## Box 2 needs to be identified, analyzed, and agreed on

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---

### Step 1: Understanding the budget — major issues and procedural steps
- Four major issues when preparing baselines:
  - Level of disaggregation and approaches to costing must balance complexity and accuracy; prioritize the “big picture” by focusing on the largest components and lumping items with common expenditure drivers.
  - Choice of a base (starting point) should be case-by-case; multiple base approaches can be used concurrently depending on program characteristics.
  - Choice of a time horizon: the typical horizon for preparing baselines is three to four years, set with the medium-term budget framework of the MoF; longer horizons may be required for pension and health spending.
  - Base adjustments: remove previous one-off spending items (examples: cost of elections; census collections; IT upgrades; spending linked to natural disasters or health emergencies such as Ebola or COVID-19) and include the full-year impact of policies adopted during the year (examples: ongoing IT modernization program; wage/pension reform that began midway in the base year).
- Practical preparatory steps (numbered sequence):
  1. Understanding the budget
     - a) Make strategic choices:
       - Choosing a preferred level of disaggregation (for example, main spending units/areas; programs)
       - Choosing the costing approach and the tools to use
       - Other decisions such as the level of effort to apply
     - b) Set the base, which is the starting point of a baseline projection
     - c) Adjust the base by:
       - Identifying previous one-off spending items to remove from the base.
       - Including the effect of past policies not fully implemented in the base year.
  2. Understanding and applying medium-term cost drivers
     - a) Identify price and volume cost drivers for each level of baseline projection.
     - b) Link these cost drivers to macroeconomic and demographic variables (for example, consumer price index (CPI) or population growth or old (young) dependency ratio).
     - c) Adjust base spending by the price and volume parameters.
  3. Sum up to get the overall baseline projections for the desired level of aggregation (for example, ministry level).
  4. Aggregate for overall baselines.
- Example institutional practice:
  - The Budget Directorate of the MoF prepares, at the start of the budget cycle, baselines for each program. The 2021 budget contained 135 programs for 34 missions, excluding special earmarked accounts—comptes spéciaux du Trésor.
  - Programs are decomposed into “blocks” (e.g., a wage block) forecast using a Price x Quantity approach or, when not possible, a trend analysis approach. Aggregate forecasts across blocks generate baselines for each program and further for each LMA.

### Choosing a base — comparative advantages and disadvantages
- Current year’s budget
  - Advantage: No need to reopen recent budget discussion
  - Disadvantage: Budget may be aspirational, so will need to be corrected to take into account information related to the interim execution of the current year.
- Last year’s realization
  - Advantage: Reflects actual execution
  - Disadvantage: LMAs to justify again new budget funding for current year.
- Previous years’ budget
  - Advantage: Avoid difficult-to-identify one-offs in recent years
  - Disadvantage: LMAs to justify again new budget funding for recent years. Could have been badly estimated or aspirational.
- Legal entitlement only
  - Advantage: Suitable for demand-driven programs for which recent spending has been volatile
  - Disadvantage: Legal entitlement may not reflect current level of funding.

### Choosing level of disaggregation — healthcare example
- Healthcare spending often falls under goods and services, and wages; subcategories have distinct price and volume drivers:
  - Goods and services subcategories: pharmaceuticals, medical goods, general primary care, medical diagnostics, hospital care.
  - Further disaggregation examples:
    - Pharmaceuticals subdivided into patent medicines and generics (price of patent medicines often grows faster).
    - Inpatient care subdivided into public and private hospitals (different specializations/policies).
    - Hospital spending can be analyzed as inpatient care/outpatient care where diagnosis-related group systems exist.
- Level of disaggregation depends on available information and understanding of expenditure dynamics.

### Step 2: Identifying and applying medium-term cost drivers
- Price drivers:
  - Include wages, inflation, and specific input factor prices (for example, fuel, utilities, and other consumables).
  - First step: identify price parameters or proxies (for example, many consumables assumed to adjust with inflation; fuel prices driven by world oil prices).
  - Rule: rely on common macro parameters where possible; choose central scenario for macro variables or a more prudent scenario to create buffers.
  - Custom parameters can be used if large differences with macro parameters occur (examples: wage forecasts for specific groups; specific price forecasts for pharmaceuticals).
- Volume drivers:
  - Factors include demographic change, macroeconomic factors, and past policies that mature.
  - Volume parameters should, to the extent possible, be linked with variables for which forecasts already exist (real GDP growth, unemployment rate, demographic forecasts).
  - Exceptions: volume parameters not strongly correlated with these variables may be forecast separately.
- Price x quantity approach:
  - Apply identified price and volume evolutions to the adjusted base (accounting for one-offs).
  - Recognize potential interactions between price and volume (e.g., volume increases affecting unit prices).
- Simpler methods for small spending lines:
  - Trend extrapolation using recent cost experience.
  - Lump-sum costing assigning a fixed amount when costs are small and uncertain.
  - Analogous estimation projecting costs based on known costs of something similar.

