter deals with some basic issues of the required budget structure: (i) the issues related to the fund system, (ii) the off-budget units and (iii) the classification system.
2.3.1 Fund System Separation of capital and current budget: golden rule, operating deficit. In many countries (e.g., the USA) the public finance system differentiates two funds in the budget: one for the operating revenues and expenditures and the other for the capital budget. These systems attempt to constrain the cross-financing between these two funds, e.g., through the “golden rule” prohibiting a deficit in the current budget. However, most European countries do not follow this rule. In the opinion of opponents of this very rigid regulation, this rule is based on a false assumption, namely on the Harrod-Domar model which assumes a mechanistic relationship between economic performance and capital investment.18 Moreover, this could result in false incentive effects on the spending units. Because they do not have the option to shift funds between the two budgets, they will attempt to maximize both of them rather than changing the mix of operating and capital costs. In Hungary, each level of the government creates a unified budget. There is only one fund and there is no “golden rule” requirement. But the public finance (classification) system separates capital expenditures and revenues from operating expenditures and revenues into different lines of the budget both as a whole and at the institutional budget level as well. The local budget proposals have to include the municipal (cash-based) balance sheet which also indicates the capital and operating items separately. Despite the lack of a central requirement, almost every municipality in our research states that the balance of these funds is one of the most important features of the budget that is analyzed by local politicians. Many local governments define the golden rule as their main budget goal. Some of them have declared this goal in different local decrees, e.g., in the Local Decree on Municipal Property or in the annual budget concept approved in November. However this balance could be achieved only in a few cities. For example, one of the frequently mentioned “successful municipalities” has a budget in which 40% of the operating expenditure is financed from capital revenue. But the technique of separation is criticized frequently because it is based only on the value of the goods: capital expenditures are purchases above HUF 30,000. (This limit grows to HUF 50,000 in 2001.) But this definition does not take into account the useful life of the asset. On the revenue side, capital revenues are calculated as the sum of the centrally defined class of revenues. However, this system does not consider whether the revenue is one-off or recurring. For calculating revenues and expenditures 352
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(and balances) of the capital and operating parts of the budget, the municipal finance system provides another definition as well. Because the vis-major grant system requires the applicant municipalities to not invest more than the capital revenue, this system should allow the treatment of a small portion of the local taxes (on property) as capital revenue. Those municipalities applying for this transfer have to employ this definition, but many others also use this method when presenting the operating and capital funds in the required table of the budget document. Some municipalities define not only these basic “funds” in their balance sheet, but also differentiate others either based on central requirements or on local decisions for earmarking some revenues. In Tatabánya, the municipality declared that they would not approve a budget with a deficit in “the operating budget.” More exactly, the deficit in the operating budget may not be covered from capital revenue, but instead must be financed from credit. The budget separates not only the operating and capital budget. The operating budget is divided into two parts: (i) institutions and (ii) “city tasks.” This latter contains mainly those functions which were fulfilled formerly by municipal institutions, but since have been contracted out. On the revenue side, the Personal Income Tax (PIT), the vehicle tax and the municipal revenues are distributed between the two funds. The main principle was that, together with the institutional revenue and the central grant, PIT would be the only resource to finance the institutional expenditures. But currently 28.5% of the local taxes also finance the expenditures of the institutions. Thus, this three-fund-system is a little bit voluntaristic (especially on the revenue side), with revenue distribution shifts in almost every year. Owing to the reduction in the municipal share of the PIT, the reduction in the real value of the central grants, and the increased share of the institutional expenditures, the mentioned “source distribution” has to be modified for increasing the proportion of the “institutional fund.” Apart from these problems, this method seems to be an appropriate tool for indicating the budget constraints and limiting the expenditure requirements. The municipality created another special fund: the investment fund. The main goal is to ensure that revenue from the sale of municipal assets is spent only for investments. Following the budget decree, this fund may finance “only the purchase of goods for commercial and industrial goals and value-added investment programs.” Its sources were defined in former years and currently there are no new revenue streams for this fund. The total amount changes only if the municipality repays the money that was spent for other purposes from the fund in previous years.
Earmarked funds. Almost every budget has special revenue streams that are earmarked. In Hungary, the central legislation requires the separation of municipal revenues from two sources: • The housing fund. The central regulation requires that revenues from the privatization of council flats should be used only within the housing sector.
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The municipalities have to prove that the unspent money from this source is always on the municipal account. So, the housing fund is a typical fund with defined revenues and expenses. The central operational grants. The central grants do not have well-defined expenditure goals, but the central legislation forbids that these sources be used to finance the repayment of municipal debts. It is required that these sources be held in a separate sub-account and that debt repayment is not allowed from this sub-account.
The municipalities have unlimited freedom to create other funds and to earmark other revenues. • Naturally, the municipalities separate some funds for unexpected expenditures or for contingent programs, e.g., by creating general and special reserve funds. The number and amount of these funds varies within broad limits. The central legislation defines some expenditures which must be budgeted for these items. The general hardship (rainy day) fund is one of the most interesting parts of the local budget. In some municipalities, these are discretionary funds for the mayor, so the local opposition strives to reduce the amount or to set very broad constraints on its use. In other cities, the fund provides a backup for financing unforeseen expenditures and unrealized revenues. In general, the budget contains only a small amount for this hardship fund, but this has the adverse effect that the financial department is forced to plan additional amounts in other appropriations. Thus, the result of constraints placed on hardship funds is non-transparency of the budget. In Dombóvár, the local government appropriates every year 5% of the funds (including both operating and development funds) granted to the institutions. The rationale for this appropriation is that the revenues of the local government (either coming from the central government or from local sources) are uncertain. So the appropriation is an instrument for constraining institutional expenditures in order to preserve budget equilibrium. The institutions own revenue sources are exempt from this appropriation. The institutions must manage to finance their activities with this reduced budget. The municipal government can free up these funds following an examination of the budget processes of a given institution.
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The other frequent example are funds budgeted for specific politically sensitive policies (typically, for social care, healthcare, education, and environmental issues), the spending authority over which is given to the municipal committees. There are cities where such funds are not used and, at the other extreme, there are municipalities where all committees have discretionary funds. Naturally,
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the number and the amount of these funds has an effect on the administration of the budget decree: the more the budget contains these funds, the more the tools that remain in the hands of the local politicians for influencing the administration as well as for constraining and controlling the activities of the mayor and his office. This results in higher political accountability (the committees have more detailed control over the spending), but also in more rigidity in budget administration (the administration has to wait for the decisions of the committees). In Esztergom, the municipality grants special rights to the committees in the administrative process: they shift money among the appropriations of the mayor's office to the sectors of the committee. The only limit is that these shifts are prohibited from one main spending category to another (e.g., from personnel to goods and services). They use this right without prior approval from the mayor—the budget decree requires only that he be informed. Naturally, these rights are limited, because the committee decisions have to be signed by the mayor. However, this local decision creates very strong political constraints on the mayor's activity.
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And in some cases, the deliberative bodies are only prepared to levy new local taxes or other burdens on the local communities if the revenues are earmarked. This is generally viewed as a good method for informing the local taxpayers of the reasons for levying a new tax. However, most municipal financial departments are aware of the fact that this earmarking has no effect on real spending: the expenditure for the given policy goals would be financed without earmarking as well. The earmarked funds do not increase the fund for the given goal—the funds from other sources are replaced with this new one. In Oroszlány, the municipality has no earmarked revenue, but the idea for creating one appeared in 2000. The municipality proposed to levy a tax on residential properties and they communicated that this revenue would be earmarked for investments. In the end, the municipality canceled the proposal because of the strong pubic opposition to the plan. (The planned tax rate was high.) On the other hand, the earmarking was mainly a PR technique, because this revenue would not have had any effect on investment. The office forecast HUF 55 million from this tax, which was an insignificant share of the total investment (for road development alone the budget contains HUF 500 million in expenditures per year).
There are some municipalities where the fund is required to be balanced not only at the end of the year, but during the year as well (i.e., prior spending is impeded). In addition, there are municipalities which separate revenues into subordinate bank accounts in order to ensure that the money is used only for predetermined goals.
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In Gyôr, the local government created two additional funds. The tourism fund receives the tourism tax and the environmental fund takes in fines and some other special revenues (e.g., fees for replacing trees which have been cut down). In case of these special funds the municipality employs a special accounting system. Although the local government has not separated them into sub-accounts in the bank, the budget requires that, at the end of year, the office show that expenditures equal revenues from the defined sources. The local budget orders that expenditures from these funds may not exceed realized revenues.
2.3.2 Extra-Budget Funds, Off-Budget Units Creating extra-budget funds and off-budget units: Every public finance system provides the option to form public entities (e.g., foundations, companies, non-profit organizations) that are not part of the budget. But for the transparency and the efficiency of public funds, it is necessary that most revenues be part of a single budget. The Hungarian Law on Public Finance states that only laws may create separated funds, therefore local governments are not allowed to create an extra-budget municipal fund. The municipal cash flow has to be incorporated into a single, unified budget. The Hungarian municipalities are able to create extra-budget institutions only by establishing municipal companies or public foundations. But these are not part of the public finance system and instead work under the regulation of private laws. According to Hungarian law, local governments are allowed to take any economic action that a commercial unit or a person may do—the only constraint being that the municipal financial liability for the company may not exceed its equity in this. Thus, the company must be a limited liability company. Three main forms could be defined: • Municipal limited company. These are commercial companies working under the same rules as private companies. The only difference is that the municipality is the owner. • Municipal public interest companies. Public interest companies are firms (working under the Civil Law) which: (i) provide public services and (ii) do not pay dividends—the profit must be retained in the firms and used to finance the public service (the core function). • Public foundations. The municipalities are allowed to form or join a (public) foundation. The details are not regulated. The only requirement is that the elected officials must decide to support the foundation, so that every decision, irrespective of the amount, must be backed by a decree of the local municipal body. This form is preferred especially in case the municipality expects that the private sector will also support the goals of the foundation. This is the main form for gathering private money for public goals.
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Reasons: There are two main strategies for creating such off-budget units: (i) Many municipalities think that the management of an independent company will be more efficient. In this case the municipality signs a (long- or mediumterm) contract with the company for providing some public services, and the local government pays a fee to the company defined in the service contract. They do not deal with the issue of the costs of the service. Naturally, in case the firm is underfinanced for an extended period, it will go bankrupt and, in the end, the municipality will have to finance the losses of the firm. In Paks, two municipal institutions are run as independent, public interest companies owned by the local government but are excluded from the local budget. There is a difference in the financing of the two companies as well. The broadcaster signs a service contract with the local government every year, which determines how many minutes of municipal news it will broadcast and how much subsidy the company will receive in return. In contrast, the arts center must have its yearly activities accepted by the local government: some of its functions are financed by the town in full (e.g., library services) while its programs are only sponsored partially.
