## _cr1204 ## Source details **Canonical URL:** [_cr1204](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1204.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1204.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1204.pdf.json) --- ### Construction of the Organic Budget Law (Chapter I) - Objective: design a single integrated act that applies to all public institutions and covers all phases of the budget cycle (fiscal policymaking, budget formulation, budget execution, end-of-year accounting). - Rationale: Iceland has a relatively large municipal and public corporations sector by advanced country standards and the crisis highlighted substantial fiscal risks these sectors can pose to central government. - Preserve strengths of the 1997 Financial Reporting Act (FRA): - FRA is concise and clearly written, with detailed operational guidance confined to regulations. - FRA applies to the central government’s budget and to entities and corporations it controls. - FRA specifies required content of key financial documents (annual budget and final accounts). - FRA ensures preparation of these documents according to the same accounting standards to allow comparability between plan and outturn. - Key weaknesses to address: - Coverage excludes municipalities and their corporations and focuses primarily on ex post financial accounting and reporting. - Silence on principles and procedures for macroeconomic forecasting and fiscal policymaking and their link to the annual budget. - Fragmented budget formulation with the country’s 260 individual agencies as the focus of budget discussions. - Budget execution loopholes enabling government overspending with relative impunity. - Fiscal reporting needs more comprehensive and timely information to inform fiscal decisions. - Recommended structural reforms: - Expand institutional coverage to encompass the whole public sector and integrate timetable for the entire budget process. - Strengthen interactions between fiscal policymaking, budget formulation, budget execution, and accounting so elements reinforce each other. - Indicative OBL structure (Box 1.1): - Section I: Roles and Responsibilities. - Section II: Macroeconomic and Fiscal Policy. - Section III: Budget Formulation and Approval. - Section IV: Budget Execution and Treasury Management. - Section V: Accounting, Reporting and Audit. - Section VI: Oversight of Municipalities and Public Corporations. ### Macroeconomic and Fiscal Policymaking (Chapter II) - Problem statement: in the ten years before the 2008 crisis, fiscal policy was characterized by pro-cyclicality, weak budget discipline, lack of coordination between levels of government, and inadequate surveillance and management of fiscal risks. - Aim: provide a transparent and credible framework for macroeconomic and fiscal policymaking through fiscal responsibility provisions in the OBL. - Recommended provisions: - Establish a procedural fiscal rule anchored in a set of permanent principles for fiscal policymaking. - Require each newly elected government to submit to the Althingi a Statement of Fiscal Policy setting out its numerical fiscal objectives for the tenure of the Parliament and demonstrating consistency with the above principles. - Oblige the government to present an annual Medium-term Fiscal Strategy (MTFS) to the Althingi for debate in the Spring and to seek its endorsement of key economic, fiscal, budgetary, and policy parameters. - Strengthen arrangements for independent evaluation of the government’s ex ante fiscal forecasts and ex post fiscal performance. - Procedural fiscal rule rationale: - IMF advises against a permanent numerical rule for Iceland given expected gross general government debt peaking at 100 percent of GDP in 2011 and Iceland’s exposure to unusual economic volatility. - Recommendation: adopt a procedural fiscal rule supported by strict accountability arrangements. - Example principles to anchor the procedural rule (Recommendation 2.1): - a. Sustainability: ensure sustainable levels of public liabilities and net worth. - b. Prudence: maintain a prudent balance between revenue and expenditure consistent with a. - c. Economic Stabilization: contribute to stabilization of economic activity, subject to a and b. - d. Predictability: avoid sudden, unexpected changes in revenue and primary expenditure policies, subject to a, b, and c. - e. Transparency: set clear, measurable, medium-term objectives and report regularly on performance. - Statement of Fiscal Policy specifications (Recommendation 2.2): - a. post-election economic forecast for the medium term; - b. long-term fiscal projections covering at least 30 years and based on a range of scenarios; - c. numerical fiscal policy objectives for no less than next five years; - d. a small number of indicators to measure performance; - e. sources of data to be used; and - f. a statement of conformity with the government’s fiscal principles. - Parliamentary role: - Recommendation 2.3: Althingi should approve, amend or reject fiscal policy objectives. - Recommendation 2.4: Government may revise Statement between elections with Althingi approval under specified conditions. - Recommendation 2.5: Fiscal objectives should combine (a) long-term stock goal and (b) medium-term balance objective. - MTFS operationalization: - MTFS should translate Statement objectives into operational targets and multi-year expenditure ceilings by ministry. - MTFS to be submitted in the Spring and approved by the Althingi. - MTFS should include a central unallocated provision; at least 1 percent of expenditure should be ringfenced for contingencies in the budget year and rise thereafter. - Historical projection errors noted: one-year expenditure projection error averaged about 1¼ percent of GDP before the crisis; three-year projection error exceeded 2 percent of GDP. In 2008-11, the one-year projection error increased to 3 percent of GDP, while the three-year projection error increased to 6¾ percent of GDP. - Recommendation 2.6 (MTFS content, by April every year) bullet summary: - a. macroeconomic outturn for the last two years and forecast next five years with comparisons to independent forecasters; - b. fiscal outturn last two years and forecasts next five years for all Statement indicators; - c. targets for at least next three years for Statement indicators; - d. list of policies required to meet targets and fiscal impact vs baseline; - e. medium-term budget framework for central government with (i) overall expenditure ceiling for central government (Group A) reconciled to prior budget, (ii) indicative expenditure ceilings by ministry, (iii) an unallocated margin on a rising profile with at least 1 percent for contingencies in budget year; - f. local government outturn and five-year forecasts split into own revenues and transfers; - g. summary of public corporations’ finances for last two and next five years; - h. fiscal risk statement with alternative assumptions and discrete risks; - i. statement of compliance with the Statement of Fiscal Policy. - Budget Orientation Debate (Recommendation 2.7, by May): - Parliament should review government performance based on INAO report and approve or reject MTFS through resolution endorsing medium-term targets, an overall nominal expenditure ceiling for central government, and a program of implementing legislation. - Independent scrutiny (Recommendation 2.8): - OBL should specify who produces government forecasts, require comparisons with independent forecasts, give INAO formal responsibility for evaluating performance against objectives, and establish a limited-tenure independent commission to scrutinize incoming governments’ Fiscal Policy Statements. ### Budget Formulation and Approval (Chapter III) - Diagnosis: budget formulation featured steady upward drift in expenditure as the budget passed through Cabinet and Althingi. - Goal: institutionalize a comprehensive, orderly, policy-oriented approach so government fiscal objectives shape the annual Budget. - Key timing and calendar weaknesses: - MTFS presented alongside annual budget in early October, so Parliament has no formal role in defining preparation framework. - Annual Budget Bill based on July forecast and subject to amendments before December approval. - Final Budget Bill authorizes carryovers retroactively; audited outturns available six months after year-end. - Revised timetable goals: - MTFS presented and approved by Althingi in Spring Budget Orientation Debate. - Broad parameters voted by Althingi well in advance of the year. - Carryovers and retained revenues finalized before year start. - Accounts closed, consolidated, and audited in time to inform MTFS and Budget Orientation Debate. - Recommendation 1.3: OBL should prescribe the integrated timetable. - Budget Bill submission timing (Recommendation 3.1): - FRA requires submission “as soon as it convenes in the autumn”; in practice submitted in early October. - Recommendation: bring forward deadline to first week of September to provide four months for consideration. - Economic forecasting synchronization (Recommendation 3.2): - Statistics Iceland should bring forward Autumn forecast to September and not produce another until January. - Medium-term Budget Strategy (MTBS) and contents (Recommendation 3.3; Box 3.1 highlights): - MTBS coverage: previous year, current year, budget year, and subsequent three years. - Include medium-term macro forecast with reconciliation and comparisons; medium-term fiscal forecast with alternative scenarios; medium-term budget plan broken down by ministry and economic category; medium-term debt management strategy with guarantees, PPPs, and contingent liabilities. - If annual Budget deviates from April MTFS targets substantially, government should submit a new Statement of Fiscal Policy before discussing the annual Budget. - Unit of appropriation issues and recommendation (Recommendation 3.4): - Current basic unit: 260 individual agencies causing over 900 legally binding appropriations (TOTAL 966). - Comparative totals shown: Netherlands TOTAL 170; France TOTAL 256; UK TOTAL 414; Sweden TOTAL 550; Australia TOTAL 936; Iceland TOTAL 966; Greece TOTAL 14,000; Turkey TOTAL 34,583. - Recommendation: elevate legal appropriation unit from agency to ministry, reduce appropriations by around two-thirds from over 900 to around 300, group agencies into three to five programs per ministry, two economic categories per program, and three funding sources. - Virement rules (Recommendation 3.5): - Prohibit reallocation between ministries without Parliamentary approval. - Permit reallocation between programs up to 3 or 5 percent of ministry’s approved budget. - Either prohibit transfers between operating and capital or allow only transfers from operations into capital but not reverse. - Contingency reserve (Recommendations 3.6–3.8): - MoF appropriation should include an unallocated contingency reserve of at least 1 percent of total budgeted expenditure. - Reserve use limited to expenditures that are temporary, unforeseeable, unavoidable, and unabsorbable. - Transfers from reserve notified in monthly reports and audited by INAO; inappropriate access requires Supplementary Budget. - Claims on reserve should be deducted from ministry carryovers. - Parliamentary amendment powers and voting sequence (Recommendations 3.9–3.10): - Limit Althingi amendments so they cannot increase total central government expenditure, reduce total revenue, or increase net public sector liabilities. - Adopt top-down sequence: first reading vote on total expenditure/revenue/liabilities; second reading on allocation by ministry/program; third reading finalize division by economic category. - Range of budget approvals, PPPs, and multi-year commitments (Recommendations 3.11–3.12): - Expand non-expenditure approvals to include an annual ceiling on total value of new PPP contracts. - Require demonstration that PPP flows are consistent with MTBS. - Require Althingi approval for multi-year commitments above a percentage threshold and MoF presentation of total costs, flows, and accommodation within medium-term plans; public corporations require MoF approval via annual financial plans. ### Budget Execution and Treasury Management (Chapter IV) - Historical performance: over the past decade Iceland overspent its approved budget by around 12 percent on average; between 2005 and 2011 overspent by around 4 percent on average. - Root causes of overspending: - Discretionary increases responding to surging revenues. - Above-budget wage increases and transfers negotiated mid-year. - Legal loopholes enabling overspending: - a. Increase/anticipate collection of own revenues netted against appropriation (Articles 12 and 23). - b. Fund overspend from accumulated underspends carried forward (Article 37). - c. Deduct overspend from following year’s appropriation (Article 45). - d. Seek retrospective Parliamentary authorization before year-end via Supplementary Budget (Articles 33 and 34). - e. Seek retrospective authorization after year-end via Final Budget Bill (Article 44). - Recommended execution and treasury reforms: - Oblige all public entities to manage cash efficiently (Recommendation 4.1). - Tighten rules on retention and earmarking of revenues; require gross reporting of revenues (Recommendation 4.3). - Restrict carryover of underspending and repeal carryover of overspending (Recommendations 4.5 and 4.6). - Require Althingi approval of a Supplementary Budget before overspending can take place except for non-discretionary items (Recommendation 4.7). - Treat unauthorized spending as “in excess” and expand sanctions beyond current options (Recommendations 4.10–4.11). - Cash management and planning (Recommendations 4.1–4.2): - Payments not in advance of need, minimize borrowing costs, pay invoices on time. - Require approved operating and cash plans by December 31 consistent