- Common price and volume drivers for current spending (selected from Table 2):
  - Wages and salaries
    - Price: Negotiated wage increase; wage drift (reflecting promotions and increments, new staff replacing higher paid retired staff)
    - Volume: Projected recruitment and separation, replacement rate
  - Social contributions
    - Price: Contribution rate; wage increase
    - Volume: Projected recruitment and separation
  - Goods and services
    - Price: Macro variables (inflation; oil prices); specific components of the CPI (utilities, food), other price specific parameters (for example, pharmaceuticals)
    - Volume: Volume of goods and services (quantities of medicine; number of vehicles; number of square meters of office space; demographics)
  - Subsidies
    - Price: Inflation; price-specific parameters
    - Volume: Estimates of demand in volume
  - Grants
    - Price: Grant formula; inflation
    - Volume: Estimates of demand in volume
    - Grant inflows from donors: Relevant donor coordination unit; Donor agreement
  - Social transfers
    - Price: Inflation, wage increase, pensions specific formula
    - Volume: Unemployment, demographics, ongoing increasing pension age reform

### Step 3: Aggregation and reconciliation
- Aggregate across spending units and spending areas to obtain ministry-level baselines.
- Sum ministerial baselines to provide an estimate of the baseline covering the entire budget.
- Price and volume parameter variations can be summed to provide a reconciliation of changes in baselines.

### IV. Specific questions in preparing baselines for different expenditure types — wages example
- Wages baselines typically follow the “price x volume” approach:
  - Volume (number of employees in occupations) generally assumed unchanged except when increases are needed to maintain service levels or when multiannual replacement policy exists.
  - Example linkage: number of teachers assumed to track the number of school-age children.
  - Where policies on labor force size are clearly stated, use those policies to inform baseline assumptions (Box 4 reference).
  - Price (level of compensation) can be assumed to change in response to negotiated increases and wage drift as outlined in Table 2.

### Box 4. Singapore: An Example of the Price x Volume Approach in Wage Forecasting
- Wage forecasting: price × volume framework
  - Baselines for wages can be constructed by decomposing wage bill changes into price and volume drivers.
  - Price drivers typically reflect negotiated settlements, existing wage-setting policies, or, where policies are not clear, economic indicators such as inflation or private sector wages.
  - Volume drivers capture changes in the number of employees and composition of employment.
- Wage drift
  - Includes salary increments for seniority; promotions; reclassification; turnover effects (retirement of higher-paid aged staff and recruitment of lower-paid young staff).
  - Wage drift can be estimated using econometric analysis or structural modeling.
- Practice on inclusion of wages in LMAs’ baselines
  - Practice varies: in many advanced economies, LMAs prepare baselines across all spending categories, including wages. In other countries, wage baselines are prepared centrally (by Ministries of Finance or Public Service) while LMAs prepare non-wage baselines.
- Two approaches to provide wage baselines
  - Headcount and compensation by occupation: uses aggregated data by occupational groups from HR and payroll systems.
  - Age-specific matrices from anonymized microdata: models employment dynamics with large anonymized data sets (ranging from hundreds of thousands to millions) and allows age-specific aggregation early.
- Sensitivity of assumptions and disclosure considerations
  - Assuming full pass-through of inflation to wages may fuel higher wage demands; disclosure practices vary (example: South Africa; Austria).
- Capital spending baselines
  - Major projects: request annual project expenditure profiles from agencies and confirm the approval basis.
  - Minor projects / small capital goods: treat the current level of spending as the baseline and hold steady for durable goods (cars, ICT equipment, and so on).
  - Operating and maintenance costs associated with capital projects must be included in baselines and identified at project approval.
- Interest spending baselines
  - Interest depends on debt stock and, with a lag, on current financing needs; present interest costs add to financing needs and hence next year’s debt.
  - Two main approaches:
    - Top-down: relies on aggregate debt stock and effective interest rate projections.
    - Bottom-up: detailed cash-flow and financing plans developed in cash management and debt management units.
- Social welfare and pension spending baselines
  - Forecasting formula-driven entitlement programs requires understanding of target population, intertemporal dynamics, eligibility criteria, and external environment.
  - Recommended approach: use agency-provided estimates as baselines with MoF oversight to check consistency of macroeconomic and fiscal assumptions.
- Other transfers
  - For discretionary transfers not linked to entitlement mechanisms, a historical average of actual spending may be acceptable; zero baseline is seldom realistic without a political decision to phase out support.