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The other extreme is when the municipality, as owner, keeps very strict (input) control over the management of the companies. The firm works similarly to a budget unit, but with a different legislative background. In this case the main reason for forming an off-budget unit is to utilize the options that the Civil Law accepts and that are not allowed for institutions in the public finance system. In Dorog, a very important tool in the hands of the city management is outsourcing: the transformation of many former municipal institutions into public interest companies. The first case was the cultural center in 1996. The functions of this new institution have been enlarged since then, with it becoming responsible for the management of the other (small) cultural center, for the youth camp, for local celebrations and for publishing the local newspaper (managing the printing). Seeing the success of this project, the out-patient health services and the technical city management services were transformed into similar organizations in 2000. The community-owned company is responsible for managing the municipality-owned residential and non-residential real estate, community services, road maintenance, cleaning and park maintainance. The main reason for these changes was the higher flexibility of the private units, especially in the field of human resources. As the example of the community center proves, the policy of unifying different functions into a single company yields extra savings due to the termination of parallel services and the reduction of the costs of the joint functions (although the shares of the joint functions are relatively low, e.g., the additional payment to the top management.) On the other hand, the (micro)control over these institutions is similar to the former method (when they were budget institutions). The municipality does not finance these institutions
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according to their functions or performance based on service contracts, but rather on the annual budget plans which have to be submitted to the economic department for evaluation similar to any request from the budget institutions. Based on this control, in some cases the municipal body has to make managerial decisions (e.g., whether it is necessary to heat the empty hospital property owned by the Holy Borbála Health Kht.). And the municipality, as the owner, directs the institutions to administer the municipal decisions.
Consolidation of the budgets: The municipal companies and foundations are not part of the local budget. The municipalities have ownership control over them. They appear in the budget only when cash flows from the municipalities to the companies or from the companies to the municipalities, e.g., in case of deficit financing, investment subsidy, payment for service, dividend or rent for using municipal assets. These transfers among the different units and between the units and the municipal budget (support, transfer or free use of municipal asset, dividend, investment on behalf of the municipality, etc.) would create a very complex system. But Hungarian budget regulation does not require presenting this information in the local budget. In most cases, the units with no budget effects (no subsidy, for services, dividends or rent to the municipality) are controlled through the municipal asset management, e.g., by the representatives of the local governments in the managing board or in the supervisory board. The members of these bodies inform the legislative assembly legislative assembly and the local administration about the financial situation. Some large municipalities set up a special committee for inspecting the asset-management (for among other things, the performance of these units) and for dealing with the issues of privatization. On the other hand, those off-budget units receiving money from the municipal budget are controlled in the budgeting process as well. In this case the municipality has to evaluate how much subsidy should be planned for the budget period. If there is no service contract between the company and the municipality, the municipality must gather information on the financial situation and financial plans of the firm during every budgeting process. In Gyôr, in the sectors where municipal companies deliver the services, the local investment can be financed in two ways. The investment could be part of the municipal budget with the service provider only receiving the asset for management (e.g., the sewer system). In other cases, the company undertakes the investment and the municipality finances the investment by increasing the capital of the firm. This latter method is employed only in companies fully owned (100%) by the municipality, especially in the community and real-estate management companies.
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2.3.3 Classification System According to the Law on Public Finance, the Hungarian municipal budget has to classify: (i) the titles, (ii) the main lines and (iii) the sub-lines. The titles are the municipal institutions. These can be fully or semi-independent. The main difference between them is the existence and function of the financial management in the institutions: the fully independent unit has its own financial management (e.g., accounting, banking), while the semi-independent units fulfill these financial management functions through (fully independent) institutions. The option for limiting the independence of the budget units is utilized in many municipal budget systems. Three main local strategies can be defined: • These semi-independent units are under the budget of the mayor's office. This is often employed for community services or for fire services. In these cases, the economic department of the mayor's office is responsible for fulfilling the management functions of the units. • The fully independent institution is an economic agency, which is typically set up only in order to fulfill these financial management and accounting functions for the semi-independent units. • The semi-independent units working in the same sector are unified into a single institution. Often this is used in the field of social care where the different services and institutions are unified into a single budget unit. The main lines are the total amounts of capital and operating receipts and expenditures (within the units). The municipal budget has to separate receipts and expenditures according to whether they are operating or capital, and it must establish the centrally defined classes or lines. The expenditure lines are for: (i) employee payments, (ii) social and other contributions paid by the employer, (iii) goods and services, (iv) social transfers, (v) other transfers and (vi) expenditures of the locally defined investments.19 The municipalities can modify this “central list” in many cases. Most municipalities present very detailed appropriations in the budget decrees, especially in the line for “goods and services.”20 The main reason for this separation is the variety of planning methods. For example, in some municipalities, expenditures for public utilities can be increased by the inflation rate, but the “other good and services” remain at the previous year's level. For meals provided by public institutions, the institutions calculate with the changing local norms. However, this modification in the planning method does not require that these expenditure classes be in separate appropriations. Performance budget: planning at the institutional or program level. Performance budgeting would require the assignment of institutional costs to services and programs.
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But within the mayor's office the division of expenditures is often presented according to the goals (or programs) as well. But in most budgets, this “program budgeting” covers only the “discretionary budget”: the basic structure of the office budget follows the standard expenditure classification (e.g., salary, contribution to social security, goods and services) and only the remaining expenditures, especially transfers to other institutions or for social policy, must be shown separately. However, there are municipalities where the budget represents the largest expenditure of the mayor's office. (See the examples of Gyôr and Baja where the budget of the mayor's office is more detailed and provides more information on the costs of different programs.) The main difference between the performance budgeting technique and the classical budget is that the classical budget focuses primarily on compliance and expenditure control, while the performance budget concentrates on the efficiency of the programs. The main issue in the classical budget is the micro-control of the expenditures and of the related output, while the performance budget provides information on the performance of the funded programs and services. Many experts consider the global budget to be synonymous with the performance budget, which consists of one consolidated appropriation for all operating expenditures. This method enables the institutional and program management to mix the different input types to fit the technical efficiency requirements. Functional classification is one of the weakest points of the Hungarian system. The public finance information system requires that the municipalities provide information on the revenues and expenditures of the different “tasks,” but the “tasks” differ from the functions. Tasks depend on the spending unit—e.g., in many cases, almost all spending of the mayor's office is accounted for as “administration.” This means that if the municipality signs an educational contract with a non-municipal school or with another municipality and then transfers money to that institution, then this spending will be classified as “administrative” and not educational spending. Moreover, the municipalities are not required to present this classification in their budget documents. In addition, the previously mentioned detailed classification of line “goods and services” is especially important because any shift between budget lines requires a municipal decision, so that if the institutions want to use their money in a different structure, they have to apply for municipal approval.
Summary Current situation: Hungarian budgets contain only one unified fund. There are no separate capital and operating funds, but most local governments follow the golden rule. The municipalities have no right to create extra-budget funds, but they can establish companies or foundations in order to benefit from either greater management efficiency or from less restrictive regulation in Civil Law. These institutions, as in many other 360
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countries, are not part of the public finance system. The central legislation provides minimal restrictions on local autonomy in the budget process. The most important regulations are: (i) the dedication of some revenues to defined goals and (ii) the classification system. The classification system requires that the appropriations in the municipal budgets be approved according to the administrative units and to the objectives of the spending (and the related revenues). Advantages of the current system: The current Hungarian system can be judged to be a well-functioning system, which meets the classical requirements for compliance and expenditure control. The requirement of the single budget and the restriction on creating extra-budget funds enhances the accountability, the comprehensiveness and the transparency of the local budget. Moreover, the central authority only imposes minimal restrictions on the local budgeting process so that local politicians have great autonomy for creating local budgets appropriate to the local requirements. Disadvantages of the current situation: The main problem with the current budgeting structure can be found in the classification system. This does not deal with a functional classification. The title system (institutional and non-program budgeting) and the very rigid virement system (each shift between the appropriations in the budget document requiring explicit approval from the municipal body) impedes a change in the focus of the budget process toward efficiency. Moreover, many municipal budgets over-emphasize these “control” requirements, e.g., by creating more rigidity in the local budget than the central authority requires. In summary, local politicians and administrative officials do not utilize their options for creating the elements of a performance-based budgeting system (e.g., global budgeting and outsourcing for greater incentives to efficient management with appropriate consolidation methods).
2.4 Budgeting Techniques The traditional line-item budgeting considers only the input size of the services and institutions. Incremental budgeting, which is the complement to the line-item technique, assesses budget requests using the previous year's input (expenditure) level as a base: this could be multiplied with the defined growth rate in every institution without analyzing the necessity of the expenditure level in the previous year.
Line-Item Techniques in the Hungarian Municipalities Planning the employee expenditure: Hungarian regulations force municipalities to employ incremental and line-item budgeting. The central budget defines the method through which the employee payments (and the contributions related to these payments) are 361
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calculated. This process has to start by defining the number of staff allowed in the given institutions as well as their salary structure. The budget document has to contain the number of the staff allowed and the budget has to be planned based on this data. These figures should be calculated according to the requirements in the central budget regarding the expected reduction in the number of municipal staff as well. This method means that, if the municipalities want to reduce employee payments, they also have to define the input structure in detail. Practically, this method requires that management decisions be made at the municipal level and not at the institutions. But most municipalities simply accept the number and structure of the current staff and recalculate the necessary number of workers only in case of great shifts in functions. In Szekszárd, at the start of the budget process, the local government gives the budget principles to the institutions and they have to construct their own budget on the basis of these principles. The principles are linked to functional indices such as the ratio of pupils to teachers or the number of lessons per week per teacher. These functional indices are calculated, e.g., according to the Law on Education. Using these indices it is easy to determine the number of teachers a school can employ. According to the calculated number of teachers (number of positions), the school receives funds for the employee expenses from the local government (wages, social insurance, etc.). Even if the school employs fewer teachers than calculated, the school is still obligated to give the legally prescribed number of lessons to the pupils. The school can use the total funds for employee expenses, but it has to meet its obligations, whether with overtime pay, contracting extra teachers or through some other solution.
Planning the “goods and services ”: The other main part of the operating budget is the expenditure for goods and services. The central government does not issue such a strict planning requirement for these items as for employee expenditures. The central budget contains only information about the rate of the expected increase in expenditures which the central government uses in planning the budget of the overall municipal sector. (This is referred to as an automatic increase.) The municipalities generally adopt these centrally defined rates. So while they employ line-item budgeting for employee payments, they use incremental budgeting for goods and services—the previous year's expenditures multiplied by the rate of increase. As seen in the previous chapter, municipalities refine the central techniques by dividing these expenditures according to the types of goods and services and then multiplying them by different rates. The actual value of this rate depends on the fiscal potential of the municipality. In the municipalities contained in our research, price increases for public services (utilities) are accepted in almost every municipality based on the expenditure for these utilities, but the rate of increase for other costs varies between zero and the inflation rate.