with budgeted limits. - Retained and earmarked revenues (Recommendations 4.3–4.4): - Around 17 percent of gross expenditure is funded out of retained or earmarked revenues (second highest among advanced countries informally surveyed). - Law should report all revenues on a gross basis. - Distinguish revenue types and set rules for retention and return of overcollections; two options for tax earmarking (prohibit or allow only in exceptional circumstances with five-year renewal). - Carryover regime (Recommendations 4.5–4.9): - Article 37 grants Minister of Finance unlimited carryover authority; Article 45 permits carryover of overspends. - Since 2007, total stock of carryovers fell from over 5 percent of central government budget to around 3 percent in 2010. - At end-2010: about 130 entities had positive carryovers >10 percent; 20 appropriations had positive carryovers >100 percent; around 50 appropriations had negative carryovers between 1 and 78 percent. - In 2010 MoF eliminated carryover of overspends, restricted underspend carryover to 4 percent of budget, and capped total stock at 10 percent. - Recommendation 4.5: repeal provision permitting carryover of overspending. - Recommendation 4.6: retain underspend carryover at ministry level with limits: a. maximum 3 percent of ministry’s total budget for previous year; b. limited to non-wage, non-transfer operating and capital; c. attributable to efficiency or justifiable delays; d. based on audited accounts; e. limited to level of drawdown approved by Parliament in following year. - Supplementary Budgets and Final Budget Bill (Recommendations 4.7–4.8): - Require any unbudgeted expenditure that cannot be accommodated via virement or contingency reserve to be authorized by Althingi through Supplementary Budget before expenditure takes place, except for interest payments, demand-led social security payments, and international subscriptions. - Final Budget Bill should be abolished or forbidden from retrospectively increasing total expenditure or any appropriation except for small non-discretionary items. - Wage agreements (Recommendation 4.9): - Repeal Article 34 permitting retrospective authorization of above-budget wage agreements. - Wage agreements should be negotiated within MTFS parameters, take effect the following year, and be fully reflected in that year’s budget. - Sanctions and oversight (Recommendations 4.10–4.11): - INAO should report overspending/irregularities to Althingi and Althingi should investigate and decide authorization or sanction. - Provide a broader range of intermediate administrative, financial, and criminal sanctions including public hearings, management plans, additional reporting, freezing appropriations, suspension of carryover/vire/retention/borrowing powers, appointment of overseer, and merger requirements. ### Fiscal Reporting (Chapter V) - Rationale: government accountability requires more comprehensive and timely financial reports. - Current strengths: - Government prepares accrual-based operating statement, cash-flow statement, and balance sheet. - Financial report audited by INAO with unqualified opinion. - Budgets prepared on same accounting basis as end-of-year financial statements. - Statistics Iceland produces good general government statistics. - Needs and recommended reporting reforms: - Accelerate timetable so audited consolidated accounts inform MTFS in April. - Require forecast and end-of-year accounts to use same accounting basis (Recommendation 5.1). - Expand coverage to consolidated public sector and subsectors (Recommendations 5.2–5.4). - Recognize physical assets on balance sheet (Recommendation 5.5). - Show net lending in operating statement (Recommendation 5.6). - Statistics Iceland should produce full balance sheet and statement of other economic flows for central, local, general government, and public sector (Recommendation 5.7). - Consolidation options and recommendation (Recommendation 5.3): - Option 1: central government only (current). - Option 2: central government plus all commercial entities it controls. - Option 3: entire public sector including local governments and their commercial entities. - Recommendation 5.3: financial statements should cover either (a) central government and all commercial entities it controls; or (b) the public sector (central government, local governments, and all commercial entities they control). - Subsector reporting (Recommendation 5.4): - Require disaggregated reporting for central government, local government, nonfinancial public corporations, monetary financial public corporations, and nonmonetary financial corporations. - Nonfinancial assets and accounting implications (Recommendations 5.5–5.7): - Remove exception that prevented recognition of central government physical assets; recognize nonfinancial assets on balance sheets. - Operating statement should show government’s net lending as well as standard surplus measures. - Statistics Iceland to produce full balance sheet and statement of other economic flows. - Table 5.2 examples: Australia 32 percent of total government assets; Canada 15 percent; France 50 percent; Sweden 36 percent; UK 59 percent; US 29 percent (with respective Percent of GDP figures where provided in source). - Leases and PPPs (Recommendation 5.8): - Assets and liabilities associated with leases and PPPs should be recognized in budgets and accounts when required by IPSAS. - Interest costs (Recommendation 5.9): - Accounting should calculate interest cost by multiplying outstanding principal by the "effective interest rate" per IPSAS 29 and recognize inflation-linked increases in principal of indexed debt. - Long-term fiscal projections (Recommendation 5.10): - OBL should require publication of long-term fiscal projections based on a range of macroeconomic, demographic, and other assumptions and provide present values of main lines of projections. - Table 5.4 US example: Total Receipts 175 trillion dollars / 20.2 percent of 75-year GDP; Primary spending 192 trillion dollars / 22.1 percent of 75-year GDP; Receipts less primary spending −16.3 trillion dollars / −1.9 percent (source figure in PDF). - Accounting standards (Recommendation 5.11): - OBL should require financial reports to comply with International Public Sector Accounting Standards (IPSAS). - Timeliness (Recommendation 5.12): - OBL should require audited annual financial statements no more than four months after end of financial year. - Comparative lags figure shows varying publication lags (specific month values presented in source figure). ### Coverage of Public Sector and Municipalities (Section I.A and Box 2.1) - Institutional coverage: - Finding: Iceland’s 76 municipalities account for around 26 percent of public sector expenditure and 15 percent of public sector liabilities. - Finding: OECD average for local government share of public expenditure is around 18 percent. - Finding: Public corporations account for around 26 percent of public sector expenditure and 32 percent of public sector liabilities; Landsvirkjun and the Housing Financing Fund (HFF) account for large shares. - Recommendation 1.1: OBL provisions should apply to whole public sector including central government, municipalities, and financial and nonfinancial public corporations. - Box 2.1 implications for municipalities: - Bringing forward central government Budget submission to September and top-down sequence enables municipalities to finalize and submit budgets by December 15 per LGA Article 62. - Statement of Fiscal Policy and MTFS presentation in April informs costing and allocation of service mandates per LGA Articles 129, 128, and supports LGA Article 62’s four-year horizon requirement. - Eliminating mid-year wage agreement negotiation by central government limits unexpected cost pressures for municipalities. - Consolidated public sector statistics and accounts improve understanding of linkages between central and local finances. ### Simulations and Choice of Fiscal Indicators (Appendix / Chapter on Fiscal Rules) - Procedural fiscal rule under OBL would require each new government to specify numerical fiscal objectives and relevant indicators. - Desirable indicator properties: sustainability, operability, counter-cyclicality, medium-term planning facilitation, and simplicity. - Example fiscal indicators considered and simulated: - 7-year rolling surplus: Indicator = Overall Balance; Coverage = GG; GDP Indicator = Average 7-yr growth; Adjustment = Automatic: 7-yr horizon; Expenditure Adjustment = No. - Augmented growth-based balance: Indicator = Overall Balance; Coverage = GG; GDP Indicator = Long-term growth; Adjustment = Automatic: 50% of slippage; Expenditure Adjustment = No. - Limit on real spending growth with deficit brake: Indicator = Primary Expenditure; Coverage = CG/GG; GDP Indicator = Long-term growth; Adjustment = Automatic: 50% of slippage; Expenditure Adjustment = Yes. - Simulation baseline assumptions: - New fiscal objectives introduced in 2013 and commence in 2014 when output expected at potential. - Targeted debt ratio of 60 percent of GDP to be achieved in 7 years. - 2014 projected general government debt ratio of 96 percent of GDP implies average surplus of at least 1.5 percent of GDP over consolidation period. - Use long-term growth 2.3 percent of GDP for 2000-2010 as benchmark. - Shocks applied in simulations: growth shock, interest shock, combined shock, contingent liability shock of 30 percent of GDP, and boom-bust scenario. - Key simulation findings: - Rolling surplus and augmented growth-based objective more likely to anchor debt sustainability than a real expenditure limit. - Under baseline, debt declines faster under expenditure limit due to decline in expenditure ratio as economy recovers, but shock scenarios can derail spending and slow debt reduction. - Rolling surplus and augmented growth-based objectives succeed in bringing debt to 60 percent of GDP in 7 years under all scenarios except a contingent liability shock. - Rolling surplus preserves economic stability better than augmented growth-based balance; augmented growth-based balance preserves sustainability more strongly but requires abrupt adjustments. - Expenditure limit helps rapid debt reduction in boom-bust but needs a stringent deficit brake to avoid reversal in bust. - Trade-offs summarized: balance between sustainability, stabilization, operability, and political transparency must guide choice of numerical fiscal objective for Iceland. *IMF Fiscal Affairs Department technical assistance report to Iceland (mission visit October 18–31, 2011).* ### Preface ................................................................................................................ ### Preface ### Reference - Preface ....................................................................................................................................... 6 *https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1204.pdf* ### Executive Summary and Overview ......................................................................................... ### Executive Summary and Overview ### Construction of the Organic Budget Law (Chapter I) - Objective: design a single integrated act that applies to all public institutions and covers all phases of the budget cycle (fiscal policymaking, budget formulation, budget execution, end-of-year accounting). - Rationale: Iceland has a relatively large municipal and public corporations sector by advanced country standards and the crisis highlighted substantial fiscal risks these sectors can pose to central government. - Preserve strengths of the 1997 Financial Reporting Act (FRA): - FRA is concise and clearly written, with detailed operational guidance confined to regulations. - FRA applies to the central government’s budget and to entities and corporations it controls. - FRA specifies required content of key financial documents (annual budget and final accounts). - FRA ensures preparation of these documents according to the same accounting standards to allow comparability between plan and outturn. - Key weaknesses to address: - Coverage excludes municipalities and their corporations and focuses primarily on ex post financial accounting and reporting. - Silence on principles and procedures for macroeconomic forecasting and fiscal policymaking and their link to the annual budget. - Fragmented budget formulation with the country’s 260 individual agencies as the focus of budget discussions. - Budget execution loopholes enabling government overspending with relative impunity. - Fiscal reporting needs more comprehensive and timely information to inform fiscal decisions. - Recommended structural reforms: - Expand institutional coverage to encompass the whole public sector and integrate timetable for the entire budget process. - Strengthen interactions between fiscal policymaking, budget formulation, budget execution, and accounting so elements reinforce each other. ### Macroeconomic and Fiscal Policymaking (Chapter II) - Problem statement: in the ten years before the 2008 crisis, fiscal policy was characterized by pro-cyclicality, weak budget discipline, lack of coordination between levels of government, and inadequate surveillance and management of fiscal risks. - Aim: provide a transparent and credible framework for macroeconomic and fiscal policymaking through fiscal responsibility provisions in the OBL. - Recommended provisions: - Establish a procedural fiscal rule anchored in a set of permanent principles for fiscal policymaking. - Require each newly elected government to submit to the Althingi a Statement of Fiscal Policy setting out its numerical fiscal objectives for the tenure of the Parliament and demonstrating consistency with the above principles. - Oblige the government to present an annual Medium-term Fiscal Strategy to the Althingi for debate in the Spring and to seek its endorsement