### Key success factors for baselines
- Regular updates:
  - Baselines must be updated between forecasting rounds to reflect changes in price and volume parameters, new policy adoptions that become baseline, one-off spending, and accounting changes.
  - For rolling three-year LMAs baselines at the start of a budget cycle:
    - Reconcile approved budget with actuals and update previous approved budget with realizations (column A).
    - Reconcile outer-year estimates using previous year’s estimates as starting point and update with new price and volume parameters, new policies, and technical adjustments to reach approved budget (column B); apply same for first outer year (column C).
    - Add a new estimate for the second outer year (column D).
  - Costing of new measures can be done at detailed levels (sub-programs or activities) and then aggregated to integrate into revised baselines.
- Distribution of roles and coordination:
  - Successful baseline preparation combines strong central MoF guidance and active LMA participation.
    - Initial stage: MoF prepares baselines with LMA inputs (example: Kenya).
    - Intermediate stage: LMAs prepare baselines with MoF guidance (example: Poland).
    - Advanced stage: LMAs prepare baselines; MoF provides macro parameters and performs a challenge function (example: Australia).
  - Within the MoF, collaboration is needed between cross-cutting fiscal strategy units and sectoral budget units; sectoral units typically produce higher baselines than cross-cutting units and can better challenge LMAs.
  - A strong MoF challenge function mitigates incentives for LMAs to under- or overstate baselines depending on budget constraints.
- Consistency with macro-fiscal environment:
  - Macro-fiscal forecasts should be prepared during the strategic phase, updated regularly, and timed to budget milestones.
  - LMAs should have a channel to the macro-fiscal unit for parameter identification (for example, CPI subcomponents or lower-level indexes such as fuel, import, construction prices).
- Use of baselines in low-capacity settings:
  - Baselines are useful beyond advanced economies; several low-income and emerging market economies (for example, Kenya, Peru, and Senegal) have incorporated baselines successfully.
  - A full MTBF is not required to benefit from baselines; even high-level baselines help assess fiscal space and monitor commitments for capital projects.
- Complementary PFM tools:
  - Spending reviews complement baselines by periodically assessing spending quality (examples: comprehensive reviews in the United Kingdom every four or five years; rolling reviews in Australia, Canada, Korea, The Netherlands).
  - Mechanical reliance on baselines can lead to incremental budgeting; spending reviews provide a benchmark for identifying savings or spending needs.

### Introduction of a medium-term approach to budgeting — role and implementation
- Role of baselines and top-down budgeting
  - Baselines provide a forward-looking vision of expenditure pressures that help determine available fiscal space or meet fiscal constraints.
  - An effective top-down approach requires:
    - a reassessment of the fiscal space every year,
    - a limit on total expenditure adopted,
    - a budget process that ensures that expenditure allocations do not exceed this limit.
  - Institutionally, top-down budgeting requires a strong MoF and strong political commitment to resolve conflicting pressures.
  - Some countries (Australia and Sweden) introduce a charge against the baseline forecast to reflect expected “efficiency or productivity gains.”
- Benefits and analytic function of baselines
  - Baselines focus discussions on design and adoption of spending or saving measures requiring new decisions.
  - Baselines aid in identifying expenditure pressures and framing negotiations on spending ceilings and fiscal space.
  - The baseline approach is spreading across countries and income categories because it highlights future costs and incentivizes policy action.
- Implementation challenges and principles
  - Applying baselines requires assumptions and judgement; differentiation by economic nature of expenditure is important.
  - Complementary tools (spending reviews, strong top-down process) are needed to avoid baseline pitfalls.
  - Finance ministries typically lead baseline introduction but should move responsibility progressively to LMAs.
  - A comprehensive and well-designed budget classification system is a key enabler.

### Annex: Select country practices and time frames (exact time frames preserved)
- Australia
  - Time frame: 4 years
- France
  - Time frame: 3 years
- Senegal
  - Time frame: 3 years
- United States
  - Time frame: 11 years
- European Union
  - Time frame: 3 years
- Poland
  - Time frame: 3 years
- Peru
  - Time frame: 3 years
- Kenya
  - Time frame: Annual

### Annex: Definition of baseline according to nature of expenditure — French budget circular guidance (selected points)
- Definition:
  - The “baseline” corresponds to the progression of an expenditure linked to its own dynamic, all things being equal.
  - Baseline expenditure needs to be distinguished from the impact of new measures.
  - Some expenditures have a compulsory character from a legal standpoint (debt payment, pensions, social transfers); for such expenditures, the notion of baseline is fully relevant.
  - Other expenditures linked to past commitments require showing the impact of multi-year commitments.
- High-level rules by category (selected)
  - Staffing and payroll expenditures: Measures implemented in legal text will be taken into account; by convention, there will be no general increase of civil servants’ wages (stability of point fonction publique).
  - Operating expenditures: Impact of exogenous economic factors is taken into account if a direct link exists; inflation applied only for expenditures which are legally indexed; activity level is stabilized in real terms.
  - Subsidies to supervised entities: payroll parts follow State payroll rules; other evolutions are new measures or savings.
  - Investment expenditures: any investment not authorized by a commitment appropriation or legal commitment from 2017 to 2020 treated as a new measure; sequencing corresponds to most recent forecasts.
  - Discretionary transfers: any change is a new measure or saving.
  - Transfer expenditures considered entitlement: final outturn for 2019 and forecasts for 2020 are taken into account, as well as indexation if planned in valid legal/regulatory/contractual text.
  - Equity injections: rules applicable to State direct investment apply when subsidized toward investment expenditures.