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In Oroszlány, for planning goods and services, expenditures are divided into three main categories: (i) Public utilities, which are forecast based on figures from previous years, (ii) Meals provided by public institutions, (iii) Others, which are allocated according to various formulae (e.g., classes, number of students, number of beneficiaries). Guidelines covering the main points and calculation methods are approved in the budget document in November. According to this document, the municipality does not increase expenditures for public utilities or other goods and services. This appears to be unusual especially in view of the increasing costs for public utilities. However, this practice has been employed for years and, despite the absence of additional fund transfers during the year, the experiments are positive—each institution was able to manage these costs.
Naturally, problems arise with this planning technique if the base year is not representative. For example, if the heating cost in one year is low as the result of a relatively warm winter, the appropriation will be inadequate in the next (maybe very cold) heating period, if the budget is calculated on this “warm winter basis.” Some municipalities attempt to avoid these problems by using a moving average method: the quantities of the most costly inputs are estimated based on average consumption during the last three years. New programs with no prior experience: One of the biggest problems that a budget officer has to face is the introduction of a new program with no base year experience concerning spending requirements. Fortunately most of these programs do not require new institutions. Because the current budgeting techniques are based on institutional and not program budgets, in most cases these programs can be started with no explicit change in the budget—the institutions are expected to finance these new activities out of the “basic” budget. They can meet this obligation either by employing some previously unproductive resource or by more efficient management. Problems occur only when new inputs and especially new institutions are required. In this case, the budget officer must depend on professional estimates provided by the internal line office. Naturally, this estimate is rarely accurate. But during the year the budget office can monitor whether the appropriation is sufficient to finance the new activity.
Forecasting Revenues and Expenditures Naturally, forecasting revenues and expenditures is essential for the creation of multiyear budgets. But the single year budget also requires an estimate of revenues and expenditures for the budget year, especially when the economy is unpredictable, e.g., a 363
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high inflation rate. Additional problems can arise if the primary own source revenues are very sensitive to the local economy, as is the case in Hungary. Revenues from the privatization of assets and from taxes levied on a variable base (i.e., the business turnover tax) are a significant part of the municipal budget. As a result, forecasting is one of the most important tasks in the budget preparation process. Tax revenue: Although it is well known that the primary local tax, the business turnover tax, is very sensitive to the tax base, the municipal officers do not take into account an estimation of the change in the tax base. Most municipalities plan this revenue with a simple mathematical or incremental method. • The “mathematical method” uses the previous year’s tax data and calculates the tax base which is then assumed to remain constant—only a change in the definition of the tax base would result in a modification.21 This “corrected” tax base is then multiplied with the tax rate. Obviously, this method does not take into account any change in the tax base (normally to a change in turnover). • The “incremental method” is based not on the tax base but instead on the tax revenue of the previous year. The “expected” tax revenue is calculated simply by multiplying the base year’s revenue with some economic indicator (usually the inflation rate). Revenue from privatization: Some municipalities view this revenue as being absolutely unpredictable and therefore do not waste effort and time to forecast it accurately. Instead, this revenue is used to “balance” the budget. Where the budget officers are not prepared to use this “dirty trick,” two methods are typically employed. Either only a small portion of the value of the property available for sale is budgeted or—in case of a more conservative fiscal policy—only the sum of the signed privatization contracts is used.22 The other main issue with regard to privatization revenues is the publicity of this data. Even if the list of property for sale is disclosed, the budget document does not contain an itemized list of expected revenues so that potential buyers cannot get accurate estimates of the expected sale values.
Performance Budget—The Role of Performance Indicators As defined by the OECD (1997b), the performance budgeting method links the planned performance level with the budget. But this method does not require direct links between the previous year’s performance and current budget. The role of performance indicators in the budget is only influential. In general, the ex-post evaluations play a significant role during the negotiation phase, when the budget officers and the managers of institutions set explicit output/outcome targets. These negotiations often result in an agreement between the financial department and the agency. These agreements are 364
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very similar to the performance contracts between the public and the private sector. Based on the indicators in these contracts, many countries set up incentive systems for public sector managers, e.g., in the form of performance-related payments, either on an individual (management bonus) or group basis. In many countries (e.g., in New Zealand and Great Britain), this is a widely used, or even obligatory, budget technique. Hungarian regulations do not require any output or performance information to be incorporated into the local budget documents. Naturally, because the definition of the expected performance is implicit, the legally defined consequences for bad performance are also missing. Management incentives are not part of the budget system and are based on the regulations regarding all servants and public employees. This system is frequently criticized with the argument that the rigid career and salary systems are not effective for motivating and rewarding management performance. The municipalities in our research employ quasi-performance based budgeting only in three forms. • Formula-Based Finance (especially for education): Several municipalities have attempted to create a formula with which the educational fund could be distributed among the institutions. Strictly viewed, this fund can only contain goods and services—owing to the aforementioned strict planning method for employee payments. However, this formula has not been implemented in most cities because according to the calculation of the expert team, this “new” budgeting technique would require more funds than the current appropriation. (This problem appears because some experts use the term formula-based finance as a synonym for zero-based budgeting and, in the Hungarian budgeting literature, zero-based budgeting is a “scientific calculation method” for defining the minimum cost of the necessary input. • Program Budgeting: In the recent past, program budgeting is the most frequently mentioned potential reform program in municipal budgeting. This is mainly the PPBS system. The main difference from the classical line-item budget is the long list of performance indicators and calculated average cost indicators contained in the annex to the budget document. The cities using this method provide a very detailed justification for the budget. This justification lists the programs and the planned activities of each program in very much detail (e.g., which bushes will be replaced from the park maintenance fund, how much will be spent to support a small children’s theater group). These contain detailed information about the performance of the different programs, but most of them measure only the quantity of the program (e.g., how many students attend any given school, how many meals are provided during the year in the public institutions, the size of the real estate used by the institutions) and not the quality of the programs or the public satisfaction. They attempt to calculate the cost and to define the performance indicators for each program and activity. 365
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Theo-retically, the method should define objectives and alternative solutions for every program, but as in the case of classical PPBS, this analysis is missing for most programs. Most local budgets contain a table which indicates the parameters used for calculating the central formula-based finance. Some cities have expanded this table. They provide more detailed information on the duty/performance level and compare these parameters with, for example, the number of staff in the given institution. (It is worth recalling that employee expenditures are the largest part of the institutional budget.)23 In Baja, the budget document presents some “duty and performance measures” in a table, which also contains the number of workers (planned status) according to the institutions. The numbers of workers are divided into: (i) core workers, (ii) administrators and (iii) economical, technical service. The duty measures are more-or less same as the central statistics. The main exception is for education where the figures do not present the number of students, but the number of classes. The only performance measure in education is the number of people provided with meals in public institutions.
CFOs define two main problems with the implementation of output/outcomebased budgeting. First, the currently used indicators are not appropriate for measuring the performance of the institutions. Second, there does not exist an effective incentive system for institutional management. The quality of the management is assessed typically only at the end of the period of appointment. During their tenure, the heads of the institutions are subject to evaluation only if their activities are against the law.
Accrual (Cost-Based) Budgeting or Cash-Based Budgeting While most countries use a cash basis in the budget process, some countries have changed to an accrual basis.24 The new GFS standards (GFS 2000) and the EU standards (ESA 95) also require that an accrual basis be used in the public finance system and that the deficit be calculated using accrual accounting. Although these standards are guidelines for reporting only and not for budgeting, it is clear that this change in reporting method is relevant only if it aids in the formulation of policy (budgeting for output, outcome). In accrual budgeting and accounting, revenues and expenses are recognized when incurred and not when cash is received or paid. Contrary to these suggestions, Hungarian regulations concerning public finance define the budget as “a financial plan and the related funds containing the allowed expenditure [...] in the budget period” (Law on Public Finance Section 7). This is clear—Hungarian
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budgets have to be prepared on the cash basis. Thus, Hungarian local governments are forced to employ the cash basis for budgeting. However, most CFOs not only employ these techniques, but also agree with the cited differences between commercial and public accounting. The accounting for capital expenditures also differs in the two systems. Accrual accounting, similarly to private sector accounting, spreads these costs during the useful life of the asset (through depreciation), while the cash-basis budget records the entire expense in the year of the investment. The utilization of the assets is one of the problems that the mentioned “program budgeting” technique attempts to solve—but this technique is built on the comparison of the net (depreciated) value of an asset to its gross (original, historical market) value. The aforementioned annexes contain such information for every institution.25 Naturally, this method is far from accurate because the mentioned ratio between the gross and net value is very sensitive to the time of acquisition, especially during periods of high inflation. But this can be viewed as a first step.
Multi-year, Guaranteed Budget In Hungary, there are two main tools to extend the planning period in the budget preparation process. Biennial budget: Beginning in 2000, the central budget of Hungary will have been enacted for two years. The new regulation allows the municipalities to prepare a budget for two years. However, most municipalities do not utilize this new option because they consider that most factors affecting the budget are unforeseeable in advance for two years. Baja is among those few municipalities which utilize the new centrally created option to create a biennial budget. They are able to do it because the most important parts of the municipal budget (the employee payments and the central grants) are defined for two years in the central legislation. Because Baja has many institutions, the central grant is by far the most important revenue source. Moreover, in planning for goods and services expenditures, the municipality uses only the centrally defined expected growth rates, the institutions must calculate their expenditures by multiplying the previous level with these rates. The most important difficulty was in planning the own source revenues. For operating revenues (19% of total revenues), the biennial local decrees (e.g., on the fees for services) create a strong basis for the planning of these revenues, and where this is not sufficient (e.g., in case of the local tax revenue) they also employ the centrally defined growth rate. The own capital revenue was planned at the level of HUF 207 million in 2001 and HUF 232 million in 2002. This source is only a minimal portion (3%) of the total revenue. Moreover, as the basis for this planned revenue, the budget classified real estate valued at about HUF 600 million (according to the financial department estimate) as property for sale.
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Rolling budget: The Law on Public Finance requires that the municipal budget show the full scope of the effects of the current year programs on the next two years. This would be useful for creating and analyzing the multi-year effects of different financing options for the same programs. But the local governments view this only as an unnecessary function because the data are unforeseeable. So the local rolling budgets cannot be used as a basis for budget decisions (e.g., timing the start of the significant programs). Multi-year forecasting: Naturally, the key issue in multi-year budgeting is what data to use for the calculations. Most municipalities employ the centrally supplied forecasts. (The central government issues annual guidelines containing the financial and economical forecasts of the central governments. These guidelines contain the central expectations on economic growth, other macro-economic indices,26 inflation, wage increases, the rate of social contributions, minimum wages and minimum pensions.27 In this document the central government indicates the centrally planned revenues and expenditures of the municipal sector as a whole, as well as the main lines of the cashbased municipal balance.) Multi-year liabilities: The regulation attempts to limit liabilities. According to the basic principles, multi-year programs can be approved only if certain future revenues will be enough to finance the programs and the operation of other municipal functions. Practically, this means that the legislative assembly should enact such programs by way of municipal decree.