of key economic, fiscal, budgetary, and policy parameters for ministries, municipalities, and public corporations to use in preparing their budgets for the coming year. - Strengthen arrangements for independent evaluation of the government’s ex ante fiscal forecasts and ex post fiscal performance, drawing on existing institutional arrangements. ### Budget Formulation and Approval (Chapter III) - Diagnosis: budget formulation was characterized by a steady increase in the expenditure level as the budget passed through Cabinet and Althingi. - Goal: institutionalize a more comprehensive, orderly, and policy-oriented approach to budget preparation and approval so the government’s fiscal objectives shape the annual Budget. - Specific recommendations: - Bring forward to early September the deadline for submission of the Budget Bill and require it to be accompanied by a Medium-term Budget Strategy demonstrating consistency with the government’s stated fiscal objectives. - Reduce the number of appropriations by two-thirds from over 900 to around 300 by elevating the basic unit of appropriation from the agency to the ministry level and grouping agencies into three to five policy-based programs per ministry. - Give ministries greater flexibility to reallocate resources within their budgets to meet spending pressures that emerge during budget execution. - Establish a central, unallocated contingency reserve in the Budget with clear access criteria and reporting requirements. - Move from a bottom-up to a top-down sequence to budget approval in the Althingi and ensure any legislative amendments to the Budget Bill are consistent with the fiscal strategy approved in the Spring. - Expand the range of budget approvals to encompass borrowing by all public sector entities, public-private partnerships, and other multi-year commitments. ### Budget Execution and Treasury Management (Chapter IV) - Historical performance: over the past decade Iceland has overspent its approved budget by around 12 percent on average and has had one of the poorest track records in enforcing budget discipline in the advanced world. - Objective: ensure the approved budget is respected during execution by closing loopholes that enable overspending. - Recommended reforms: - Place an obligation on all public entities to manage cash efficiently. - Tighten rules concerning the retention and earmarking of revenues. - Restrict the carryover of underspending and abolish the carryover of overspending from one year to the next. - Require the Althingi to approve a Supplementary Budget before any overspending can take place, with the exception of a small number of mandatory items. - Treat all other spending not authorized in advance by the Althingi as “in excess,” and expand the range of sanctions for excess expenditure beyond the current “soft” and “nuclear” options. ### Fiscal Reporting (Chapter V) - Rationale: government accountability for fiscal performance requires a more comprehensive and timely set of financial reports. - Strengths and needs: - Existing reporting provisions are relatively good and were ahead of earlier standards, but international accounting standards have moved on and crisis lessons require broader and timelier information. - Reporting reforms recommended for the OBL: - Accelerate the timetable for the production of audited consolidated accounts so they are available in time to inform the Medium-term Fiscal Strategy in April. - Improve consistency of budget forecasts and end-of-year accounts by requiring both to be prepared on the same accounting basis. - Expand coverage of public institutions in fiscal statistics and financial statements to provide better information on consolidated public sector finances. - Broaden coverage of fiscal flows and assets and liabilities so the central government recognizes physical assets on its balance sheet, including those related to long-term leases and public-private partnerships. - Adopt International Public Sector Accounting Standards (IPSAS) to ensure financial reporting follows good practice. *Executive Summary and Overview — IMF Fiscal Affairs Department technical assistance report to Iceland (mission visit October 18–31, 2011).* ### 1. The development of a new organic budget law (OBL) presents an opportunity ### The development of a new organic budget law (OBL) presents an opportunity ### A. Coverage of the New Organic Budget Law — key findings and recommendation - Finding: Iceland’s 76 municipalities account for around 26 percent of public sector expenditure and 15 percent of public sector liabilities. - Finding: OECD average for local government share of public expenditure is around 18 percent. - Finding: Iceland’s public corporations account for around 26 percent of public sector expenditure and 32 percent of public sector liabilities; the national energy company (Landsvirkjun) and the Housing Financing Fund (HFF) account for a large share of the total. - Finding: Municipalities and public corporations have historically operated with a large degree of fiscal autonomy and pose fiscal risks to central government finances highlighted by the crisis. - Finding: The 2011 Local Government Act introduced new fiscal rules and enhanced fiscal oversight for municipalities. - Recommendation 1.1: Institutional Coverage. The provisions of the organic budget law should apply to the whole public sector including central government, municipalities, and financial and nonfinancial public corporations. ### B. Scope of the New Organic Budget Law — findings, causes of overspending, and recommended architecture - Finding: The legal framework (1997 Government Financial Reporting Act (FRA), 2011 Althingi Procedures Act, and related acts) is relatively clear, concise, and comprehensive by international standards but includes gaps and inconsistencies that should be addressed. - Finding: The legal framework currently: - applies to central government ministries, agencies, and corporations but excludes municipalities and their corporations; - primarily concerns annual budgeting and accounting but is largely silent on (i) procedures for ex ante fiscal policy-making and medium-term budget planning and (ii) linkages between ex post accounting, audit, and sanctions; - has timetables for budget cycle phases characterized by discontinuities that weaken transparency, discipline, and integrity. - Finding: Over the last 12 years the steady upward drift in expenditure begins during budget preparation when the multi-year expenditure frames set in the previous budget are exceeded by around ISK 28 billion. - Finding: During budget approval various government- and Althingi-initiated amendments add a further ISK 11 billion. - Finding: During budget execution Spring wage agreements and other expenditure pressures add a further ISK 18 billion in the Supplementary Budget. - Finding: Ex post adjustments to the Final Accounts can add a further ISK 46 billion. - Recommendation 1.2: Architecture of the Law. The OBL should apply to the whole of the budget cycle and be organized around the four key phases: macroeconomic and fiscal policy; budget formulation and approval; budget execution and treasury management; and accounting, reporting, and audit. - Indicative structure for the OBL (Box 1.1): - Section I: Roles and Responsibilities — clarify legal powers and obligations of Althingi, Government, Minister of Finance, Line Ministries, Municipalities, Public Corporations, INAO, and Statistics Iceland. - Section II: Macroeconomic and Fiscal Policy — principles and procedures for formulation, approval, and evaluation of medium-term fiscal policy and strategy. - Section III: Budget Formulation and Approval — process for preparation, adoption, and modification of the annual budget. - Section IV: Budget Execution and Treasury Management — arrangements for cash planning, asset management, and liabilities. - Section V: Accounting, Reporting and Audit — standards, coverage, format, timetable for government financial reports and procedures for addressing authorized deviations identified by INAO. - Section VI: Oversight of Municipalities and Public Corporations — specify financial arrangements for more autonomous public entities. ### C. Budget Calendar — weaknesses and recommended timetable integration - Key weaknesses in current timetable: - The government’s Medium-term Fiscal Strategy (MTFS) is presented to the Althingi alongside the annual budget in early October, so Parliament has no formal role in defining the strategy and framework for budget preparation. - The annual Budget Bill is based on an outdated macroeconomic forecast from July and is often subject to substantial amendment before approval in December, making it difficult for ministries, agencies and municipalities to finalize annual budget, cash and work plans well in advance. - Authorization of carryovers through a retroactive Final Budget Bill means some institutions’ total resource envelope is not finalized until several months into the year; Supplementary Budgets can be approved late imposing large windfalls or cuts. - Audited outturn data are available only six months after year-end, which is still too late to inform the Spring discussion of the government’s fiscal strategy for the coming year. - Goal of revised timetable (Table 1.2) — integrated calendar outcomes: - MTFS is presented to and approved by the Althingi in a Budget Orientation Debate in the Spring so ministries, agencies, public corporations, and municipalities have an agreed framework for budget preparation. - Broad parameters of the annual Budget are voted by the Althingi well in advance of the start of the year so managers can finalize implementation plans. - Carryovers and retained revenues are added to or deducted from budgets prior to the start of the year so cash and work plans can be approved and implemented from January 1. - Accounts are closed, consolidated, and audited in time to inform the Medium-term Fiscal Strategy and Budget Orientation Debate for the next budget. - Recommendation 1.3: Budget Calendar. The OBL should prescribe a new and better integrated timetable for the budget process in line with the revised timetable proposed. ### II. Macroeconomic and Fiscal Policymaking — legal elements and gaps - Core elements a comprehensive OBL should contain: - a statement of permanent principles or rules guiding fiscal policymaking and conditions for modification/suspension; - a requirement that government state medium-term fiscal policy objectives justified with reference to long-term macroeconomic and fiscal trends and risks; - an obligation to present a medium-term fiscal strategy covering at least a five-year horizon and a medium-term budget framework setting multi-year expenditure limits by ministry; - arrangements for seeking Parliamentary input into and endorsement of fiscal objectives and expenditure plans at the start of budget preparation; - a mechanism for independent scrutiny of government fiscal policy and performance. - Gaps in Iceland’s legal framework: - FRA and other legislation do not contain specific fiscal objectives or rules. - Article 28 of the FRA requires a four-year projection and assessment of economic impact, but projections are presented alongside the annual budget and play little role in shaping budget preparation. - Recent amendments to the 2001 Althingi Procedures Act require government presentation of medium-term fiscal and expenditure plans in April, but there is no requirement to present longer-term (more than 30-year) fiscal projections to show long-term sustainability. - No requirement to provide a comprehensive statement of fiscal risks or explore a range of alternative fiscal scenarios. - No requirement to compare government macroeconomic projections with other domestic or international forecasters and explain differences. - No requirement for independent evaluation of government performance against fiscal targets. *Source: _cr1204 - 1. The development of a new organic budget law (OBL) presents an opportunity* ### 14. Despite the above gaps in the legal framework, Iceland has developed a number ### _cr1204 - 14. Despite the above gaps in the legal framework, Iceland has developed a number ### Good fiscal policy practices developed over the past decade - Medium-term “frame budgeting” introduced from the early 2000s based on Article 28 and elaborated in a 2003 MoF guidance note, producing an MTBF in the Spring with a four-year forecast setting indicative expenditure ceilings by administrative units and project priorities; framework decided by the Government by end-April and guides fiscal policy in the upcoming budget year. - 2003 government policy declaration (reiterated in subsequent budgets 2003–2008) established a quasi-fiscal rule: restrain real growth of central government consumption to 2 percent per year and transfers to 2.5 percent per year; committed to maintaining fiscal surpluses for central government. - 2006 enhancements to the fiscal framework with guidance on frame budget procedures: strengthened quasi-fiscal rule by adding a mechanism to correct slippages in expenditure growth and clarified ministries’ responsibility to adhere to medium-term expenditure frames and government role in approving amendments. ### Implementation weaknesses and fiscal outcomes before and during the crisis - Rules-based framework lacked legal support and broad political commitment, contributing to chronic fiscal indiscipline pre-crisis. - Budget proposals frequently exceeded real spending limits; parliamentary approval and weak implementation discipline led to actual current spending exceeding the real growth target in each of the five years prior to the crisis by an average of 11 percent, while transfers exceeded the target by an average of 5 percent (Figure 2.1 reference). - Headline fiscal performance appeared good pre-crisis due to surging revenues that far exceeded