### Key takeaways and policy recommendations
- Use baselines as a forward-looking tool to identify expenditure pressures and fiscal space, and to frame multiannual budget negotiations.
- Combine baselines with spending reviews and a strong top-down process to avoid entrenching incrementalism and to safeguard value for money.
- Ensure institutional arrangements where MoF leads initial baseline work and LMAs progressively assume responsibility, supported by a comprehensive budget classification system.
- Consider applying productivity or efficiency charges to baseline forecasts (as in Australia and Sweden) to reduce the risk of baselines being treated as entitlements.
- Apply differentiated methodological rules for baselines by expenditure type (payroll, operating, subsidies, investment, transfers, entitlements, equity injections) to reflect legal, contractual, and technical drivers.

*Source: "HOW TO PREPARE EXPENDITURE BASELINES", Fiscal Affairs Department How-to Notes, International Monetary Fund | May 2022*

### Box 2 needs to be identified, analyzed, and agreed on

### Box 2 needs to be identified, analyzed, and agreed on

### Step 1: Understanding the budget — major issues and procedural steps
- Four major issues to address when preparing baselines:
  - Level of disaggregation and approaches to costing must balance complexity and accuracy; prioritize the “big picture” by focusing on the largest components and lumping items with common expenditure drivers.
  - Choice of a base (starting point) should be case-by-case; multiple base approaches can be used concurrently depending on program characteristics (see examples below).
  - Choice of a time horizon: the typical horizon for preparing baselines is three to four years, set with the medium-term budget framework of the MoF; longer horizons may be required for pension and health spending.
  - Base adjustments: remove previous one-off spending items (examples: cost of elections; census collections; IT upgrades; spending linked to natural disasters or health emergencies such as Ebola or COVID-19) and include the full-year impact of policies adopted during the year (examples: ongoing IT modernization program; wage/pension reform that began midway in the base year).
- Practical preparatory steps (numbered sequence from the source):
  1. Understanding the budget
     - a) Make strategic choices:
       - Choosing a preferred level of disaggregation (for example, main spending units/areas; programs)
       - Choosing the costing approach and the tools to use
       - Other decisions such as the level of effort to apply
     - b) Set the base, which is the starting point of a baseline projection
     - c) Adjust the base by:
       - Identifying previous one-off spending items to remove from the base.
       - Including the effect of past policies not fully implemented in the base year.
  2. Understanding and applying medium-term cost drivers
     - a) Identify price and volume cost drivers for each level of baseline projection.
     - b) Link these cost drivers to macroeconomic and demographic variables (for example, consumer price index (CPI) or population growth or old (young) dependency ratio).
     - c) Adjust base spending by the price and volume parameters.
  3. Sum up to get the overall baseline projections for the desired level of aggregation (for example, ministry level).
  4. Aggregate for overall baselines.

- Example institutional practice from the source:
  - The Budget Directorate of the MoF prepares, at the start of the budget cycle, baselines for each program. The 2021 budget contained 135 programs for 34 missions, excluding special earmarked accounts—comptes spéciaux du Trésor.
  - Programs are decomposed into “blocks” (e.g., a wage block) forecast using a Price x Quantity approach or, when not possible, a trend analysis approach. Aggregate forecasts across blocks generate baselines for each program and further for each LMA.

### Choosing a base — comparative advantages and disadvantages
- Table 1 summarized in bullets (preserving labels and trade-offs):
  - Current year’s budget
    - Advantage: No need to reopen recent budget discussion
    - Disadvantage: Budget may be aspirational, so will need to be corrected to take into account information related to the interim execution of the current year.
  - Last year’s realization
    - Advantage: Reflects actual execution
    - Disadvantage: LMAs to justify again new budget funding for current year.
  - Previous years’ budget
    - Advantage: Avoid difficult-to-identify one-offs in recent years
    - Disadvantage: LMAs to justify again new budget funding for recent years. Could have been badly estimated or aspirational.
  - Legal entitlement only
    - Advantage: Suitable for demand-driven programs for which recent spending has been volatile
    - Disadvantage: Legal entitlement may not reflect current level of funding.

### Choosing level of disaggregation — healthcare example highlights
- Healthcare spending often falls under goods and services, and wages; subcategories have distinct price and volume drivers:
  - Goods and services subcategories: pharmaceuticals, medical goods, general primary care, medical diagnostics, hospital care.
  - Further disaggregation examples:
    - Pharmaceuticals subdivided into patent medicines and generics (price of patent medicines often grows faster).
    - Inpatient care subdivided into public and private hospitals (different specializations/policies).
    - Hospital spending can be analyzed as inpatient care/outpatient care where diagnosis-related group systems exist.
- The level of disaggregation depends on available information and understanding of expenditure dynamics.

### Step 2: Identifying and applying medium-term cost drivers
- Price drivers:
  - Include wages, inflation, and specific input factor prices (for example, fuel, utilities, and other consumables).
  - First step: identify price parameters or proxies (for example, many consumables assumed to adjust with inflation; fuel prices driven by world oil prices).
  - Rule: rely on common macro parameters where possible; choose central scenario for macro variables or a more prudent scenario to create buffers.
  - Custom parameters can be used if large differences with macro parameters occur (examples: wage forecasts for specific groups; specific price forecasts for pharmaceuticals).
- Volume drivers:
  - Factors include demographic change, macroeconomic factors, and past policies that mature (examples provided in source).
  - Volume parameters should, to the extent possible, be linked with variables for which forecasts already exist (real GDP growth, unemployment rate, demographic forecasts).
  - Exceptions: volume parameters not strongly correlated with these variables may be forecast separately.
- Price x quantity approach:
  - Apply identified price and volume evolutions to the adjusted base (accounting for one-offs).
  - Recognize potential interactions between price and volume (e.g., volume increases affecting unit prices).
- Simpler methods for small spending lines:
  - Trend extrapolation using recent cost experience.
  - Lump-sum costing assigning a fixed amount when costs are small and uncertain.
  - Analogous estimation projecting costs based on known costs of something similar.