Summary Current situation: Although there is no explicit central requirement for using line-item (or incremental) budgeting techniques, some points of the regulations (e.g., concerning the budgeting for employee payments) impede the use of other techniques. Among many others, this is one of the reasons why many municipalities use the incremental budgeting techniques in as many cases as they can—especially in the field of “goods and services.” Strangely, this method is also used in many municipalities also for predicting the main own source revenues (the business tax and privatization revenue). The current Hungarian public finance system requires the use of the cash basis for budgeting with three-year projections of the effects of the current year budget (rolling budget). From 2001 the municipalities have the option to prepare a biennial budget, but the majority of them (almost all municipalities) have chosen to remain with the annual period. Currently, the figures in most local rolling budgets are unreliable and not appropriate for analyzing the different options of the given local programs because these are calculated only by multiplying the base year data with the centrally supplied growth rate without analyzing the foreseeable local changes. 368
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Disadvantages of the current situation: While the Hungarian techniques meet the traditional requirements concerning the public finance systems, the new performancebased method is almost absolutely unknown at the municipal level. Although some local governments attempt to compare the performance of their related institutions (especially schools), performance-based budgeting techniques are not used. Because the current Hungarian regulation concerning civil servants and public employees defines a very rigid career system, most municipalities do not have an option for creating incentives (e.g., performance-related payments or other benefits). The instability of the primary own source revenues in the Hungarian municipal system results in many budgeting problems. In particular, because many budgeting techniques used locally only calculate the expected revenues from these sources based on the prior year's figures, they do not analyze the potential (and likely) changes.
2.5 Major Stages of Budgeting The Hungarian budget year runs from January 1 to December 31. This applies to both the central and local budget. The first step of the municipal budget making process is the government submission to parliament of the guiding principles for the following year's budget (by May 15) and the concurrent notification to the local governments of the main directions of budget policy. In the next phase, based on these guidelines, the mayor's office must collect the plans of the budget institutions for the next year. The revenues must be estimated; based on these estimates, the mayor's office prepares the budget ideas for submission (by November 30) to the municipal body. To support this process, the central level provides information concerning the amount of funds expected to be made available to the municipality in the budget year. After acceptance of the central budget, the Minister of Finance and the Minister of the Interior publish, in a joint decree, the central sources per local government and per legal title. By February 15 or by the forty-fifth day following the acceptance of the central budget, the mayor must submit the local budget proposal prepared by the notary to the municipal body. The municipalities have the right to act by local decree on the interim budget for the budget period before the final budget is accepted. During the year, the municipalities have an unlimited right to modify the budget. The central government defines only a very flexible standard concerning when the mayor may submit a modification: “The mayor can submit a proposal for modifying the budget to the legislative assembly, if conditions have changed so much that the implementation of the budget is jeopardized to a great extent.” 369
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Each year, local governments must prepare quarterly reports for the public finance information system by April 15, June 15 and October 15. In addition, semi-annual and annual reports are due by August 10 and by March 15, respectively. By April 30, the mayor submits the final accounts and the reports prepared by the notary. These documents must be supported by an audit report, if the municipality is required to hire an external auditor. Local variations: All municipalities prepare and most of them ratify the two required decrees on time (the budget concept by November 15 and the budget proposal before February 15). However, the remaining points of the centrally set timetable are not fully accepted at municipal level. The main variance is the point when the institutions enter into the budget process. Many local governments only collect the initial budget plans of the institutions in January, following the approval of the amount of the central transfers and the local budget concept in November. Many municipalities define the main guidelines for institutional budgets according to this concept. The main reason for this policy is to avoid having the institutions prepare unaccepted budget plans in many versions. Modification to the local budget: Most municipalities do not define explicitly the crisis situations requiring a modification to the local budget. Primarily, this is due to the fact that the local budget must be revised regularly every three months when the unplanned funds (e.g., from central transfers) must be recorded in the budget. (There are some cities where small budget modifications are discussed at every meeting of the municipal body.) The municipal officers view this frequency (every three months) as being appropriate for responding to the budget problems as well.
2.6 Participants and Actors in Local Government Planning In Hungary, the central government does not regulate in detail the range of the local participants. The only exception to this is for public employees. The regulation concerning interest reconciliation forces municipalities to form an Interest Reconciliation Board for the Budget Institutions. This board includes representatives from the public employee and civil servant unions and is given the task to negotiate the main issues of the local budget. Some municipalities extend the membership of these groups and institutions to include local civic groups. Leaders of the institutions: In many cases, the heads of the budget units are members of the municipal body (or of the committees), especially in the smaller municipalities. In the opinion of the CFOs, they constrain many reforms that would cut their funds or reduce their financial power. The role of external experts in the committees: Most financial committees have external members, and many of them are financial or tax experts. (However, in large municipalities, 370
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most of the committee members are delegated by their respective political parties.) Some municipalities attempt to make use of these experts by enlarging the role of the committees (e.g., when they participate in the budget negotiations or when all committee members participate in meetings organized by the municipality as in the workshop in Dorog.)
Publicity At the municipal level, the dissemination of the budget is achieved primarily through two channels: (1) the public hearings organized during the budget preparation and (2) the local (county) media. Public hearings: Public hearings, as required by the Law on Local Governments, are an open forum in which each participant can express an opinion on the performance of the municipal institutions and programs. According to the law, such a hearing must be organized annually. Many municipalities hold this meeting in the first months during which the new budget is being debated. In the opinion of the local officers, the outcome of these hearings is not very significant because the inhabitants” wishes are very biased in favor of investments and infrastructure developments. (Local politicians formulate similar wishes in the municipal bodies.) Voters and politicians are not interested in the problems of operating the public services, especially social care or education. Local media: Most Hungarian cities utilize the media for disseminating information about the local budget to the voters. Budget information is disclosed in local media in two main forms: (i) Live broadcast of the meetings. Many communities have their own local TV broadcast. The meetings of the municipal body meetings (and in some places the most important committee meetings) are broadcast on television. (ii) Short news articles. Because tax experts in the local media are relatively rare, local committee members or members of the mayor's team tend to write the articles reporting the local budget. These articles indicate issues which, in the opinion of the authors, seem to be most interesting or relevant for the local community. Typically, these concern tax rates and planned tax revenues (how much the citizens will pay for the municipality), the planned investments (especially with regard to major investments planned to start in the coming year) and the primary financial data (the total, the amount of the deficit, the planned financing, etc.).
2.7 Information Systems This chapter is structured according to two information types: fiscal (financial) and performance. 371
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Fiscal Information Contained in the Budget Document Information in the budget document: The budget proposal is prepared for politicians and the local community, so it should include all relevant information needed to assess the efficiency, effectiveness and fairness of the budget. Hungarian legislation lists tables required in the municipal budget documents, but naturally the municipalities are absolutely free to include other information in their own budget format as well. Central legislation defines only the format of the budget report required for the Finance Ministry's field offices (TÁH). According to the regulation, this final summarized report concerning the budget implementation must contain: (i) a cash flow statement, (ii) a balance sheet (according to the accrual basis), (iii) an accounting for unspent funds and (iv) income statement. Nearly every Hungarian budget contains, as the central regulation requires, tables presenting • revenues according to sources, • operating expenditures in total according to budget units (municipal institutions) and in detail according to lines (categories) in the institutional budgets, • capital budgets according to goals (programs), • expenditures of the mayor's office, in total according to the goals (programs) and in detail according to: (i) the general and (ii) the special reserve funds, • the number of staff (public employees) permitted within the budget units, • a rolling budget of the multi-year projects, • a cash flow statement with separate lines for operating and capital expenditures, for revenues and for planned borrowing, • the budget of the local governments for the national minorities. In 2001 the municipal budget documents were required to contain the monthly financial plans in order to estimate the liquidity situation of the municipal budget. Most, but not all, budgets indicate tax expenditures as well. Some cities (e.g., Tatabánya) list not only tax expenditures, but also the revenues lost as a result of reduced rents from the users of real estate owned by the municipalities. Most Hungarian municipal budgets typically analyze the following three issues: • Balance. Naturally, almost every document contains some paragraphs stressing that the municipality must follow conservative fiscal policy in the next period, that spending should be cut, that the appropriateness of the institutional structure should be analyzed, that the parallel functions should be terminated, etc. It is interesting to note that these paragraphs vary with respect to the definition of the deficit. Some budgets consider total revenues (including debt financing)
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and expenditures, while others define the deficit to be the overall credit in the budget and even others analyze the attainment of the golden rule.28 In Tatabánya, within the “city tasks” (see footnote 20), the budget attempts to present the amount of discretionary spending options available to politicians. There are separate titles for funds appropriated in long-term contracts and those which are available for “free” budget (political) decisions. Almost 22% of the “city task” is appropriated through contracts, so they can not be modified simply through a budget decision. But not all unappropriated expenditures are “free money,” e.g., the line for communal service contains both appropriated and unappropriated amounts in the same line—but the split is clear from information available in the annex to the budget. The other important example of unappropriated yet unavailable funds arises when the social policy defined by central legislation lists the criteria for eligibility and size of payments.
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Changes in expenditures and revenues from the previous years: In most cases, the annexes include tables indicating the amounts shown in different lines in previous year(s) as well as a written analysis comparing the intertemporal differences of the various aggregated expenditure and revenue categories (at the level of the main lines). Typically the written analysis concentrates on the revenue side, i.e., why the revenue mix shifted or by how much the amount of the central transfer was reduced. Expenditure level for different institutions and programs: In addition, many budgets contain inter-institutional comparisons in order to indicate the proportion of total expenditures covered by the central formula-based transfers. Especially for institutions in the same sector (primarily in the area of education), most budgets compare average expenditures of the institutions as well.
Inflated Data Requirements: Nearly all municipal officers complain of the great amount of unnecessary information that must be incorporated into the budget. Some of this information is viewed as being unreliable—most CFOs mentioned the rolling budget in this group. Other information would be useful, but the politicians do not use it, or worse, misunderstand it. This problem occurs frequently when information provided in the municipal budget has a different meaning than that used in the commercial sector—e.g., the structure and the total amount shown in the balance sheet. However, the data requirements are not inflated in every budget. Some offices attempt to protect politicians from an unlimited amount of information by preparing a budget of only ten to twenty pages. In some cases, this results in the omission of some centrally required data. At the other extreme, the aforementioned program budgeting technique creates documents with many annexes—the total length of which is more than 200 pages for a medium-sized city.