Supplementary Budget projections, masking lack of credibility in the fiscal framework. - Onset of the crisis exposed the weaknesses: fiscal rule was abandoned entirely as revenues collapsed, expenditures spiked, and deficits (excluding bank recapitalization) soared in 2009 (Figure 2.2 reference). ### Additional procedural weaknesses revealed by the crisis - Fiscal projections: Frequent substantial revisions to medium-term macroeconomic projections undermined adherence to medium-term fiscal targets and nominal expenditure ceilings; with high inflation rates (albeit falling below 5 percent more recently), expenditure ceilings were treated as potential lower limits on spending. - MTBF process: Abandonment of Spring discussions between line ministries and the MoF shortened line ministries’ planning horizon. - Fiscal risks: Limited quantitative analysis of risks beyond potential calling of government guarantees; macroeconomic and fiscal scenarios rarely featured in medium-term fiscal strategy preparation; contingency buffers inadequate in face of macro shocks, wage negotiations, subsidies to crisis-hit households, and recapitalization of financial institutions. - Parliamentary engagement and scrutiny: Medium-term fiscal strategy and expenditure framework were discussed in Cabinet in Spring but not presented to the Althingi and the public until Autumn, preventing Althingi participation in strategy definition and legislative planning. - Intra/inter-governmental fiscal coordination: Central government failed to provide timely information to local governments on required fiscal effort; publication of a medium-term consolidation plan in July 2009 sought to remedy this but practice was not sustained. ### Implications for the New Organic Budget Law (OBL) — required fiscal responsibility provisions - Introduce a procedural fiscal rule anchored in permanent principles for fiscal policy set out in law. - Require the government to submit a Statement of Fiscal Policy to the Althingi following each election setting out numerical fiscal objectives covering at least the length of the Parliament and consistent with the principles. - Annual obligation for the government to present a Medium-term Fiscal Strategy (MTFS) to the Althingi setting out: (i) fiscal targets for the central government, general government, and public sector; (ii) nominal expenditure ceilings for each ministry; and (iii) a summary of specific policy measures required to implement the strategy. - Provision for an annual Budget Orientation Debate in the Spring to seek Althingi input into and endorsement of fiscal targets, expenditure ceilings, and required legislative changes. - Arrangements to ensure independent evaluation of government ex ante forecast assumptions and ex post fiscal performance. ### Principles for fiscal policymaking (Recommendation 2.1 and discussion) - Choice between procedural versus numerical rules: - Procedural rule elements: (i) principles for fiscal policymaking, (ii) requirement for each government to set numerical objective(s) for fiscal aggregate(s), (iii) content of fiscal strategy statement, (iv) arrangements for reporting performance. - Numerical rule elements (additional): (i) permanent numerical objective(s), (ii) accounting methodology for compliance assessment, (iii) an escape clause for exceptional circumstances. - IMF analysis argues against a permanent numerical fiscal rule for Iceland given: expected gross general government debt peaking at 100 percent of GDP in 2011, prolonged fiscal consolidation, and Iceland’s exposure to unusual economic volatility (Figure 2.3 reference). A permanent numerical rule would either require complex accommodation mechanisms (undermining transparency) or frequent use of an escape clause (undermining credibility). - Recommendation: adopt a procedural fiscal rule in the OBL supported by strict accountability arrangements to allow government flexibility in specifying precise fiscal objectives while maintaining principles-based guidance. - Example principles to anchor the procedural rule (Recommendation 2.1): a. Sustainability: The government will ensure sustainable levels of public liabilities and net worth. b. Prudence: The government will, on average, maintain a prudent balance between revenue and expenditure which is consistent with achieving a. c. Economic Stabilization: Subject to a and b, the government will contribute to the stabilization of economic activity. d. Predictability: Subject to a, b, and c, the government will avoid sudden, unexpected changes in revenue and primary expenditure policies. e. Transparency: The government will set clear, measureable, medium-term objectives for fiscal policy which are consistent with a, b, c, and d, and report regularly on actual and forecast performance against those objectives. ### Statement of Fiscal Policy — requirements and recommendations - Government should be required to state fiscal policy objectives at the outset of a Parliamentary term, based on updated macroeconomic and fiscal forecasts and showing adherence to OBL principles. The Statement should present long-term economic and fiscal projections covering 30-50 years and include a range of scenarios (see Chapter V reference). - Statement should set numerical fiscal objectives for the government’s tenure, specifying time periods for achievement. Possible objectives include a stock aggregate (gross/net debt or net worth), a balance aggregate (overall/primary/structural/operating balance), and/or an expenditure aggregate (real/nominal expenditure growth). - Statement must specify ex ante the precise indicators and data sources to be used to measure performance against objectives, detailing indicator measurement and data sources to prevent later “shopping” for favorable indicators and to enable unambiguous ex post evaluation. - Althingi should provide an opinion on the Statement and may propose amendments; it should be able to draw on independent expertise on consistency with OBL fiscal principles (Recommendation 2.8). Government may amend the Statement between elections with Althingi approval in event of crisis or significant, evidenced changes in long-term outlook. - Institutional coverage of fiscal objectives should be broad (general government or public sector) to enhance coordination and surveillance of fiscal risks from public enterprises; MTFS would set operational targets for sub-sectors (central government, local government, public corporations). Monitoring such objectives requires fiscal reporting reforms discussed in Chapter V. - Recommendation 2.2 (Statement content): No later than the first Budget Orientation Debate or Budget following an election, the government should produce a Statement of Fiscal Policy setting out: a. a post-election economic forecast for the medium term; b. long-term fiscal projections covering at least 30 years and based on a range of scenarios for important macroeconomic, demographic, and other parameters; c. numerical fiscal policy objectives for no less than next five years; d. a small number of indicators that will be used to measure performance against those objectives; e. the sources of data to be used in measuring performance against those objectives; and f. a statement of conformity with the government’s fiscal principles. - Recommendation 2.3: The Althingi should approve, amend or reject the fiscal policy objectives in c. - Recommendation 2.4: The government may submit a revised Statement of Fiscal Policy to the Althingi for approval between elections; the OBL should specify the conditions and procedures for revision. - Recommendation 2.5: Government fiscal objectives should comprise a combination of (a) a long-term goal for the stock of liabilities or net worth and (b) a medium-term objective for the fiscal balance. ### Medium-term Fiscal Strategy (MTFS) — operationalization and specifications - MTFS should translate numerical fiscal objectives in the Statement of Fiscal Policy into operational targets for different levels of government and multi-year expenditure ceilings for each ministry. - MTFS should be submitted to the Althingi in the Spring; Law 84/2011 calls on the government to submit a three-year budget framework for approval by Parliament no later than April 1 each year. - MTFS targets and ceilings should be approved by the Althingi and used as basis for preparing individual budgets for the coming year. - MTFS should include a central unallocated provision to handle contingencies and new policies in later years without frequent revision. At least 1 percent of expenditure should continue to be ringfenced for contingencies that arise during the budget year. The provision should be on a rising profile thereafter to reflect increasing uncertainty and margin for error in later years. - Historical projection errors to inform contingency sizing: one-year expenditure projection error averaged about 1¼ percent of GDP before the crisis; three-year projection error exceeded 2 percent of GDP (see Figure 4.1 reference). *IMF staff assessment and recommendations as contained in the source PDF.* ### 33. The MTFS should include not only the government’s targets for the public ### 33. The MTFS should include not only the government’s targets for the public finances but also the policies required to ensure they are met ### Medium-Term Fiscal Strategy: content and purpose - The MTFS should include a summary of the main policy measures the government proposes to introduce in the annual budget to meet its fiscal targets, along with estimates of the fiscal impact of those measures. - The MTFS should provide a summary of the legislative changes required to implement those policies so the government can implement them from the moment the budget is approved. - The MTFS should enhance fiscal policy coordination within the general government and public sector by: - making medium-term fiscal projections available to local governments earlier in the year so they can plan on a consistent basis; and - identifying policies affecting operations and mandates of local governments and estimating their impact on local government revenues and expenditures both during the upcoming fiscal year and over the medium term. ### Fiscal risk disclosure and management - Iceland faces a wide range of risks to its fiscal outlook: macroeconomic volatility, financial instability, loss-making public enterprises, government guarantees, litigation risks, natural disasters, and increasing public-private partnerships (PPPs). - The MTFS should contain a fiscal risk statement that provides a permanent mechanism for demonstrating that fiscal policy is based on prudent macroeconomic and fiscal assumptions and for improving fiscal risk management by requiring discussion of mitigation measures, for example: - charging risk-based fees for all guarantees; - reducing exposure to commercial risks through privatization of enterprises; - improving regulation of PPPs to ensure proper risk-sharing; and - making explicit fiscal provision for unavoidable risks. - Historical forecasting performance: "In 2008-11, the one-year projection error increased to 3 percent of GDP, while the three-year projection error increased to 6¾ percent of GDP." ### Recommendation 2.6: Medium-term Fiscal Strategy (by April every year) - The Government should present its Medium-Term Fiscal Strategy setting out: a. macroeconomic outturn for the last two years and forecast for next five years with comparisons with those provided by independent external and domestic economic forecasters, such as the CBI, commercial banks, IMF, and the OECD; b. fiscal outturn for the last two years and forecasts for next five years including projections for all of the indicators included in the Statement of Fiscal Policy; c. targets for at least the next three years for each of the indicators included in the Statement of Fiscal Policy; d. a list of policies required to meet the fiscal targets and a summary of their fiscal impact relative to a baseline (“policy-off”) fiscal scenario; e. a medium-term budget framework for central government setting out: i. an overall expenditure ceiling for the central government budget (Group A) with reconciliation to the budget and ceiling set in the previous budget, ii. indicative expenditure ceilings by ministry, and iii. an unallocated margin in on a rising profile over the forecast horizon within which at least 1 percent is earmarked for contingencies in budget year; f. outturn for the last two years and forecast revenues (split into own revenues and transfers), expenditure, and balance for local government for the next five years; g. a summary of the finances of public corporations for the last two and next five years; h. a fiscal risk statement showing the impact of alternative economic assumptions and discrete fiscal risks on the government’s performance against its fiscal targets; and i. A statement of compliance with the Government’s Statement of Fiscal Policy setting out how fiscal projections are consistent with meeting the government’s fiscal policy objectives with confidence. ### Budget orientation debate and parliamentary engagement - Shortcoming identified: frame budgeting has taken place entirely within the government, with neither Parliament nor the public playing an active role in defining fiscal and budget strategy. - Recommendation to address this: require the MTFS to be discussed by the Althingi in its Spring session to engage Parliamentarians early on medium-term fiscal targets and operational ceilings, increase visibility and political commitment, and ensure Parliament is notified of and committed to adopting necessary implementing legislation. ### Recommendation 2.7: Budget Orientation Debate (by May) - Parliament should: a. review the government’s performance against its fiscal objectives and targets based on a report from the National Audit Office; and b. approve or reject