- Table 2 (common price and volume drivers for current spending) summarized (preserving labels):
  - Wages and salaries
    - Price: Negotiated wage increase; wage drift (reflecting promotions and increments, new staff replacing higher paid retired staff)
    - Volume: Projected recruitment and separation, replacement rate
  - Social contributions
    - Price: Contribution rate; wage increase
    - Volume: Projected recruitment and separation
  - Goods and services
    - Price: Macro variables (inflation; oil prices); specific components of the CPI (utilities, food), other price specific parameters (for example, pharmaceuticals)
    - Volume: Volume of goods and services (quantities of medicine; number of vehicles; number of square meters of office space; demographics)
  - Subsidies
    - Price: Inflation; price-specific parameters
    - Volume: Estimates of demand in volume
  - Grants
    - Price: Grant formula; inflation
    - Volume: Estimates of demand in volume
    - Grant inflows from donors: Relevant donor coordination unit; Donor agreement
  - Social transfers
    - Price: Inflation, wage increase, pensions specific formula
    - Volume: Unemployment, demographics, ongoing increasing pension age reform

### Step 3: Aggregation and reconciliation
- Aggregate across spending units and spending areas to obtain ministry-level baselines.
- Sum ministerial baselines to provide an estimate of the baseline covering the entire budget.
- Price and volume parameter variations can be summed to provide a reconciliation of changes in baselines.

### IV. Specific questions in preparing baselines for different expenditure types — wages example
- Wages baselines typically follow the “price x volume” approach:
  - Volume (number of employees in occupations) generally assumed unchanged except when increases are needed to maintain service levels or when multiannual replacement policy exists.
  - Example linkage: number of teachers assumed to track the number of school-age children.
  - Where policies on labor force size are clearly stated, use those policies to inform baseline assumptions (Box 4 reference in source).
  - Price (level of compensation) can be assumed to change in response to negotiated increases and wage drift as outlined in Table 2.

*Source: htnea2022002 - Box 2 needs to be identified, analyzed, and agreed on*

### Box 4. Singapore: An Example of the Price x Volume Approach in Wage Forecasting

### Box 4. Singapore: An Example of the Price x Volume Approach in Wage Forecasting

### Wage forecasting: price × volume framework
- Baselines for wages can be constructed by decomposing wage bill changes into price and volume drivers.
- Price drivers typically reflect negotiated settlements, existing wage-setting policies, or, where policies are not clear, economic indicators such as inflation or private sector wages.
- Volume drivers capture changes in the number of employees and composition of employment.

### Wage drift
- Wage drift refers to factors that drive individual wage levels independently of broader wage-setting policies and includes:
  - salary increments typically awarded for seniority;
  - promotions;
  - reclassification of employment positions;
  - turnover effects (retirement of higher-paid aged staff and recruitment of lower-paid young staff).
- Wage drift can be estimated using econometric analysis or structural modeling.4

### Practice on inclusion of wages in LMAs’ baselines
- Practice varies:
  - In many advanced economies, LMAs prepare baselines across all spending categories, including wages.
  - In other countries, wage baselines are prepared centrally (by Ministries of Finance or Public Service) while LMAs prepare non-wage baselines, often justified by highly centralized employment and payroll systems.5

### Two approaches to provide wage baselines
- Headcount and compensation by occupation:
  - Uses aggregated data by occupational groups from human resource and payroll systems.
  - Provides good forecasts where entries and exits are low and stable.
- Age-specific matrices from anonymized microdata:
  - Suitable when wage baselines are prepared centrally.
  - Models employment dynamics, particularly entries and exits that are staggered around specific ages.
  - Uses large anonymized data points (ranging from hundreds of thousands to millions) and allows age-specific aggregation early, generating data sets manageable in Excel.6

### Sensitivity of assumptions and disclosure considerations
- Assumptions on future wage increases are sensitive and can influence wage negotiations.
  - Assuming full pass-through of inflation to wages may fuel higher wage demands; this assumption is public in South Africa and can affect negotiations.
  - Some countries avoid public disclosure of the expected factor for wage increases during budget preparation and keep the corresponding amount as a general reserve until negotiations conclude. For example, in Austria, expected wage increases are generally tied to inflation but without public disclosure in the budget preparation phase.