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Performance Information For analysis of the measurement of performance, the research concentrates only on two key issues of a performance information (audit) system: (i) the measurement and (ii) the criteria used for assessment. Measurement: Theoretically, performance measurement should indicate the efficiency and effectiveness of the programs and should provide useful information for decision-making (both for institutional managers and for budget makers). This would require adequate data that is limited in number and in complexity as well as the appropriate analytical tools for assessing the results. As mentioned in the chapter on performance budgeting, the Hungarian municipal budget usually contains some “task” or quantity measures for the institutions (programs), but there is no data about program quality or the related satisfaction of the citizens. Not only is this data missing from the budget document, but the whole performance measurement system at the municipal level is also very weak (almost completely missing in most cities). The formal municipal channels for gathering performance information from the institutions is missing because the institutional management is overloaded (especially in the preparation of many statistical reports that are never used) and the mayor's offices do not want to ask them to provide additional information. However, it is more interesting to note that while most municipalities commission public opinion surveys to assess the work and popularity of the local politicians and the mayor's office, this information is not used in the budget process nor is it used in most cities for strategic planning or for measuring the progress of medium-term programs. Assessment: The performance information can be utilized effectively only by comparing it with a database. In order to avoid arbitrary goal setting, a municipality should use intertemporal and intergovernmental benchmarks. • Intertemporal comparisons. As discussed in the section concerning fiscal information, the comparison of fiscal indices with similar data from the previous years is widespread. But in most cases, such comparisons do not give indications about the performance level. This data is presented in the budget not in order to measure the output or the task of the institutions, but only in order to inform the decision-makers about the calculation method used in the central grants. • Intergovernmental comparisons. In Hungary, as was previously shown, the field offices of the Finance Ministry (TÁH) collect “task” information. They prepare and publicize some basic indicators for use as benchmarks. Typically, these are national averages concerning local expenditures (e.g., expenses per pupil, expenses per hospital bed, etc.) listed separately by county and according to the size (and type) of the municipality. But the budget-makers do not employ these indicators during the preparation of the budget because of their high
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level of generality—the main statistical method (averaging) is not sensitive to differences in the number of clients (i.e., economies of scale) or to the varying fiscal potential among the municipalities. The typical case against a comparison based on average costs is that “...there are no two municipalities in the same situation....” On the other hand, occasionally, municipalities attempt to gather information from similar municipalities (e.g., cities with county right or similarly sized cities in the same county or region). However, these comparisons are rarely used for budget issues, but instead for the setting of fees for local public services, for tax policy and for use in special and infrequent problems (especially when the local government establishes medium-term sectorial programs or has plans to restructure some institution such as a theater or TV).
Summary Current situation: The central legislation defines the information (tables) required in the local budget. These tables concentrate almost exclusively on fiscal (financial) information. This list contains the most important fiscal measures, so that if the municipality follows the rules the local politicians are provided with much important information. Although the exact contents of this list can be debated, it does provide information relevant for more-or-less all important fiscal issues. Disadvantages of the current situation: The main problems connected to the information system arise from two facts. First, the centrally required information is vast and the amount is increasing continuously. Second, the central list does not contain any information about performance. Although the public information system does collect much data concerning performance, this data is not required to be included in the budget documents and the centrally administered databases are not analyzed and distributed adequately. As a result, local politicians must make budget decisions without reliable information about public services. Naturally, they would prefer to define additional requirements, but owing to the large amount of information required by the central regulation these extra demands would make the budget documents unmanageably large.
2.8 Budget Implementation The budgeting process contains not only budget preparation, but also implementation and execution. The finished budget is just a document. The overall quality of the budget also depends on its management and administration.
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Cash Management Practices Cash management has two extreme methods: a centralized treasury system or decentralization based on the principle of management autonomy. The primary reasons for establishing a treasury are the resulting specialization (and concentration) of knowledge, the simplicity of balancing the cash surpluses and deficits of individual agencies, the higher interest rates received on short-term (e.g., overnight) deposits and the special bank conditions given for large account balances. However, in this case, alternative measures of an institution's financial management performance may be required methods because the cash performance, which is one of the best indicators of the performance of the financial management, is not available. Central regulations concerning the rights of the institutional management. The central definitions of the main forms of the budget institutions are based on the main characteristics of their financial management (functions). According to central decree, the independent budget units must fulfill the following tasks: (i) planning, (ii) appropriating, (iii) establishing responsibility (i.e., set by laws or decrees), (iv) setting up the functions of the institution (operation, maintenance, investment), (v) utilizing the assets, (vi) managing labor, (vii) managing cash, (viii) accounting and reporting and (ix) gathering and providing the required information. The independent budget unit has its own CFO who is nominated by the head of the institution and approved by the municipality. All other employer rights are in the hands of the head of the institution. The CFO has the right to decide on financial and economic issues. Local treasuries. The Hungarian municipalities are free to decide whether to employ a single centralized account system or to maintain the decentralized financial management of the institutions. Naturally, if the municipality establishes a local treasury, the fully independent units will be downgraded to semi-independent ones. In the municipalities, opinions vary regarding the problems (costs) and benefits associated with the centralization of the cash management system. Although the central government employs and urges the centralized system, there are only a few municipalities which have a hard treasury with a single account and centralized accounting control.29 As mentioned, in smaller cities having fewer fiscal experts, the financial management was traditionally centralized in a single independent economic agency. While completely centralized cash management is rare, other forms of local treasury are set up in many municipalities: • In a passive treasury, institutional payments are made directly through the municipal account—the office sets limits on the total amount of transfers made in the name of the institutions, but does not control the individual payments.
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In Oroszlány, every institution has its own bank account and the financial management is able to achieve most of the benefits of the single-account system. The institutions keep their own source revenues at their bank account. The municipality does not transfer money to these accounts. As long as the institutional account is not depleted, the institutions are required to finance their activities without municipal transfers (i.e., from their own source revenues). When the balance of the account falls to zero, the municipality establishes a limit for payments initiated by the institution directly from the municipal central account. The money remains on the central account, but the bank accepts the payment orders sent by the institutions unless the established limits are exceeded. •
In a multi-account system, the municipality attempts to avoid having a shortage (and the resulting bank borrowing) in some accounts when at the same time there are surpluses in other accounts. Methods used include ad hoc financing when account balances fall to zero and transfers from the central account have not been received, the collection of money each night for deposit in its central account, the creation of an incentive system involving the sharing between the central and institutional accounts of interest earned on the institutional funds. In Gyôr, the so called ad hoc financing model is functioning. The basis for cash management consists of: (i) the monthly financial plan approved in the budget and (ii) the special “ad hoc financing” of the institutions. Ad hoc financing means that the mayor's office does not transfer money regularly (monthly, weekly) to the bank accounts of the institutions. Instead, transfers are made only when the account of the institution is depleted or when it must pay a bill exceeding the balance in the bank account. In this way, excessive amounts of noninterest-bearing funds in institutional accounts is avoided. The only exception to this is for the support received from the central government for vocational training, this being the only significant fund allowed to “lay” freely on the accounts. (The other own source revenues, typically, have to be paid almost immediately for the related expenditures of the programs generating these revenues—e.g., fees for meals, rent for the assets of institutions, etc.) The mayor's office controls the schedule of the institutional spending only in order to prevent excessive overspending by the institutions. In Keszthely, the institutions have their own bank accounts. But every night these accounts are cleared, with all money exceeding HUF 1,000 being transferred to the central account and the bank paying liquidity interest on the amount in this central account. The institutional accounts do not earn interest. Due to its special status as part of the Health Fund, the hospital is not involved in this clearing mechanism. Tatabánya employs a multi-account system. If the institutions have temporarily free, unspent money on their account, they have two options. (i) They can transfer this fund to the central account, with the municipality then granting supplementary appropriations as “interest.” (ii) The money can remain on the institutional account, but in this case the municipality takes this into account when calculating the weekly municipal transfer, thus reducing the municipal support.
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The institutions do not have interest-bearing accounts, so the only way for them to receive additional funds is to “lend to the municipality.” This incentive system results in the elimination of surpluses on the institutional accounts while at the same time maintaining the financial autonomy of the institutions. In return, the interest on the municipal account (and the savings arising from the avoidance of short-term borrowing) is shared with the institutions which disburse funds at a slower than planned rate.
Investment policy for surplus funds and short-term borrowing. The Hungarian municipalities are free to select a bank for account keeping. However, the local governments are prohibited from keeping multiple budget accounts (for budgeted cash flows). The Decree on Public Finance defines those revenues (targets) for which the municipality is allowed to open sub-accounts.30 The budget institutions are obliged to keep their accounts in the same bank used for the municipal budget. The central regulation permits deposits to be held in other banks as well, but payments for budgeted expenditures must be made from the budget account. The municipalities are absolutely free to purchase securities, bonds or shares. Previously, there was a regulation which allowed the municipalities to buy only securities backed by a state guarantee, but this restriction has been eliminated. However, many municipalities have maintained this regulation. The municipal decrees typically delegate decision-making about shortterm borrowing and investing activities to the mayor with limits placed: (i) on the amount of the credit and (ii) on the form of the investment (i.e., only with state guarantee).
Controlling the Budgets of Service Organizations (Expenditures and Own Revenues) Municipal services are provided by more or less independent units: in- or off-budget municipal units, companies, private partnerships, etc. Management autonomy in the units is crucial if the municipalities want to employ a performance-based incentive (e.g., performance budget) system. On the other hand, financial information about these units is also essential. Management autonomy in the budget preparation. The key difference between the performance and classical budgeting method is not the line-item format of the budget. The performance budget can be structured in a line-item format as well. The major differences of the new method are institutional and involve management autonomy to determine the structure of inputs (operational costs), to make virement and to save unspent money for future expenditures.31 For program management to be responsible for the efficiency and effectiveness of the programs, they have to have autonomy for deciding the expenditure mix.