the MTFS through a resolution endorsing: i. the fiscal targets for the medium term; ii. an overall nominal expenditure ceiling for the central government budget; and iii. a program of legislation needed to implement the policy measures. ### Enhancing external scrutiny - Rationale: failure of the previously established expenditure rule highlights the need for enhanced external scrutiny of fiscal policy-making and performance. - Typical roles of independent bodies: - evaluating the government’s past fiscal performance based on outturn data; - validating the economic assumptions that underpin the government’s forward-looking fiscal strategy; and - scrutinizing the credibility and sustainability of the fiscal objectives that guide the government’s fiscal strategy. - Low-cost approaches for Iceland: - require the MoF to present independent forecasts produced by commercial banks, the CBI, and international agencies alongside its own assumptions and explain deviations when presenting the MTFS, MTBF, and Budget. - Institutional roles: - Statistics Iceland currently produces the macroeconomic forecast used by the MoF but, as a participant in the budget process, cannot provide independent ex ante evaluation or ex post evaluation of fiscal policy; the Iceland National Audit Office (INAO) has an advantage and expertise to perform annual ex post evaluations in parallel with auditing of annual accounts. - No existing independent agency is positioned to provide an ex ante assessment of credibility and sustainability; an alternative is a temporary commission to provide an ex ante assessment of an incoming government’s Statement of Fiscal Policy. ### Recommendation 2.8: Independent Scrutiny (OBL provisions) - The OBL should provide for independent evaluation of fiscal policy, including: a. specifying who is responsible for producing the government’s economic forecast; b. requiring the government to provide comparisons with independent forecasts in Fiscal Policy Statement, Medium-term Fiscal Strategy, and Budget; c. giving the Iceland National Audit Office formal responsibility for evaluating the government’s performance against its fiscal objectives and targets; and d. establishing a limited-tenure independent commission to periodically scrutinize an incoming government’s Fiscal Policy Statement and evaluate its consistency with the fiscal principles in the OBL. ### Box 2.1: Implications of the OBL for Municipalities (summary) - Revised Budget Calendar: bringing forward the deadline for submission of the central government budget to September and adopting a top-down sequence will provide municipalities with time and information to finalize and submit their own budgets by December 15, as stipulated under LGA Article 62. - Statement of Fiscal Policy: medium- and long-term projections will inform sustainability of current policies and impacts on shared responsibilities, supporting LGA Articles 129 and 128 on costing and allocation of service mandates. - Medium-Term Fiscal Strategy: presentation of the MTFS in April will enable informed discussion between central and local government and support fiscal rules for local governments in LGA Article 64; it will also provide advance notice of national legislative changes affecting local finances, supporting LGA Article 62’s four-year horizon requirement. - Supplementary Budgets and Wage Agreements: eliminating the provision permitting central government to negotiate and implement wage agreements mid-year will limit unexpected cost pressures for local governments. - Fiscal Reporting: producing statistics and accounts for consolidated general government or public sector will improve understanding of linkages between central and local finances. ### Budget formulation and approval: legal framework and practice (selected findings) - The FRA includes provisions that: - cover not only the core central government budget (Group A) but also budgets of all central government controlled enterprises (Group B-E); - present information and authorize expenditure on an accrual basis; - include medium-term projections of revenue, expenditure, and financing; - grant individual agencies flexibility to reallocate resources within three broad line items: operations, maintenance, and capital; and - seek Parliamentary authorization for a range of public liabilities including borrowing and guarantees. - Gaps and weaknesses in the FRA that undermine budget credibility: - no provisions require consistency between the medium-term fiscal strategy and the annual budget presented to the Althingi; - the basic unit of budget appropriation is an individual agency, many too small to be viable units of budget management; - no discussion of sequencing of Parliamentary budget debates and votes, so overall size and shape of the budget is not fully known until the final reading in December; - no requirement on the MoF to maintain an unallocated central contingency reserve, though the practice has developed during the crisis. ### Implications for the New Organic Budget Law (OBL) - To arrest persistent upward drift in expenditure, the OBL should: - bring forward the deadline for submission of the Budget Bill and autumn economic forecast to September; - oblige the government to present a comprehensive Medium-term Budget Strategy demonstrating consistency between the annual State budget and the Medium-term Fiscal Strategy for general government or public sector; - reduce the total number of appropriations by around two-thirds from over 900 to around 300 by elevating the basic unit of legal appropriation from the agency to ministry level and grouping agencies into three to five programs per ministry; - provide ministries greater flexibility to reallocate resources between appropriations within their budgets during execution; - establish a central, unallocated contingency reserve in the Budget with clear access criteria and reporting requirements; - adopt a top-down sequence to Budget approval and restrict the Althingi’s powers to amend the Budget Bill to those consistent with the agreed MTFS targets; and - expand the range of budget approvals to encompass total borrowing by all public sector entities, public private partnerships, and other multi-year commitments. *Source: IMF staff report text as provided in the content unit.* ### 48. The date at which the annual Budget Bill is submitted to the Althingi is ### _cr1204 - 48. The date at which the annual Budget Bill is submitted to the Althingi is ### Timing of Budget Submission - Finding: The FRA requires the government to submit the annual Budget Bill to the Althingi “as soon as it convenes in the autumn.” In practice the Budget is typically submitted in early October, about a month later than most other Nordic countries. - Finding: Late submission compresses time for Parliament to consider the Budget and for ministries and agencies to prepare work, operating, and cash plans. - Finding: Recent amendments to the Althingi Procedures Act bring forward the Autumn session to September, presenting an opportunity to advance the Budget submission deadline. - Table 3.1 (deadlines, months before the start of the financial year): - Denmark: Submission to Parliament 4; Approval by Parliament 0 - Finland: Submission to Parliament 4; Approval by Parliament 0 - Norway: Submission to Parliament 4; Approval by Parliament ½ - Sweden: Submission to Parliament 3⅓; Approval by Parliament 0 - Iceland: Submission to Parliament 3; Approval by Parliament 0 - Recommendation 3.1: Date of Budget Submission - The deadline for the government to submit the Budget Bill to the Althingi should be brought forward to the first week of September to provide four months for budget consideration in Parliament and implementation planning at the ministry, agency, and municipal level. ### Economic Forecasting and Budget Cycle Synchronization - Finding: Statistics Iceland produces three economic forecasts in April, July, and November. The Budget Bill presented in October is therefore based on outdated macroeconomic assumptions and typically includes a proviso that totals may need revision in November. - Finding: This undermines credibility of the initial Budget proposal and encourages budget actors to "wait and see" for the November forecast. - Recommendation 3.2: Synchronizing the Economic Forecasting and Budget Cycles - Statistics Iceland should bring forward the production of its Autumn macroeconomic forecast to September and not produce another forecast until January of the following year. ### Medium-term Budget Strategy (MTBS) - Finding: Article 28 of the FRA calls for three-year projections of government finances, but in practice projections are limited to the central government budget and by economic category rather than by ministry, with limited reconciliation to prior years. - Recommendation 3.3: Medium-term Budget Strategy - The government should be required to present, alongside the annual Budget Bill, a comprehensive Medium-term Budget Strategy with the contents set out in Box 3.1. - The MTBS should demonstrate consistency with general government or public sector fiscal targets and ministerial expenditure ceilings set in the Medium-term Fiscal Strategy in April. - Where the annual Budget Bill deviates from those targets, the government should provide explanations separately identifying impacts of changes in: - (i) baseline assumptions (e.g., overspending in the current year); - (ii) macroeconomic assumptions (e.g., GDP growth); - (iii) microeconomic parameters (e.g., increase in pensioners numbers); - (iv) accounting changes (e.g., reclassifications of entities or transactions); and - (v) policy changes (e.g., new legislation introduced since April). - Where deviations are substantial enough to breach fiscal objectives in the Statement of Fiscal Policy, the government should be required to submit a new Statement of Fiscal Policy for consideration and endorsement by the Althingi before discussing the annual Budget. - Box 3.1: Contents of the Medium-term Budget Strategy - Coverage: previous year, current year, budget year, and subsequent three years. - a. Medium-term macroeconomic forecast which presents: - i. the evolution of the macroeconomic variables that are relevant for fiscal policymaking; - ii. a reconciliation of the main forecast changes since the April MTFS; and - iii. comparisons with other independent domestic and economic forecasters. - b. Medium-term fiscal forecast which presents: - i. the evolution of the main fiscal aggregates for the consolidated general government/public sector and its subsectors broken down by economic category; - ii. alternative macro-economic and fiscal scenarios showing the impact of more pessimistic and optimistic assumptions on the public finances; - iii. how the government’s fiscal forecasts are consistent with meeting the fiscal objectives set out in the Statement of Fiscal Policy; and - iv. a restatement of the government’s fiscal targets for the medium-term and a detailed reconciliation of any changes since the April MTFS. - c. Medium-term budget plan which presents: - i. the evolution of the main budgetary aggregates for central government, local government, and public corporations; - ii. a breakdown of the central government budget by ministry and by main economic category (e.g., wages, other operating costs, transfers, maintenance, and capital); - iii. in addition to the 1 percent contingency margin in every year of the forecast, an unallocated planning margin beyond the budget year of at least 1 percent of expenditure in Y+2, 2 percent of expenditure in Y+3, and 3 percent of expenditure in Y+4; and - iv. a detailed reconciliation of changes to ministerial budget ceilings since the April MTFS. - d. Medium-term debt management strategy which presents: - i. the evolution of the government’s borrowing and debt; - ii. the evolution of the government’s financial assets; - iii. a summary of the stock and evolution of guarantees, PPPs, and other contingent liabilities; and - iv. alternative scenarios for the profile of government borrowing based on a range of assumptions for the fiscal aggregates, interest rates, exchange rates, inflation, calling of government guarantees, and crystallization of other contingent liabilities. ### Unit of Appropriation - Finding: Iceland’s basic unit of institutional appropriation is the 260 individual agencies under ministries rather than the ministries themselves, producing over 900 separate legally binding appropriations. - Finding: Each agency has separate legally binding appropriations for operations, maintenance, and capital expenditure and may have one or more line items earmarked by statute to a particular revenue source. - Comparative data (Table 3.2: Number of legal appropriations): - Netherlands: Number of Ministries 11; Programs / Agencies per Ministry 15; Line Items per Program / Agency 1; TOTAL 170 - France: Number of Ministries 32; Programs / Agencies per Ministry 4; Line Items per Program / Agency 2; TOTAL 256 - UK: Number of Ministries 25; Programs / Agencies per Ministry 3; Line Items per Program / Agency 6; TOTAL 414 - Sweden: Number of Ministries 27; Programs / Agencies per Ministry 20; Line Items per Program / Agency 1; TOTAL 550 - Australia: Number of Ministries 18; Programs / Agencies per Ministry 13; Line Items per Program / Agency 4; TOTAL 936 - Iceland: Number of Ministries 12; Programs / Agencies per Ministry 35; Line Items per Program / Agency 2.3; TOTAL 966 - Greece: Number of Ministries 19; Programs / Agencies per Ministry 100; Line Items per Program / Agency 7; TOTAL 14,000 - Turkey: Number of Ministries 182; Programs / Agencies per Ministry 15; Line Items per Program / Agency 2,300; TOTAL 34,583 - Finding: High fragmentation leads to: - discouraging ministerial accountability because parent ministries cannot move resources between individual agencies; - lowering the standard of Parliamentary