### Capital spending baselines
- Challenges:
  - Large projects: baselines can rely on existing commitments, but annual profiles are not always well defined and are subject to cost changes and implementation delays.
  - Outer-year capital spending tends to trail off as projects complete, making accurate baselines critical to avoid misallocating resources between new and ongoing projects.
- Operating and maintenance costs associated with capital projects must be included in baselines and identified at project approval.
  - For maintenance costs, good practice is to estimate baseline maintenance spending on the assumption of preserving the current level of the capital stock.
- For baseline construction:
  - Major projects: request annual project expenditure profiles from agencies and confirm the approval basis.
  - Minor projects / small capital goods: treat the current level of spending as the baseline and hold steady (in nominal, real, or share of agencies’ expenditure) for durable goods (cars, ICT equipment, and so on).6

### Interest spending baselines
- Interest payment baselines must account for the debt–interest loop:
  - Interest depends on debt stock and, with a lag, on current financing needs (revenue–spending gap), which itself is affected by interest payments.
  - Present interest costs add to financing needs and hence next year’s debt, creating an intertemporal dynamic.
  - Volatility of interest rates and short average debt maturities can produce steep rises in interest burden.
- Two main approaches:
  - Top-down: relies on aggregate debt stock and effective interest rate projections to provide ballpark estimates; does not capture interaction between current financing requirements and additional interest costs.
  - Bottom-up: detailed cash-flow and financing plans developed in cash management and debt management units.7

### Social welfare and pension spending baselines
- Forecasting formula-driven entitlement programs (pensions, unemployment benefits, income support, child benefits) is demanding:
  - Requires understanding of target population, intertemporal dynamics, eligibility criteria, and external environment (for example, unemployment and poverty rates).
  - Behavioral factors (inability or unwillingness to access non-automatic benefits) and program interactions complicate forecasts.
- Comparative advantage lies with line ministries and specialized agencies, which have administrative and survey data and routinely forecast payouts (for example, pension funds).
- Recommended approach: use agency-provided estimates as baselines with Ministry of Finance oversight to check consistency of macroeconomic and fiscal assumptions.8

### Other transfers
- For purely discretionary transfers not linked to entitlement mechanisms, a historical average of actual spending may be an acceptable baseline.
- Although absence of legal obligation might suggest a zero baseline, it is seldom realistic without a political decision to phase out long-standing discretionary support.

### Key success factors for baselines
- Regular updates:
  - Baselines must be updated between forecasting rounds to reflect changes in price and volume parameters, new policy adoptions that become baseline, one-off spending, and accounting changes.
  - For rolling three-year LMAs baselines at the start of a budget cycle:
    - Reconcile approved budget with actuals and update previous approved budget with realizations (column A).
    - Reconcile outer-year estimates using previous year’s estimates as starting point and update with new price and volume parameters, new policies, and technical adjustments to reach approved budget (column B); apply same for first outer year (column C).
    - Add a new estimate for the second outer year (column D).
  - Costing of new measures can be done at detailed levels (sub-programs or activities) and then aggregated to integrate into revised baselines.
- Distribution of roles and coordination:
  - Successful baseline preparation combines strong central MoF guidance and active LMA participation.
    - Initial stage: MoF prepares baselines with LMA inputs (example: Kenya).
    - Intermediate stage: LMAs prepare baselines with MoF guidance (example: Poland).
    - Advanced stage: LMAs prepare baselines; MoF provides macro parameters and performs a challenge function (example: Australia).9
  - Within the MoF, collaboration is needed between cross-cutting fiscal strategy units and sectoral budget units; sectoral units typically produce higher baselines than cross-cutting units and can better challenge LMAs.
  - A strong MoF challenge function mitigates incentives for LMAs to under- or overstate baselines depending on budget constraints.
- Consistency with macro-fiscal environment:
  - Internal coordination within the MoF: macro-fiscal forecasts should be prepared during the strategic phase, updated regularly, and timed to budget milestones.
  - Coordination between the MoF and LMAs: LMAs should have a channel to the macro-fiscal unit for parameter identification (for example, CPI subcomponents or lower-level indexes such as fuel, import, construction prices).
- Use of baselines in low-capacity settings:
  - Baselines are useful beyond advanced economies; several low-income and emerging market economies (for example, Kenya, Peru, and Senegal) have incorporated baselines successfully.
  - A full MTBF is not required to benefit from baselines; even high-level baselines help assess fiscal space and monitor commitments for capital projects.
- Complementary PFM tools:
  - Mechanical reliance on baselines can lead to incremental budgeting and insufficient scrutiny of existing spending.
  - Spending reviews complement baselines by periodically assessing spending quality:
    - Comprehensive reviews (United Kingdom) every four or five years or rolling reviews focused on specific areas (Australia, Canada, Korea, The Netherlands).
  - Spending reviews provide a benchmark for identifying savings or spending needs using the price and volume drivers in baselines; without reviews, baselines can become a black box.
  - A related risk is that LMAs view baselines as future entitlements, creating rigidities and discouraging efficiency gains.