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However, Hungarian regulations limit the freedom of institutional management. They do not have a centrally defined role in the budget-making process. The central legislation requires only that the budget preparation process start by collecting the institutional requirements for the next year plans and programs. But, as seen in many municipalities, institutional management is responsible only for calculating properly the budget request according to a very detailed calculation method and guidelines issued by the municipal office. The municipal decree (i.e., the municipal budget) defines the roles of the different levels in the virement process. Thus, there is ample opportunity to leave power in the hands of the institutional (program) management. But the central regulation limits the management freedom for efficient and effective performance by establishing rigid constraints on planning and changing personnel expenditures. (The main reason for this is to prevent an institution from incurring an unfunded liability for the next year.) In addition to planning and virement, the third main fiscal option in the hands of institutional management would be the free use of any undisbursed appropriations and the freedom to carry them over from one year to other. However, the central regulation requires institutions to explain any unspent funds. In any case, the institutions are required to return these funds to the municipalities, which is then free to redistribute these funds or to leave them in the hands of the efficient management. At this point most municipalities attempt to create an incentive system by extending management autonomy with the declaration that any unspent funds will remain with the institution as long as these funds are not the result of some tasks that were planned but not carried out. But there are also other examples: some municipalities deprive the institutions of the funds remaining as a result of cost-effective management, while some others earmark these funds but leave them in the hands of the institutions. With these conditions, management autonomy could be mandated in Hungary only as part of the political process. Among other issues, the limitations on management autonomy (and the fight for resources) are among the main incentives for institutional leaders to become members of the municipal body or of committees where they can influence the final decisions not just about the total amount of the institutional budget, but also about the mix of expenditures. Expenditure: proper authorization for disbursement. The other side of management autonomy must be the control over the level of spending in order to avoid financial mismanagement, deficits and over-spending (e.g., as a result of the enlargement of expenditures without a related increase in revenues). Efficient cash management requires disbursements to be based on proper authorization. The Law on Public Finance states that the head (or CFO) of the budget institution has the right to disburse the funds of the institutions. But the disbursement must be based on a plan (timing) for using the funds. The Law requires only that the spending has to be linked to the time of the flow of the revenues. 379
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Institutional managers only play a minimal role during the preparation of the budget and in many cases have similarly limited autonomy in cash management. However, the financial managers of the independent units are unconstrained during the commitment and verification stages. There is no ex ante control of future obligations to pay except in the case of a multi-year contract or forward commitment. The central regulation requires that steps be taken only in case of significant levels of arrears. The central decree defines the limits as follows: arrears 30 days after their due date may not exceed 10% of the institutional budget or HUF 100 million. The municipalities must define the exact (e.g., stricter) conditions. If these requirements are violated, the municipality must appoint a municipal commissioner to the institutions who has the right to control all payments. In this case all disbursements will be valid only with his/her signature. The other limit on institutional spending concerns the amount of any single disbursement. Some municipalities have created other special constraints as well. Examples of these are the case where: • each commitment and/or payment above a specified limit must be disbursed by the mayor's office; • the municipal institutions are not allowed to submit a tender above a specified limit without municipal authorization.
2.9 Audit System The main parts of the auditing process, the performance and compliance audit, were analyzed in other parts of the study. This chapter deals with: (i) the auditor, (ii) authorization and (iii) the subject of the audit. Auditor: Hungarian legislation contains many points dealing with the financial control and audit of municipalities. Each municipality: (i) has to organize an internal audit, (ii) has to form a financial committee and (iii) is subject to audit by SAO.32 Practically, however, these institutions do not operate effectively. The larger municipalities and those with significant debt must hire an external auditor as well. (Currently approximately 800 municipal budgets are subject to such an audit.) The main tasks of the external auditor are the auditing of: (i) the invested municipal capital, (ii) the municipal supplies (reserve), (iii) the cash flow, (iv) the municipal claims and obligations and (v) the unspent funds. He/she has the right to participate in the meetings of the legislative assembly and to discuss any subject. But the actual functioning of the system can be criticized. Because many auditors have no professional background in budgeting and have only limited information on the special requirements of the public sector, the municipal officers have a significant information advantage over them. As a result, the conclusions issued by the auditors are unreliable in many cases. 380
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As in most countries, the Hungarian State Audit Office (SAO) has responsibility for auditing the municipalities. As has been previously mentioned, the main problem of the current work of the SAO is the infrequency of the compliance audit and the lack of the performance audit. The problem with the SAO is not only that they have insufficient resources for frequent audits, but also that they have to concentrate on issues important for central legislation and not the problems of interest to local governments.33 Currently, the main forms of the municipal audit focus on issues of compliance. The internal audit offices generally deal with the issue of whether the activities of the institutional management and of the municipal budget (financial office) comply with the central or local regulations. The contracts with the external auditors typically cover only the compliance audit and the tasks required by the central legislation. However, they are occasionally requested—based on separate contracts—to analyze performance as well. But in most cases, only the financial committees evaluate the effectiveness (performance) of the municipal activities. This is very problematic, for while the other two institutions can employ professionals with appropriate skills, the municipal committees typically do not have sufficient funds for hiring external experts and must rely on the skills of their members. Authorization: There is no requirement for authorizing any part of the local budget by a central agency. Naturally, the central level attempts to ensure that the municipal budget complies with the few regulated points. The main tool for this is the authorization by the municipal external auditor. His/her prior authorization is necessary because, when the budget is enacted, it is the only guarantee that the municipal budget is legal. Without this authorization, the central government does not approve the municipal budget and the municipality does not receive central grants. Subject of audit: As mentioned, in case the municipality has off-budget units, mismanagement can have significant effects on the municipal budget as well. But the municipal companies are not part of the public finance system—they are incorporated under private law. The result is that the audit of the companies depends only on a decision by the board of directors. Therefore, the municipalities must typically depend on the board of directors to control (audit) these units because the municipal (internal or external) audit is not permitted into these units. However, there are two options to extend the “normal” forms of municipal control over the off-budget units. • Internal audit by the municipality. In Tatabánya, the municipal internal audit team can control the activity of the service provider because the city signed a service contract which stipulates that the municipal team is allowed to inspect the cost of the municipally funded activities and the use of the municipal funds. • External auditor of the municipality. Many municipalities exercise their ownership rights and hire an external auditor of the municipality for auditing the companies as well.
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Summary Current situation: The central level defines the potential forms of the budget units: fully- and semi-independent units. This definition regulates the autonomy of the institutional management in the budget implementation process. According to these regulations, management autonomy is almost unlimited during the execution of the budget execution as long as the institutions are acting legally and they do not spend more than the appropriation. On the other hand, the management of the institutions does not have, or only has a minimal, role in the budget preparation process—the municipality approves the appropriations and any change during the year is possible only based on municipal decisions. Also undisbursed funds can be carried over into the next budget period only with municipal approval. While central legislation grants significant autonomy to the management of the independent budget institutions, there are central incentives for creating a hard treasury, i.e., a single bank account system. This would eliminate the financial independence of the institutions. However, it appears that most local governments maintain a local cash management system that is not fully centralized for as long as possible. Currently, passive treasury or the multi-account systems are still the most frequently employed techniques. The auditing system in Hungary is based on three institutions: the SAO, the external auditor and the Financial Committees. The key focus of these is on compliance and legal issues, and in most cases only the committee deals with the performance audit. Disadvantage of the current situation: The role of institutional management is very limited in the budget-making process, owing to the very detailed appropriation system and to the very rigid limitation on virement and on the use of undisbursed funds. The current practices make it impossible to elicit higher efficiency from the institutions. Without the appropriate authorization, management is not able to enhance their performance. On the other hand, if the municipality does not have a locally implemented treasury (or other well-functioning cash management system) to inform the budget officers of the financial activities of the institutions (especially with regard to commitments), it is faced with the problem of managing their obligations.
2.10 Capital Budgeting Capital budgeting is one of the biggest issues in the budgeting literature. However, owing to limited space, some very important issues have to be omitted here, e.g., the implementation process, project management (e.g., public procurement, contracting, financing, borrowing and debt management, etc.) and the alternative service delivery options (e.g., privatization, concession, contracting out, regulation of a private service
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provider, etc.). This chapter concentrates only on the methods (the steps) of capital budgeting. It is generally accepted that formal links between planning and budgeting should be established and that the (capital) budget should be set up on the basis of medium- or long-term development plans and programs. In the process of capital budgeting, three key points can be defined: (i) long-term planning (creating development plans), (ii) selecting programs from the development plans, (iii) creating financial plans for the selected programs.
Establishing Long-Term Development Plans Realistic development plans cannot be set up if there does not exist an up-to-date list of existing capital infrastructure listing the age, condition and other important characteristics of each facility. This picture of the current situation should be compared with the goals for the quantity and quality of different services using this infrastructure. (See the first chapter in Part II.) Based on this information the municipality is able to define the gap (the required investments) and to prioritize the needs. Asset registers with false value. In Hungary, the municipalities have to separate their properties into three groups: marketable, semi-marketable and non-marketable according to their role in the main function of the municipal activities. The property used in the core functions (e.g., education and health) are treated as non-marketable, or semimarketable. In contrast to their commercial activities, the municipalities have to provide basic services in all cases, so these assets can not be sold even in case of fiscal crisis. The central regulation requires that the municipal asset be recorded in the municipal cadaster. This should list all (real estate) property owned by the municipality. The assets in these cadasters are valued at their historical cost less accumulated depreciation. Naturally these recorded book values are far from the real market value. Moreover, most municipalities do not plan regular, periodic revaluations.34 They attempt to avoid the task of maintaining records of the actual market value for the assets. Generally, the municipalities are ready to register the current value of those assets and properties which have well-defined market prices, but the valuation of non-marketable assets or of properties with fluctuating market values seems to be just wasted effort. For assets with fluctuating market values or with market values that can not be assessed easily and at low cost (e.g., for real estate), the municipalities are not eager to maintain records of current values or to bear the transaction costs of frequent revaluations. They assess these properties at the time of sale (in many cases, this is required in the local decree on the asset management), but they are opposed to spending time and money for annual revaluations.
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In Gyôr, although the “values” in the cadaster and the books of the municipality are not the current market values, the municipality attempts to follow the shifting values in the realestate market, but these registers are not able to provide accurate data. But if the property value in the balance sheet is below the real level, then at the time of privatization (at market or near market prices) the difference between the two values is presented as a gain or loss without any real change in the value.
For example, at the time of the sale of the local cable network, the value of the municipal assets was reduced by a few million HUF (the registered book value of these assets) and the cash was increased by several hundred million HUF (the real market value). The wealth of the municipality seems to increase to a great extent, although it is caused only by a transaction which replaced the registered book value of the assets with its real market value.
Selecting the Capital Investment Programs Based on long-term plans, the municipality should select and schedule those programs which can be implemented in the medium-term Capital Investment Plan (CIP). After selecting the programs with net positive social benefits, municipalities should forecast their own expenditures and revenues in the baseline budget (budget without the effects of the planned project) and, based on this, the investment projects should be scheduled. This multi-year CIP should ensure that the annual revenues will be sufficient to finance the direct costs and the repayment of related debts (and depreciation, in the case of accrual accounting) of the projects. Lack of medium-term planning and forecasting: While some municipalities prepare realistic economic plans and rolling budgets, most of them regard these documents only as an obligatory task. As a result of this lack of assessment of the expected budget conditions (and of the expected financial requirements of the program as well), it is not sure that the investment programs in these plans will be implemented. As seen in the sub-chapter on the multi-year budgeting method, owing to the absence of foreseeable economic conditions and to unpredictable shifts in central sources from year to year, most municipalities prepare a rolling budget using a very simple “multiplying method.” Although most municipalities see the central macro-economic forecast as unreliable, only a few of them make the effort to gather information from other sources (e.g., from publications of economic research institutes). As sources of funds for investments, most Hungarian municipalities do not calculate with revenue generated by economic changes and economic growth, e.g., by broadening the local tax base. Typically, the Hungarian budget officers are ready to accept only two types of change in their budget as a solid basis for financing additional investments.