budget discussions and encouraging MPs to focus on local agency financial implications rather than wider policy agendas; - encouraging earmarking of revenues to protect specific projects; - complicating consolidation of accounts for the State Accounting Office, which must wait for and scrutinize 430 different accounts before submitting consolidated State Accounts to the INAO for audit; - undermining the comprehensiveness and integrity of auditing as the INAO cannot audit 430 different accounts every year and must take a selective approach. - Recommendation 3.4: Unit of Appropriation - Elevate the basic unit of legal appropriation from the agency to the ministry level, and reduce the total number of legally binding appropriations by around two-thirds from over 900 to around 300. - Revise the appropriation structure so the Althingi votes the annual budget by: - each of the ten ministries (e.g., Ministry of Education, Science, and Culture); - no more than five programs/policy areas per ministry (e.g., Primary Education, Secondary Education, Tertiary Education, Culture, and Administration); - two broad economic categories per program/policy area (e.g., operations and capital), implying allowing the Government to move resources for maintenance into other operating expenditure without Parliamentary approval; and - three sources of funding (e.g., new appropriation, carried over appropriation, and retained revenue). ### Virement Rules - Finding: The FRA and the fragmented appropriation structure provide ministries and agencies relatively little flexibility to reallocate resources within budgets. - Finding: Government relies on (i) unallocated provisions within agency and ministry budgets of between 0.2 and 0.6 percent of their budgets and (ii) relatively liberal carryover rules to cope with expenditure pressures, resulting in insincere budgeting and non-transparent accounting. - Recommendation 3.5: Virement Rules - The OBL should specify the scope of the government’s authority to reallocate resources between legal appropriations during budget execution: - Reallocation of expenditure between ministries should be prohibited without prior Parliamentary approval through a Supplementary Budget to reinforce ministerial accountability. - The law should permit the government to reallocate resources between programs/policy areas up to 3 or 5 percent of the total approved budget of the ministry to provide managerial flexibility. - To protect investment and maintain the link between flow statements and balance sheets, ministers should either (i) be prohibited from reallocating resources between operating and capital expenditure or (ii) be allowed to transfer resources from operations into capital but not from capital into operations. - Box 3.2: Implications of the OBL for Ministries (summary of intended effects) - Predictability: Clearer picture of resources earlier in the budget process; publish a more credible MTFS including indicative spending ceilings in April; present Budget proposal in September; approve Final Budget (including carryovers) by November. - Flexibility: Fewer appropriations, fewer earmarked revenues, and only two line items (operations and capital) enabling ministries to allocate spending within portfolios and use virement rules. - Accountability: Line ministers and ministries would be more accountable for keeping spending within budgets; harder to obtain additional spending in Supplementary or Final Budgets; sanctions for overspending would be more credible; ministers and permanent secretaries would be expected to appear before an Althingi committee to explain overspending and remedial actions. ### Contingency Reserve - Finding: Before the crisis, the government frequently exceeded its Budget partly due to lack of adequate contingency provision. The FRA places no requirement to set aside an unallocated central contingency reserve. - Finding: Since the crisis, the MoF has included an unallocated reserve of around 1 percent of the Budget, but this is often considered “earmarked” for discretionary increases or foreseen pressures. - Recommendation 3.6: Contingency Reserve - The appropriation for the MoF should include an unallocated contingency reserve of at least 1 percent of total budgeted expenditure. - The reserve should be used only to fund expenditures which are: - a. temporary; - b. unforeseeable; - c. unavoidable; and - d. unabsorbable. - Recommendation 3.7: Auditing the Contingency Reserve - Transfers from the contingency reserve to ministerial appropriations should be notified to the Althingi in monthly budget execution reports and the INAO should be asked to audit whether access is consistent with criteria a, b, c and d. - If access is not consistent with these criteria, the government should be required to introduce a Supplementary Budget to authorize that additional expenditure. - Recommendation 3.8: Deducting Reserve Claims from Carryovers - Claims on the contingency reserve should be deducted from the stock of underspends that a ministry can carry over to the next year to provide a penalty for “abuse” of the contingency reserve. ### Parliamentary Approval of the Budget - Finding: Both the Constitution and the FRA are silent on the scope of the Althingi’s power to amend the annual Budget Bill; in principle the Althingi has unlimited powers to amend the draft Budget, even if this implies higher total expenditure, lower total revenue, or an increased deficit. - Finding: Iceland is exceptional among advanced countries in the discretion given to the legislature to amend the draft budget. - Finding: In practice, a procedural compromise exists where the Government sets aside unallocated provisions within individual agency budgets for the Althingi to allocate during approval, leading to a late-November/December “Christmas Tree Process” of allocating small amounts to Parliamentarians’ priorities. *IMF staff report excerpt.* ### 64. The MoF, ministries, agencies, and the Budget Committee of the Althingi all ### _cr1204 - 64. The MoF, ministries, agencies, and the Budget Committee of the Althingi all ### "Christmas Tree Process" and parliamentary budget amendments - Finding: The reallocation of expenditure resulting from amendments made by the Althingi amounted to 0.19 percent of the total budget over the past three years, compared with 3.31 percent increases resulting from amendments made by the Government over this period (largely to adjust interest payments and transfers for the effects of higher inflation). - Process issues: - Soliciting proposals from MPs, prioritizing requests, negotiating with the MoF, and revising the Budget Bill between readings consumes an inordinate amount of MoF, Budget Committee, and Parliamentary time. - Ministries and agencies find it difficult to plan for budget execution before final approval in late December because of last-minute Government and Althingi amendments. - For 2009, only 10 of 223 agencies had submitted annual operating plans to their parent ministry for approval before the statutory 31 December 2008 deadline; lack of an approved operating plan was an important predictor of whether that agency would overspend its budget during 2009. - Table 3.3: Size of Amendments to the Budget Bill (source: Iceland MoF and staff estimates) - 2008: Budget (ISK m) 434,232 — Government ISK m 2,256, Percent of Budget 0.52 — Althingi ISK m 1,621, Percent of Budget 0.37 - 2009: Budget (ISK m) 555,641 — Government ISK m 47,815, Percent of Budget 8.61 — Althingi ISK m 411, Percent of Budget 0.07 - 2010: Budget (ISK m) 560,724 — Government ISK m 4,470, Percent of Budget 0.80 — Althingi ISK m 651, Percent of Budget 0.12 - Desired procedural outcomes: - Budget debates should be more substantive, orderly, and policy-oriented. - Consolidation of unallocated provisions into “funds” for each ministry and devolving allocation discussions to sectoral committees are initial steps taken for the 2012 Budget. ### Recommendations on parliamentary amendment powers and voting sequence - Recommendation 3.9: Parliamentary Amendment Powers - The Althingi’s powers to amend the Autumn Budget Bill should be limited to changes that do not, in either the budget year or over the medium term: - increase total central government expenditure; - reduce total central government revenue; or - increase net public sector liabilities. - Recommendation 3.10: Sequence of Parliamentary Voting - Althingi debates and votes on the Budget Bill should follow a top-down sequence: - First reading: consider economic assumptions and fiscal targets in the government’s Medium-term Budget Strategy and vote on the total level of expenditure, revenue, and liabilities in the budget year and the medium-term. - Second reading: consider allocation of expenditure between broad policy priorities and vote on the annual budget limit for each ministry and program/policy area. - Third reading: finalize and “tidy up” allocation of expenditure within programs and vote the division of expenditure between economic categories and sources of funding for each program. ### Range of budget approvals, PPPs, and multi-year commitments - Finding: Under the FRA, annual Budget approvals cover expenditure, borrowing, and guarantees, and annual cash limits on new liabilities are voted in Article 6 of the Budget Bill. PPP contracts are not covered by an annual ceiling on the total value of new PPP contracts; only the flow of payments for the budget year and next three years need be reflected in the Budget. Total liabilities of PPP projects are included in explanatory notes but are not formally approved by Parliament. - Recommendation 3.11: Other Budget Limits - Expand non-expenditure approvals under Article 26 of the FRA to include an annual ceiling on the total value of new public private partnership contracts that can be signed by the government that year. - The Budget Bill should demonstrate how the flow of liabilities from PPPs is consistent with meeting the government’s Medium-term Budget Strategy. - Finding: FRA does not require Althingi approval for multi-year contracts or other commitments; Articles 30 and 41 permit ministers, heads of agencies, and public corporations to conclude multi-year commitments with only three-year disclosure in notes to the Budget Bill. - Recommendation 3.12: Multi-year Financial Commitments - Articles 30 and 41 should be expanded to require all public entities to ensure multi-year financial commitments are affordable within their medium-term budget plans and consistent with government medium-term fiscal objectives. - a. For ministries, Althingi approval should be required for all multi-year commitments exceeding a percentage of the ministry’s budget (percentage to be determined in regulations). When seeking Althingi approval, the MoF should present: - i. the total costs of the commitment; - ii. the flow of revenue, expenditure, and financing over the life of the commitment; and - iii. a demonstration of how the commitment is to be accommodated with the government’s medium-term budget plans and fiscal targets. - b. For public corporations, MoF approval should be sought through their annual financial plans. ### Budget execution, loopholes, and treasury management - Identified legal loopholes in the FRA that allow overspending without sanction: - a. Increase or anticipate collection of own revenues netted off against appropriation (Articles 12 and 23). - b. Fund overspend from accumulated underspends carried forward (Article 37). - c. Deduct overspend from the following year’s appropriation (Article 45). - d. Seek retrospective Parliamentary authorization before year-end through a Supplementary Budget (Articles 33 and 34). - e. Seek retroactive Parliamentary authorization after year-end through the Final Budget Bill (Article 44). - Sanctions for unauthorized overspending are relatively few and weak. - Regulatory tightening by MoF (examples): - Regulation 1061/2004 requires corrective action if an agency’s expenditure exceeds planned levels by more than 4 percent. - Annual Budget Bill used to impose more stringent conditions on Supplementary Budgets, limit accumulation of carryovers, and restrict classes of revenue that agencies can retain. - Historical overspending: - In the decade leading up to the crisis, Iceland overspent its annual budget by an average of 12 percent (among 22 EU and OECD countries surveyed, only Hungary had a worse track record). - Between 2005 and 2011, the government overspent its approved budget by around 4 percent on average. - Causes of overspending: - Large, discretionary increases in expenditures—partly in response to surging revenues. - Above-budget increases in civil service salaries and household transfers as part of wage agreements negotiated mid-year. - Implications for the new Organic Budget Law (OBL) — the budget execution and treasury management section should: - place an obligation on all public entities to manage cash efficiently; - clarify the budgeting treatment of different types of retained and earmarked revenues; - restrict carryover of underspends and overspends from one year to the next; - require any overspending against budget totals to be approved by a Supplementary Budget before it can take place, except for a small number of mandatory items; - treat all other spending not authorized in advance by the Althingi as “in excess,” and expand the range of sanctions for excess expenditure beyond current “soft” and “nuclear” options. ### Cash management and planning - Finding: The FRA says little about rules and procedures for management of government cash holdings; inefficient cash planning imposes costs: lower interest on cash deposits, higher borrowing costs from liquidity shortfalls, and opportunity costs from delayed invoice payments. - Recommendation 4.1: Cash Management - The law should include an obligation on government to manage cash efficiently, ensuring