*Italic source: htnea2022002 - Box 4. Singapore: An Example of the Price x Volume Approach in Wage Forecasting*

### introduction of a medium-term approach to budgeting

### introduction of a medium-term approach to budgeting

### Role of baselines and top-down budgeting
- Baselines are a major and powerful analytical tool that aids in good budget preparation.
- Baselines provide a forward-looking vision of expenditure pressures that help determine available fiscal space or to meet fiscal constraints in the future.
- When combined with a multiannual outlook, baselines show the cost of inaction and may incentivize reforms to quench unsustainable spending patterns.
- An effective top-down approach to budgeting can mitigate the risk that baselines become entitlements. Key elements include:
  - a reassessment of the fiscal space every year,
  - a limit on total expenditure adopted,
  - a budget process that ensures that expenditure allocations do not exceed this limit.
- Institutionally, top-down budgeting requires a strong MoF, backed by an equally strong political commitment to resolve conflicting pressures and priorities.
- To further reduce the risk of baselines becoming entitlements, some countries, such as Australia and Sweden, have introduced a charge against the baseline forecast for most agencies to reflect the “efficiency or productivity gains” that these agencies are expected to strive for in the future.
- Other considerations—such as achieving value for money or improving service delivery—should also form part of budget negotiations and may reflect input from spending reviews.

### Benefits and analytic function of baselines
- Baselines help focus discussions on the design and adoption of spending or saving measures that require fresh decisions to have an impact.
- Baselines aid in identifying expenditure pressures and framing negotiations on spending ceilings and fiscal space.
- The “baseline” approach is spreading to a wide variety of countries across continents and income categories because it highlights future costs and incentivizes policy action.

### Implementation challenges and principles
- Applying baselines requires making a series of assumptions on the expenditure dynamic and on the nature of the policies underpinned by the budget.
- Beyond technical work on expenditure drivers and price/volume mechanisms, judgement is often needed; thorough knowledge of policies and their expenditure drivers may reduce but never fully eliminate subjectivity.
- Differentiation according to the economic nature of expenditure is an important principle; specific principles apply to payroll, investment, or transfers.
- Complementary tools are needed to avoid baseline pitfalls, most notably to preclude a throwback to incrementalism; these include:
  - spending reviews, which question the value for money of baseline expenditures,
  - a strong top-down process that ensures spending is in line with policy objectives and fiscal constraints.
- Finance ministries typically take the lead in launching the baseline approach but, over time, line ministries (LMAs) should be encouraged to assume the main responsibility.
- A comprehensive and well-designed budget classification system is a key enabler.

### Annex: Examples of uses of baselines around the world (selected entries and exact time frames)
- Australia
  - Main objective(s): Identify fiscal space and facilitate budget discussions; set multi-year ministerial ceilings
  - Who prepares baselines?: Line ministries
  - Coverage of baselines: Overall budget (baselines prepared at the level of programs)
  - Time frame: 4 years
  - Comments: Baselines are defined as “spending that would be appropriated assuming that government policy is ongoing, and do not include new programs, the expansion of existing programs that the government has not agreed to, or programs that are expected to end.” Baselines are computed by LMAs following guidance and costing parameters provided by MoF and made public.
- France
  - Main objective(s): Facilitate budget discussions; facilitate review of policies; identify fiscal space
  - Who prepares baselines?: MoF and line ministries
  - Coverage of baselines: State budget (baselines prepared at the level of missions – policy areas – and programs)
  - Time frame: 3 years
  - Comments: Baselines (“dépenses à paramètres inchangés” or “tendanciel”) are calculated separately by MoF and by LMAs and then discussed in the budget negotiations (“conférences budgétaires”) prior to determination of the ceilings by the Prime Minister.
- Senegal
  - Main objective(s): Facilitate budget discussions
  - Who prepares baselines?: MoF
  - Coverage of baselines: Budget
  - Time frame: 3 years
  - Comments: Baselines are computed within the Budget Directorate and help frame the budget discussions with LMAs.
- United States
  - Main objective(s): Transparency on spending trends
  - Who prepares baselines?: Congressional Budget Office
  - Coverage of baselines: Federal spending (prepared at level of 3,000 subaccounts)
  - Time frame: 11 years
  - Comments: Baselines are neither meant to predict future outcomes, nor to determine budget allocation; but serve as a benchmark for assessing the effects of new legislation on fiscal aggregates. They are bottom-up estimates, computed on the basis of principles partly rooted in law (for example, the Deficit Control Act) and partly developed by the CBO through experience in consultation with the budget committees.
- European Union
  - Main objective(s): Fiscal surveillance
  - Who prepares baselines?: Euro area members under guidance from the Commission
  - Coverage of baselines: General government budget aggregates
  - Time frame: 3 years
  - Comments: Baselines are used in the preparation of the stability or convergence programs, and of the draft budgetary plans. The European Commission offers guidelines to ensure consistency across countries.
- Poland
  - Main objective(s): Identify fiscal space
  - Who prepares baselines?: Line Ministries
  - Coverage of baselines: State budget (baselines prepared at ministry level)
  - Time frame: 3 years
  - Comments: Baselines were introduced in 2017 in line with the transition towards a medium-term orientation to the state budget, against a backdrop of high spending rigidity (roughly 85 percent of expenditures are considered fixed or semi fixed). LMAs are now required to prepare their three-year baselines early in the budget cycle, to be submitted to MoF for review and aggregation.
- Peru
  - Main objective(s): Increase allocative efficiency
  - Who prepares baselines?: MoF
  - Coverage of baselines: General government budget
  - Time frame: 3 years
  - Comments: For each budget entity (Pliego), the MoF provides multiannual budget allocations as expenditure ceilings before the negotiation, taking into account baselines calculated by the Budget Directorate. Budget analysis focuses on the funding difference between the baseline and the proposed budget.
- Kenya
  - Main objective(s): Facilitate budget discussions
  - Who prepares baselines?: Treasury (MoF)
  - Coverage of baselines: Specific line ministries
  - Time frame: Annual
  - Comments: In 2018, the MoF embarked on an exercise to separate the cost of ongoing policies from new policy proposals in the budget submissions of line ministries. The next stage of this reform will be from 2021/22 for the line ministries themselves to provide this distinction in their budget submissions.