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•
•
A reduction of current operating expenditures. One typical solution is the reduction of operating costs, especially through the termination and consolidation of institutions (or the transfer of them back to the county level). In this case, the annual municipal support to the institution (expenditures less the own source revenues) can be seen as a potential source for investment in following years. Repayment of the current debt. According to central requirements, cities with debt have to indicate the amount of repayments scheduled for the following years. The budget officers of these cities often view the reduction (or elimination) of the annual repayment burden as an increase in sources for new investment programs.
Selection among the programs according to available central transfers: One of the most criticized features of the Hungarian municipal investment system is that they are driven almost totally by central transfers. Most municipalities in this research indicated that the main selection criteria for choosing among the potential and necessary programs is the possibility of receiving a central grant. There are municipal budgets containing significant reserve funds for use in funding several major programs. In some cases, the total amount of these funds exceeds the financial requirements. However, they initiate these programs only after receipt of the central funds, because if a program is started prior to receipt of the central transfer, the option of funding with central grants is practically lost. It appears that the primary reason for this policy is the prohibition on transferring central funds for ongoing municipal projects.
Developing Financial Plans for an Individual Project At the start of the project, the municipality should have secured the necessary financing for the project expenditures. They have to decide between borrowing the money from the capital markets and increasing the own source revenues (e.g., taxes, user charges). The central government does not set explicit planning requirements for local investments, except in the case of applications for central grants. In these cases, the municipalities must submit implementation plans containing the financial plans for the planned program. The main parts of the financial plans are defined in central decrees. The implementation plan should analyze: (i) whether the program is economical, (ii) whether it is the best way to meet the requirements after due consideration of the alternative options, (iii) whether it can be financed in case the economic conditions of the municipality and the local residents changes, and (iv) the size of future operating expenses. This plan must present the expected total expenditures of the investment, its annual cash flow plan and the mix of the planned sources as well. In addition, it should
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contain emergency plans in case expected revenues are not realized. A prediction must be made of the fee levels, of the fee-structures and of other additional burdens placed on the local residents as a result of the investment. The plan also should study the expected operating costs following the implementation, and this amount should be compared with the operating costs in the baseline (i.e., without the investment) case. For use in estimating the relative costs of a program, the central government publishes annually the sectorial average costs. Since municipalities apply for grants for almost every significant program, nearly all investment plans contain such financial plans. The main problem with these plans is the reliability of the financial information contained in them. Sources for municipal investments: The municipalities select among the potential sources almost exclusively based on cost. Naturally, the most preferred source is the (locally free) central transfer. In second place is the annual revenue in the municipal budget. Naturally this comes mainly from the sale of assets and properties. Project financing is not widely used in the Hungarian municipal sector. Typically, the sources for the financing of projects are neither the special revenue generated by the project nor the tax levied on the future users based on the benefit principles. This effects the credit market as well because the financing of the project requires loans to bridge the gap between the time of the expenditures and of the start of the revenue stream generated by the project. In most municipalities, a loan is considered to be a (temporary) source of financing for municipal investments only used in the worst case in order to avoid levying an additional local tax or increasing the service fees on the local residents. Also, the repayment of the debt is not usually planned to be made from increased local fees or taxes, but instead from the “normal revenue” contained in the baseline budget (typically from privatization revenues).
Summary In summary, the system of capital budgeting in Hungarian municipalities is similar to many of the previously analyzed problems and can be viewed as a legally well-developed system that is not functioning well because of a lack of local expertise. The most important problems can be summarized in three points: • The registration and assessment of municipal assets is obligatory, but a regular and periodic revaluation is missing, so the data in the asset register are unreliable. Even though these figures misinform the decision-makers about the real values of municipal property, the high transaction costs involved in appraising the market values are a significant barrier to showing the assets in the register at their actual values.
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• •
3.
The absence of an assessment of future fiscal conditions leads to the situation where it is uncertain whether the selected investment programs can be financed. While the central level finances local investments following a well-developed capital transfer system, the municipal programs depend enormously on these grants. The main selection criteria for programs and for the financing mix is the availability of the central grants. This dependency could be reduced by: (i) reforming the central transfer system (e.g., by creating incentives for private participation in the project, thus reducing the required share of central financing), (ii) enlarging the share of the own source revenues of the municipalities (e.g., by terminating some central grants, by reducing centrally collected taxes and by concurrently increasing local taxes).
ISSUES AND RECOMMENDATIONS
Before formulating the recommendations, it is worth remembering Meyers’ criteria for effective budgeting which were mentioned in the first paragraphs of this chapter. Table 5.6 provides a short assessment of the current Hungarian municipal budgeting techniques following Meyers’ criteria. Table 5.6 The Assessment of the Hungarian Municipal Budgeting Techniques Following Meyers’ Criteria for Effective Budgeting Term
Criteria
Hungarian System
Accountability Detailed controls should be established which have the goal of ensuring that policy directives are carried out by managers, contractors and all concerned parties.
The Hungarian municipal budget does not contain explicit policy directives and goals, due to a lack of realistic planning methods necessary for their preparation. Thus, managers and other participants are unable to carry out the unknown policy directives.
Comprehensiveness
Includes all uses of the government's financial resources
The Hungarian system includes all of the institutions which are typically part of the public finance system. The municipal companies and public foundations are excluded in almost all countries.
Constraint
Contains limitations on the amount of money that need be acquired by government
One of the most important goals of the Hungarian public finance system is the constraint on public spending.
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Table 5.6 (continued) The Assessment of the Hungarian Municipal Budgeting Techniques Following Meyers’ Criteria for Effective Budgeting Term
Criteria
Hungarian System
Cooperation
Budgeting should exist in harmony with other decision processes and should not be dominant.
When funds are short, the budget always dominates the other decision processes. Most municipal budgets clearly define which former decisions can be implemented and which ones must be altered or delayed.
Honesty
Contains unbiased projections
Projections are missing from almost all local budgets. The frequent modifications to the local budget give an indication that the local politicians are aware that the approved and the “real” budget will differ.
Judgment
Encourages participants to seek the most effect at the least cost
Most municipal budgeting systems do not compare costs and benefits. Assessment is based only on whether the expenditure is minimal and is made independently of any benefit.
Legitimacy
The budget process should Proper authorization is the cornerstone of the reserve important decisions Hungarian municipal budgeting system. to legally appropriate authorities. Maybe this criteria is over-stressed, especially when institutional appropriations are extremely detailed.
Perception
Considers both the nearand long-term
Due to the rapidly changing economic conditions and the unpredictable central grant system, planning has become one of the weakest points of the system.
Responsiveness The budget must adopt policies to match public preferences.
The information gathering about public preferences is missing. The current system “tests” public satisfaction only through regular elections—so the public's preferences appear only through their choice of representatives.
Timeliness
A budget process should complete regular tasks when expected
The municipal budgeting process has very rigid deadlines with hard punishments in cases of failure. The budget implementation process is also very limited in time, with appropriations which are not disbursed by December 31 not allowed to be carried over into the following budget period without explicit municipal approval.
Transparency
The budget and budget procedures should be understood by participants and outside stakeholders.
The Hungarian budgets, due to their large information content, are a little bit too complex, and the specialized knowledge of the participants and of the other stakeholders is relatively low in the field of budgeting.
SOURCE: Meyers, Roy T.: Is There a Key to the Normative Budgeting Lock, (The World Bank, Washington DC, 1996).
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Following the former chapters and the assessment in Table 5.6, it would appear to be a very simple task to formulate recommendations for modernizing the Hungarian municipal budgeting process, but it must be remembered that the municipal budgets are a part of the overall public finance system. Comprehensiveness requires that any changes in the local budget preparation process be consistent with the entire system. For example, a new method implemented at the local level with no related change in the central budgeting system could result in non-transparent government operations. This report concentrates only on the municipal level and does not examine the reforms needed in the entire system (e.g., accounting/budgeting on an accrual basis or changes in the classification system needed to move toward performance budgeting).
Connection to the Other Elements of the Public Finance System It is worth recalling that the aforementioned comprehensiveness is relevant only at two stages: for the public information system and for financial reporting and accounting. However, as in the new GFS and European standards for accrual accounting which do not deal with budgeting techniques and instead concentrate only on financial reporting, it is possible to modify the budget-making process at municipal level, while still maintaining the reporting and accounting practices of the entire system. Naturally, the reform would be more effective if the entire system would move toward performance budgeting because the differences between the categories contained in the local budget and those contained in the public financial information or reporting system would require double-work at municipal level. Based on our findings, some points of the municipal finance system and the budgeting regulation can be identified as the potential subject for reform. The following are worth considering: 1) To establish an additional option in the municipal decision-making process— the conditional approval which would delay the fiscal implication of the new policy until the deadline when it is included in an approved budget. (For example, the municipal body would approve the program, but the annual budget would define the implementation date, the amount of payment or other fiscally important points.) 2) To define budget appropriations which are not voted on annually (e.g., longterm contracts, debt repayment, some social assistance required by the central government). Of course, the budget would provide information to the decisionmakers about the amounts, with the budget clearly showing these obligations separately from the discretionary spending, thus indicating that any potential delay in the approval of the budget would not impede making payments on these commitments. 389
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3) To allow the calculation of the municipal borrowing limits in a new way in addition to the current method. The new method would state that the annual borrowing is not allowed to exceed the capital spending less the capital revenue. This balance could be checked not only in the approved budget, but at the end of the year as well. 4) To formulate explicit rules against institutional overspending. The mayor's office would be empowered to set up ex-ante control over financial commitments even for the independent institutions, to refuse payment orders and to establish sanctions for institutions and programs that are overspending.