that: - (a) payments are not made in advance of need; - (b) borrowing costs are minimized; and - (c) invoices are paid on time. - Recommendation 4.2: Cash Planning - The OBL should require ministries and agencies to have approved operating and cash plans for the coming financial year by December 31. Plans must be consistent with budgeted limits and in the format prescribed by the MoF. ### Retained and earmarked revenues - Finding: Around 17 percent of gross expenditure is funded out of retained or earmarked revenues in Iceland (the second highest percentage among advanced countries informally surveyed). - Problems from retained/earmarked revenues: - reduces government discretion to prioritize expenditure across entities during budget preparation; - reduces flexibility for budget managers during execution and increases likelihood of needing a Supplementary Budget; - complicates accounts preparation by requiring MoF to match specific revenues to expenditures after year-end. - FRA’s current stance: creates an “enabling framework” for hypothecation of revenues; three articles devoted to budget and accounting treatment of earmarked/retained revenues but without clear criteria. - Recommendation 4.3: Reporting of Own Revenues - The law should require all sources of revenue to be reported on a gross basis in budgets, statistics, and accounts. - Recommendation 4.4: Retention of Revenues - The law should specify principles distinguishing revenue types: - a. Operating revenues from sale of goods and services: count as negative expenditure in all budgets; ministries/agencies can retain and spend overcollections during the year without exceeding gross appropriation. - b. Capital receipts from sale of assets: all capital receipts should be returned to the MoF and allocated through the budget process. - c. Fees and charges from direct beneficiaries: set to recover service costs as reflected in ministry budgets; collections above budgeted amounts should be returned to the MoF. The MoF may, subject to Recommendation 4.6, credit some/all overcollection to a ministry’s stock of carryovers for future expenditure to incentivize collection. - d. Social security contributions: may be earmarked to particular appropriations or funds that benefit contributors only (i) with MoF approval; (ii) by an Act of Parliament; and (iii) where annual expenditure is approved in the budget as a mandatory expenditure. - e. Taxes: tax revenues should be deposited with the MoF in line with gross budgeting. Two options for responding to pressures to earmark tax revenues: - i. Option 1: prohibit earmarking of tax revenues to specific expenditures; use presentational means in budgets and accounts to demonstrate earmarked spending. - ii. Option 2: allow earmarking only (i) in exceptional circumstances; (ii) by an Act of Parliament renewed at least every five years; and (iii) to the ministerial (not agency or program) level of appropriation. *Source: IMF staff summary of chapter content in _cr1204 (provided content).* ### 84. Iceland has a relatively liberal regime for carryover of appropriations by ### _cr1204 - 84. Iceland has a relatively liberal regime for carryover of appropriations by ### Carryover regime: legal features and international comparison - Article 37 of the FRA grants the Minister of Finance unlimited authority to carryover an unused appropriation from one year to the next, with the consent of the line minister concerned. - Article 45 of the FRA permits agencies to carryover overspends from one year to the next by allowing them to be deducted from future appropriations. - Most advanced countries that allow carryover: - limit carryover to certain types of appropriation; - place a limit on the on-flow, stock, or drawdown of carryovers; - require Parliament to “revote” the appropriation carried over to the subsequent year. - Few other advanced countries permit the government to “borrow” against future appropriations as Article 45 allows. ### Stock, trends, and budget management concerns - Since 2007, the total stock of carryovers has fallen from over 5 percent of the total central government budget to around 3 percent in 2010. - At end-2010: - about 130 budgetary entities had positive carryovers of more than 10 percent of their total budget; - 20 appropriations had positive carryovers exceeding 100 percent of their annual budget (though most of the latter were earmarked funds or investment projects); - around 50 appropriations were classed as having negative carryovers of anywhere between 1 and 78 percent of their annual appropriation. ### Administrative restrictions introduced by the MoF during the crisis - In 2010 the MoF: - eliminated the carryover of overspends; - restricted the underspend that a ministry or agency can carryover in a given year to 4 percent of its budget; - capped the total stock of carryover that can be accumulated over time to 10 percent. - Comparative practice: most advanced countries also prohibit carryover of overspending and tend to cap the total stock of accumulated carryovers at around 3 percent. ### Operational and accounting complications from carryovers - Crediting underspends to each ministry and agency complicates accounting and weakens annual budget discipline at the margin because: - the final stock of underspends from the previous year is not known until individual agencies and ministries submit accounts two or three months after year-end; - ministries and agencies do not know their full resource envelope until after the budget is approved. - Possible operational improvements noted in the text: - base the amount carried over on the previous year’s audited accounts to end post-Budget “haggling”; - reduce the number of appropriations and credit carryovers to ministries rather than individual agencies to simplify budgeting. ### Recommendations on carryovers (Recommendations 4.5 and 4.6) - Recommendation 4.5: Carryover of Overspending. - The provision in Articles 37 and 45 of the FRA permitting carryover of overspending in the current year and “deducting” it from future appropriations should be repealed. - Recommendation 4.6: Carryover of Underspending. - Retain the possibility to carry forward underspends with the approval of the MoF but apply it at the ministry (rather than agency) level in line with Recommendation 3.4. - The law should limit the MoF’s authority to approve the carryover of unspent appropriation to: a. a maximum of 3 percent of the ministry’s total budget for the previous year; b. non-wage, non-transfer operating expenditure and capital expenditure; c. underspending that can be attributed to either more efficient utilization of resources or justifiable delays in the execution of expenditure; d. underspends reported in the audited accounts from the previous year, rather than unaudited estimates for the current year; and e. the level of drawdown approved by Parliament in the annual budget appropriation for the following year. ### Supplementary Budgets and retrospective authorization (Articles 33, 34, 44) - Provisions permitting retrospective legitimation of overspending include: - Article 33: MoF may make payments not authorized in the annual Budget if they (i) are due to “unforeseen circumstances;” (ii) “cannot wait;” (iii) are notified to the Budget Committee; and (iv) are subsequently authorized through a Supplementary Budget. - Article 34: empowers the government to negotiate above-budget and often retroactive wage agreements with social partners and seek Althingi approval through a Supplementary Budget after implementation. - Article 44: allows the Final Budget Bill, presented months or even years after the end of the financial year, to retrospectively authorize overspending associated with the “unforeseen circumstances, wage agreements, or new legislation.” - Identified problem: these provisions undermine budget credibility and the principle that expenditure must be authorized by Parliament before it takes place. ### Recommendations on supplementary budgets and Final Budget Bill (Recommendations 4.7 and 4.8) - Recommendation 4.7: Supplementary Budgets. - The new OBL should require any unbudgeted expenditure that cannot be accommodated through the utilization of the virement rules or funded from the contingency reserve to be authorized by the Althingi through a Supplementary Budget. - The law should require that the Supplementary Budget be approved by the Althingi before the expenditure can take place, with the exception of a small number of non-discretionary expenditures such as: (i) interest payments on debt; (ii) demand-led social security payments; and (iii) subscriptions to international organizations. - Recommendation 4.8: Final Budget Bill. - In the new law, the Final Budget Bill should be either: a. abolished and all unauthorized overspending identified in accounts treated as “in excess”; or b. retained but forbidden from retrospectively increasing either total expenditure or any legal appropriation, except for a small number of non-discretionary items. ### Wage agreements and budgeting (Recommendation 4.9) - Recommendation 4.9: Wage Agreements. - Article 34 of the FRA which grants the government the power to retrospectively authorize above-budget wage agreements via a Supplementary Budget should be repealed. - Instead, wage agreements should be negotiated: (a) within MTFS parameters, (b) take effect in the following year; and (c) be fully reflected in the annual budget for that year. - Rationale: ensure wage negotiations and budget discussions move in sync within the Medium-term Fiscal Strategy affordability framework. ### Sanctioning of overspending: current framework and gaps - Current provisions: - Article 49: “The Heads and Board of Directors of government entities are responsible that their financial measures are in accordance with spending limits.” This may be interpreted as statement of fact rather than an enforceable obligation. - Chapter V of Regulation 1061/2004: requires financial managers of agencies to report overspending to their parent ministries only after it exceeds 4 percent of the budget. - Sanctions for budgets “repeatedly or considerably in excess of budget limits” are limited to an internal written reprimand or temporary/permanent relief of duty. - International practice: - Effective OBLs place judgment on overspending with the National Audit Office (NAO) and refer findings to Parliament’s Budget or Public Accounts Committee for adjudication. - Parliamentary committees can call responsible officials to public hearings and decide whether to (i) authorize expenditure through a “vote of excess” or (ii) refer for administrative, financial, or criminal sanction. - Intermediate sanctions (public hearing, management plans, additional reporting, repayment requirements) are important and largely missing in Iceland’s legal framework. ### Recommendations on investigation and sanctioning of overspending (Recommendations 4.10 and 4.11) - Recommendation 4.10: Investigating Overspending. - The new OBL should place an obligation on the INAO to report any overspending or other financial irregularities and require the Althingi to investigate the matter and determine whether the overspending or irregularity should be authorized or sanctioned. - Recommendation 4.11: Sanctioning Overspending. - The new OBL should provide the Althingi and Government with a broader range of administrative, financial, and criminal sanctions to deal with overspending or other financial irregularities. - The range of possible intermediate sanctions should include: a. a requirement to give evidence in a public hearing; b. the formulation of a financial management improvement plan; c. additional reporting requirements; d. freezing or withholding of appropriation or cash disbursement; e. suspension of powers to carryover, vire, retain, or borrow resources; f. tighter controls on the authorization of major expenditure commitments; g. suspension of performance-related bonuses; h. appointment of a financial overseer or administrator; and i. a requirement to merge with another agency or entity. ### Fiscal reporting: current strengths - Features of Iceland’s fiscal reporting that align with international standards: - the government prepares an accrual-based operating statement, a cash-flow statement, and a balance sheet; - the government’s financial report is audited by the INAO and currently receives an unqualified audit opinion; - budgets are prepared on the same accounting basis as end-of-year financial statements, facilitating comparison of plans with outcomes; - Statistics Iceland produces good statistics for general government and some data for the entire public sector. ### Developments and opportunities for improvement - Since the 1997 FRA, international standards (IPSAS and GFSM 2001) and reporting practices have evolved; opportunities for improvement include: - aligning reporting with current IPSAS/GFSM guidance (for example, recognition of nonfinancial assets); - improving discussion of fiscal risks and long-term sustainability; - extending high-quality reporting to the consolidated public sector beyond central and general government. ### Implications for a new Organic Budget Law (OBL) - Main reporting improvements to reflect in a new OBL: - further improve consistency of budgets and ex post reporting by requiring forecast financial statements to be prepared on the same accounting basis as ex post reports; - extend scope of fiscal reporting to provide high-quality information on the public sector as well as the central and general government; - improve reporting of certain fiscal flows and stocks to provide fuller information on the government’s financial performance and financial position; - adopt International Public Sector Accounting Standards to ensure financial reporting follows good practice; and - improve the timeliness of audited financial statements as an input into fiscal policy evaluation and planning. ### Consistency of forecasts and financial statements (Recommendation 5.1) - Identified problem: - Budget forecasts are not reliable estimates of all parts of final accounts; certain items are consistently underestimated in the Supplementary Budget when compared to Final Accounts (average 2000–10): pensions, tax write-offs, transfers to entities outside central government (Group A). - Recommendation 5.1: Accounting Basis of Forecasts. - The government’s budgets, fiscal forecasts, and other prospective reports should be prepared on the same accounting basis as its retrospective reports. *Source: IMF staff analysis and recommendations as presented in the provided text.