### Annex: Definition of baseline according to nature of expenditure — French budget circular guidance (selected points)
- 1. Definition of baseline (tendanciel)
  - The “baseline” corresponds to the progression of an expenditure linked to its own dynamic, all things being equal. This estimate is based on the appreciation of expenditure drivers and their evolution.
  - Baseline expenditure needs to be distinguished from the impact of new measures, be it additional expenditure or savings.
  - Some expenditures have a compulsory character from a legal standpoint (debt payment, pensions, social transfers); for such expenditures, the notion of baseline is fully relevant.
  - Other expenditures linked to past commitments (outstanding payments related to investments made over past fiscal years, payments under public private partnerships) require showing the impact of multi-year commitments.
- 2. Type of expenditure (high-level rules by category)
  - 2.1. Staffing and payroll expenditures (title 2)
    - Evolution of staffing ceilings must reflect overall objectives set for evolution of civil service staffing levels until 2022.
    - Measures implemented in legal text will be taken into account in the baseline. No other specific measure or redeployment support shall be integrated in the baseline unless a legal text has been published.
    - By convention, there will be no general increase of civil servants’ wages (stability of point fonction publique).
  - 2.2. Operating expenditures other than subsidies to supervised entities (title 3, category 1)
    - Impact of exogenous economic factors (exchange rate, oil price) is taken into account if a direct link exists between the cost driver and the expenditure.
    - Inflation rate applied only for expenditures which are legally indexed.
    - Activity level is stabilized in real terms; absent direct cost evolution, any change is a new measure or a saving.
  - 2.3. Subsidies to supervised entities (title 3, category 2)
    - For entities whose total budget includes more than 50 percent of payroll expenditure and majority staff under public employment contracts:
      - for the part covering payroll, same rules as State payroll apply;
      - for the rest, any evolution is a new measure or saving.
    - For other supervised entities, any evolution in expenditure is a new measure or saving.
  - 2.4. Investment expenditures (title 5)
    - Any investment expenditure not authorized by a commitment appropriation or a legal commitment inscribed in the Finance Laws from 2017 to 2020 shall be treated as a new measure.
    - Sequencing of disbursements shall correspond to the rhythm of realization of investments as planned in the most recent forecasts, independently of the schedule initially announced.
    - Recurring investment expenditures linked to maintenance: any change is a new measure or saving.
  - 2.5. Discretionary transfer expenditures (part of title 6)
    - Transfers toward end beneficiaries (households, businesses, local government, nongovernmental organizations) such as allowances for public work schemes, emergency housing or fungible investment subsidies: any change is a new measure or saving.
  - 2.6. Transfer expenditures considered as entitlement (part of title 6)
    - Automatic disbursements as long as the beneficiary fulfils certain conditions set by legal texts (examples: allowance for handicapped adults, the earned income subsidy (prime d’activité), housing subsidies, means-tested scholarships).
    - Final outturn for 2019 and forecasts for 2020 are taken into account, as well as the evolution of indexation of expenditures if explicitly planned in a valid legal, regulatory, or contractual text.
  - 2.7. Equity injections in supervised entities (title 7, category 2)
    - When supervised entities benefit from a subsidy specifically earmarked toward coverage of investment expenditures, rules applicable to State direct investment (title 5) are applicable.

### Key takeaways and policy recommendations
- Use baselines as a forward-looking tool to identify expenditure pressures and fiscal space, and to frame multiannual budget negotiations.
- Combine baselines with spending reviews and a strong top-down process to avoid entrenching incrementalism and to safeguard value for money.
- Ensure institutional arrangements where MoF leads initial baseline work and LMAs progressively assume responsibility, supported by a comprehensive budget classification system.
- Consider applying productivity or efficiency charges to baseline forecasts (as in Australia and Sweden) to reduce the risk of baselines being treated as entitlements.
- Apply differentiated methodological rules for baselines by expenditure type (payroll, operating, subsidies, investment, transfers, entitlements, equity injections) to reflect legal, contractual, and technical drivers.

*Source: "HOW TO PREPARE EXPENDITURE BASELINES", Fiscal Affairs Department How-to Notes, International Monetary Fund | May 2022*

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_Source: https://www.imf.org/-/media/files/publications/howtonotes/2022/english/htnea2022002.pdf_