Enable the Municipality to Create its Own Budgeting Process It seems that over-regulation is one of the most important problems in municipal budgeting. While the municipal system leaves the municipalities almost absolutely unconstrained, the public finance system contains many unnecessary requirements that reduce the flexibility of the municipality to adjust the local budget to fit the local requirements. The number of regulations concerning municipal budgeting, especially about the information contained in the budget document, should be reduced. Currently, the local budget document includes much information that is not of interest to local politicians or that is not directly relevant for the local budget (e.g., the expenditures following a rigid classification system). Naturally, according to the rules, the municipal budget can contain other information in addition to that defined by central requirements, but in this case the budget containing both requirements becomes unwieldy. Municipal discretion: The municipalities should be allowed to select information that is of local importance. This would be especially important for the budget classification system. The local governments would then be able to move toward performance budgeting if desired. This would involve, • setting up new titles and headings, • creating a new classification system (global budgets or block appropriations for programs), • regulating the virement and the procedure for carrying any undisbursed appropriation over into the next budget period, • omitting some of the stages of the budget preparation process currently required, e.g., the initial (open-ended) budget proposals from institutions. On the other hand, the central regulations could concentrate on soft information. For example, the budget should specify policy objectives, the economic framework used for forecasting revenues and expenditures, the major identifiable fiscal risks. Currently, most local budgets do not provide appropriate information on these issues. 390
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An additional benefit from this deregulation would be the resulting differentiation among municipalities according to size, to the size of their budget, to their functions or to other important factors. The new central regulation (i.e., the suggested methods) for different types of municipalities could vary. For example, a sophisticated method appropriate for a city with a budget of HUF 20 billion does not fit a small village with expenditures of HUF 100-200 million. Unified information system: Naturally, the public finance information system must require data that is consistent with central requirements. This demand combined with institutional sclerosis are likely to result in the continued usage of the methods currently employed in most municipalities, but some reformers could follow their own path while still providing the centrally required information.
Training and Information from Central Level Instead of Just Regulation Our research has proven the hypothesis that the local offices are not aware of the policy in other, even neighboring, municipalities. There are many cases where the municipalities in one area face problems that have already been resolved in other areas, but the solutions are not disseminated. Because municipal associations are very weak in Hungary, the central government and its field offices must play a central role in arranging this information exchange. As some examples (e.g., the treasury system or the program budgeting used in budgeting the central investment program) indicate, the local governments are ready to follow the centrally used or suggested methods, especially if the central budget contains “incentive funds” and conditional grants for covering a part of the implementation costs. The shift in the central focus from regulation toward information systems and the influencing techniques could yield an additional benefit. The problem with regulation is not only that it cannot be varied according to the local demands, but that it requires the implementation of new methods everywhere without prior experience. If the policy fails, every municipality has to cope with the same problems. However, flexibility would enable the central government to set up pilot projects. They would have the opportunity to test the policies and analyze the findings before a widespread implementation. In the case of parallel projects in several cities, the analysis would also indicate the main variables effecting the results (e.g., size, revenue mix, tax capacity and institutional structure).
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NOTES 1
OECD (2000)
2
OECD (1999)
3
The cities are: Eger, Gyôr, Kaposvár, Kecskemét, Székesfehérvár, Szekszárd, Szolnok, Tatabánya (cities with county right); Ajka, Baja, Cegléd, Dombovár, Dorog, Dunakeszi, Esztergom, Göd, Gödöllô, Gyöngyös, Hatvan, Keszthely, Komárom, Oroszlány, Paks, Szentes, Tapolca, Tata (medium-sized settlements with more than 10,000 inhabitants); Andornaktálya, Boldog, Gyöngyöstarján, Hort, Istenmezeje, Kerecsend, Lôrinci, Ostoros, Parád, Tamási, Tiszanána, Veresegyház (settlements with less than ten thousand inhabitants); a district in Budapest (Ferencváros); and a county (Pest). Parallel to this research, the Center organized another municipal program for the Prime Minister's Office which aimed to prepare a proposal for the Municipal Guarantee Fund. Nine of these municipalities were assessed in that project, but based on similar terms of reference (questionnaire). Beside the 31 cities in this research, the results of nine case studies prepared for the other project were used here as well.
4
For example, British conurbations.
5
There are eight cities with county rank in our case studies. (Gyôr, Tatabánya, Kecskemét, Kaposvár, Szekszárd, Eger, Széksefehérvár, Szolnok)
6
Because of the special situation in the capital, the municipalities in Budapest were left out from the research.
7
There are only two limitations to these processes. First, the municipalities have to decide on these claims within the first few months of every election cycle. Second, if they take over the institution, they are not allowed to transfer it back within the next three years.
8
The Hungarian legislation defines tasks for the notary and not for the office (and not for the departments within the office, which are not legal entities). So, when the law says the “Notary prepares the budget proposal,” it means that the mayor’s office is led by the notary in the preparation of the proposal.
9
Our research collected information mainly from the financial departments. Naturally, in most cases, the heads of these departments do not feel (or do not concede explicitly) that they would be the “second person.”
10
Law on Local Government section 8 (1).
11
Law on Local Government section 8 (3).
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12
For example, the notaries are responsible for the administration of some forms of social assistance which are paid for both from central funds and from the local budget. This situation encourages the notary to push the “local poor” to the central programs. As a result of these experiences, the central Welfare Ministry has attempted to reduce the number of delegated functions which must be funded from the central budget.
13
This share falls to 63% without the shared tax and to 57% without the transfer from the Health Fund. (The Health Fund finances the operating costs of the health system, but this grant is earmarked, so the municipalities are not able to use this money to finance other sectors.)
14
According to the titles in the Budget 2000/2001, there are funds for: some specific education programs, income support for unemployed people, fire fighting, liquid waste management, municipalities in economic trouble, subsidizing water prices where they are extremely high, ferries, checkpoints, the support of people with high housing debt, the operation of the local minority governments, programs to children and youths, supporting minority education, public libraries, official municipal orchestras and choirs, staff reduction, obligatory external audits, the implementation of the local treasury functions, improving the local waste management and theaters.
15
Currently, these include investments in the water system, sewers, various fields of education or healthcare.
16
In the recent past, the sewer sub-funds were not able to finance every municipal sewer project, so the grant in fact was not distributed normatively, but instead depended on the application of the specific municipality.
17
See, Bouckaert (1992), Bouckaert and Halachmi (1996), OECD (1997a), OECD (1997b), OECD (1997c), OECD (1998), Schaeffer (2000).
18
See OECD (2001) or Ter-Minassian (1997).
19
After approving the municipal budget the local government has to make an elementary budget to the TÁH (within 30 days after the deadline for submitting the budget proposal to the legislative assembly) in which they have to show the very detailed annual expenditure and revenue plans.
20
In Baja, the budget contains 35 revenue and 8 expenditure categories.
21
In the recent past, the tax base has changed continuously, with turnover being reduced by 33, 66 and then 100% of material costs.
22
Some municipalities criticize this later method as being unnecessary and/or unreliable, because almost every municipality has had the experience where the contractual price was not received.
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23
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Indicators in the program budgets. According to the basic principles of the program budgeting, the budget also classifies expenditures according to programs. For every program, the municipality attempts to create performance (i.e., output) measures. Thereafter, the budget contains some specific measures: the unit-cost index based on these measures and the expenditure data. The Annex to the budget presents these measures and indicators. The Annex can provide a solid basis for intertemporal comparison. For example, Szentes is able to present the figures of the previous five years. The presented measures can be divided into two main groups: (i) specific sectorial measures and (ii) “institutional measures.” In most sectors, the specific measures provide information on the number of clients, the capacity of the program (institutions) and the number of workers (separated into core and technical workers). The most frequently used “institutional measures” are: (i) the size of the property (separated according to their use for core activities and the technical places), (ii) the size of green areas, (iii) the volume of heated space and (iv) the size of lit areas. Generally, the unit costs for assessing the efficiency and effectiveness of the technical expenditures are calculated by dividing these measures by the number of clients and/or the expenditures for property maintenance.
24
For example, Australia, New Zealand, Great Britain and the Netherlands.
25
This capital cost (depreciation) is not distributed into programs, but instead is treated as institutional level data.
26
For example, exports, imports, consumption and investments.
27
These are used for calculating some social expenses.
28
In Tatabánya, within the “city tasks,” the budget attempts to present the amount of discretionary spending options for politicians. There are separate titles for funds appropriated in long-term contracts and those which are available for “free” budget (political) decisions. Almost 22% of the “city task” is appropriated through contracts, so they cannot be modified simply through a budget decision. But not all unappropriated expenditures are “free money,” e.g., the line for Communal service contains both appropriated and unappropriated amounts in the same line—but the split is clear from information available in the annex to the budget. The other important example of unappropriated yet unavailable funds arises when the social policy defined by central legislation lists the criteria for eligibility and size of payments.
29
The central budget of 2001/2002 contains a strong incentive: in addition to the expected financial gains arising from a centralized cash management, the government created a new grant for the municipalities establishing a local treasury.
30
For example, for funds from the privatization of municipal flats, for the local government budget for the minorities, for the financing for the local family doctors, for
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the financing for dentists, for those funds required by the central level to be handled separately, for funds used as security for the debt management, for separating short term investments, for earmarked funds. 31
Transfering expenditure provisions from one line-item to another during the budget year.
32
For municipalities with more than 2,000 inhabitants.
33
The State Audit Office is an institution of the Hungarian Parliament.
34
This process will cause significant problems if the new GFS standard becomes a requirement in the Hungarian public sector. According to GFS 2000, all assets and liabilities must be valued at market prices, so they have to be revalued every year.
REFERENCES Bouckaert, Geert: Productivity analysis in the public service: the case of the fire service. In: International Review of Administrative Sciences, Vol. 58 (1992), pp.175–200. Bouckaert, Geert and Arie Halachmi: The Range of Performance 296 Indicators in the Public Sector: Theory vs. Practice. In: Arie Halachmi and David Grant (eds.): Reengineering and Performance Measurement in Criminal Justice and Social Programs, (Brussels: International Institute of Administrative Sciences; Perth. Western Australia: Ministry of Justice, 1996), pp.91–106. Meyers, Roy T.: Is There a Key to the Normative Budgeting Lock. (Washington DC: The World Bank, 1996). OECD: Accrual Accounting in the Netherlands and the United Kingdom. (Paris: OECD, 1997a), OCDE/GD(97)179. OECD: In: Search for Results—Performance Management Services. (Paris: OECD, 1997b). OECD: Integrating Financial Management and Performance Management. (Paris: OECD, 1997c), PUMA/SBO(99)4/FINAL. OECD: Modern Financial Management Practices. (Paris: OECD, 1998), PUMA/ SBO(98)8. OECD: Fiscal Design Across Levels of Government. Country Report: Hungary. (Paris: OECD, 1999). OECD: Fiscal Design Across Levels of Government. Year 2000 Survey. Country Report: Hungary. (Paris: OECD, 2000).
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OECD: Managing Public Expenditures. A Reference Book for Transition Countries (edited by Allen, Richard and Daniel Tommasi). (Paris: OECD, 2001). Schaeffer, Michael: Municipal Budgeting. Urban and Local Development Background Series No. 4., (Washington DC: World Bank, 2000). Ter-Minassian, Teressa: Decentralization and Macro-economic Management. (IMF Working Papers, 1997), WP/87/155.
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