* ### 106. Fiscal reporting should offer a panoramic view of the public sector, as well as ### _cr1204 - 106. Fiscal reporting should offer a panoramic view of the public sector, as well as ### Fiscal statistics for the public sector - Finding: Statistics Iceland presents detailed finances of general government but only a rough sketch of the broader public sector (e.g., 12 tables on the general government and only one on the public sector in its government finance statistics for 2010). - Finding: The single public sector table shows estimates of the net operating balance, net lending of the public sector, and net financial liabilities, but is insufficient. - Recommended minimum reporting content: - A statement of operations for the public sector. - A statement of other economic flows for the public sector. - A balance sheet for the public sector. - Implementation note: Transactions within the public sector should be eliminated in consolidated accounts, but priority should be fuller information even if elimination is imperfect. - Recommendation 5.2 (exact wording preserved): The OBL should require Statistics Iceland to prepare a comprehensive set of fiscal statistics for the public sector, including a statement of operations, a statement of other economic flows, and a balance sheet. ### Consolidated audited financial statements — scope and options - Finding: The government’s financial statements currently cover only central government (Group A). Notes include information on Groups B to E and individual entities publish high-quality reports, but the consolidated income statement, cash-flow statement, and balance sheet consolidate only Group A. - Context: The mid-1990s decision not to consolidate state-owned enterprises was partly justified because state-owned enterprises often operate like private firms and fiscal policy typically focuses on government excluding SOEs. Similar practices exist in France and Sweden and to a lesser extent Canada and the United States. - Table summary (scope differences among countries as presented): - Iceland: Reporting entity — Central government; State-Owned Enterprises — No; Central Bank — No; Local Govt — No. - Australia: Central government and entities it controls; State-Owned Enterprises — Yes; Central Bank — Yes; Local Govt — No. - Canada: Central government and financially dependent entities it controls; State-Owned Enterprises — Some; Central Bank — No; Local Govt — No. - France: Central government; State-Owned Enterprises — No; Central Bank — No; Local Govt — No. - New Zealand: Central government and entities it controls; State-Owned Enterprises — Yes; Central Bank — Yes; Local Govt — No. - Sweden: Central government; State-Owned Enterprises — No; Central Bank — No; Local Govt — No. - United Kingdom: Public sector bodies that exercise public functions or are substantially funded from public money; State-Owned Enterprises — Yes; Central Bank — Not yet; Local Govt — Yes (rescued banks excluded). - United States: Central government; State-Owned Enterprises — Some; Central Bank — No; Local Govt — No (rescued financial institutions excluded). - Three main options for the OBL’s coverage of audited financial statements: - Option 1: Maintain the existing approach of producing consolidated accounts for central government only; - Option 2: Expand scope to consolidate central government plus all commercial entities it controls (all entities in Groups B to E); - Option 3: Further extend scope to consolidate the entire public sector, including local governments and the commercial entities they control. - Assessment: - Option 1 is unsatisfactory: not consolidating controlled entities creates a misleading picture of financial performance, assets and liabilities, and risks. - The government’s finances depend heavily on state-owned enterprises such as Landsvirkjun and the HFF, which can produce large dividends or require bailouts; reporting only small equity investments understates associated risks and opportunities. - IPSAS 6 requires consolidation of all entities that a government controls (except where control is expected to last less than a year). - Statistical standards do not provide for consolidated information on central government and the entities it controls; audited financial statements should do so. - Recommendation 5.3 (exact wording preserved): The government’s financial statements should cover either: a. the central government and all the commercial entities that it controls; or b. the public sector, that is central government, local governments, and all the commercial entities that they control. ### Audited financial statements for subsectors - Finding: The government should produce statements for subsectors of the public sector to provide meaningful “close-ups.” - Possible subsector definitions discussed: - Detailed groups A to E (plus parts A and B of local government if consolidated) — would create six or eight subsectors, which may be too many. - Simpler five-subsector option (recommended integration with government finance statistics concepts): - Central government; - Local government; - Nonfinancial public corporations; - Monetary financial public corporations (i.e., the central bank); - Nonmonetary financial corporations. - Recommendation 5.4 (exact wording preserved): As well as requiring consolidated reporting, the OBL should require disaggregated reporting on subsectors of government, where the segments are defined as central government, local government, nonfinancial public corporations, monetary financial public corporations, and nonmonetary financial corporations. ### Coverage of fiscal flows and stocks - Finding: Fiscal reporting should provide information on a broad range of fiscal stocks and fiscal flows. Iceland’s accounting and statistics are better than many countries’ but could improve by recognizing additional assets and liabilities and by providing information on long-term future cash flows associated with tax revenue and social spending. ### Physical assets of central government in accounts and statistics - Current rule: The 1997 FRA requires the government to follow business accounting with exceptions, notably the non-recognition of physical assets by ministries and institutions (Group A). Central government treats spending to acquire land, buildings, and other durables as an expense rather than recognizing an asset and depreciation. - Historical justification: Difficulty valuing certain kinds of government assets and desirability of having a spending measure that showed cost of purchasing assets. - Finding: This exception should now be removed. IPSAS and GFSM 2001 require governments to recognize physical assets on balance sheets; other advanced-reporting countries do so. - Table 5.2: Physical assets in balance sheets of seven other governments (as presented) - Australia: Percent of Total Government Assets 32; Percent of GDP 8 - Canada: Percent of Total Government Assets 15; Percent of GDP 3 - France: Percent of Total Government Assets 50; Percent of GDP 23 - New Zealand: 21 15 - Sweden: Percent of Total Government Assets 36; Percent of GDP 13 - United Kingdom: 59 49 - United States: Percent of Total Government Assets 29; Percent of GDP 6 - Implementation notes and budgeting implications: - Recognizing physical assets affects budgeting: purchase of physical assets will not be expensed in the year of acquisition under accrual-based appropriation numbers; cost appears in cash numbers and in depreciation in subsequent years. - Large projects will still need separate appropriation; small replacement projects may not. - The cash-flow statement should show cash disbursed for acquisition of physical assets. - The operating statement can show net lending (surplus measure that treats purchase of nonfinancial assets as a cost). - Recommendation 5.5 (exact wording preserved): Nonfinancial Assets. The accounting required by the OBL should ensure that ministries, institutions, and the government itself recognize nonfinancial assets on their balance sheets. - Recommendation 5.6 (exact wording preserved): Surplus Measures in Accounts. The operating statement required of the government by the OBL should show the government’s net lending, as well as standard accounting measures of the surplus. - Recommendation 5.7 (exact wording preserved): Public Sector Balance Sheet. Statistics Iceland should produce a full balance sheet and a full statement of other economic flows for central, local, and general government and the public sector. ### Leases and public-private partnerships (PPPs) - Finding: Recognizing physical assets will make it easier to recognize assets and liabilities associated with certain leases and PPPs. - Current approach: The Icelandic central government appears not to treat long-term leases or PPPs as creating liabilities, possibly because the accounting system does not allow simultaneous recognition of the assets created by those contracts. - Risk illustrated by Portugal: Clear disclosure of PPP commitments did not prevent accumulation of large PPP commitments that were not recognized as liabilities (following Eurostat standards) and which added to fiscal problems. - International practice: Countries such as Australia and the United Kingdom that recognize liabilities related to PPPs on their balance sheets are more likely to ensure PPP commitments are affordable and represent value for money. *Source: _cr1204 - 106 (provided content).* ### 126. Recommendation 5.8: Leases and Public-Private Partnerships. The government ### Recommendation 5.8: Leases and Public-Private Partnerships ### Leases and Public-Private Partnerships (PPPs) - The government should recognize assets and liabilities associated with leases and public-private partnerships when that would be required by modern standards such as IPSAS. - Recommendation 5.8: Leases & Public-Private Partnerships — "Assets and liabilities associated with leases and PPPs should be recognized in budgets and accounts." ### Interest Costs - Current practice excludes inflation-linked increases in the value of the outstanding principal of inflation-indexed debt from estimates of interest expense in the government’s accounts and statistics. - This practice: - Originated as an inflation-adjusted accounting approach useful when inflation was high. - Makes inflation-indexed debt seem cheaper than nominal debt even if it is not. - Is inconsistent with IPSAS and GFSM 2001 and with practice in the seven other countries with advanced financial reporting discussed in the section. - Recommendation 5.9: Interest Cost — "The accounting required by the OBL should calculate interest cost by multiplying outstanding principal by the 'effective interest rate,' which is the projected internal rate of return on the debt, considering all future cash flows (e.g., according to IPSAS 29, Financial Instruments: Recognition and Measurement)." ### Future Taxes and Spending; Limits of Balance Sheets - Even if public-sector balance sheets included all IPSAS- or GFSM 2001-recognized assets and liabilities, they would still provide a partial picture because: - The right to tax is not recognized as an asset. - Obligations associated with future spending on education, healthcare, and other services and transfers are not recognized as liabilities. - Consequences: - A government with negative accounting or statistical net worth may still be in a comfortable financial position if projected future taxes are high enough relative to projected spending. - Conversely, a government with positive accounting or statistical net worth may still be in financial trouble. - Accounting and statistical balance sheets need to be supplemented by projections of future spending and revenue. ### Long-Term Fiscal Projections - Practice elsewhere: - Almost all OECD countries other than Iceland regularly produce long-term fiscal projections. - All members of the European Union must analyze long-term public finances as part of their annual Stability or Convergence Programs. - The United Kingdom’s Office for Budget Responsibility and the US government financial statements provide notable examples of long-term reporting. - Purpose of long-term projections: - Usually conditioned on the assumption that current policy will be maintained. - Purpose is not to predict the future but to offer an informed guess at the sustainability of current policy. - They help ensure expected future costs of current policy are taken into account even when not reflected on accounting or statistical balance sheets. - Table 5.4: US Federal Government’s Summary of Long-Term Fiscal Projections (September 30, 2010) - Trillion dollars / Percent of 75-year GDP - Total Receipts 175 20.2 - Social-security payroll taxes 38 4.4 - Medicare payroll taxes 12 1.4 - Individual income taxes 91 10.5 - Other 34 4.0 - Primary spending 192 22.1 - Defense discretionary 31 3.6 - Nondefense discretionary 31 3.6 - Social security 49 5.7 - Medicare A 17 2.0 - Medicare B and D 20 2.4 - Medicaid 24 2.8 - Other mandatory 19 2.2 - Receipts less primary spending −16.3 −1.9 - Source: Financial Report of the US government, for year ending September 30, 2010. - Recommendation 5.10: Long-Term Fiscal Projections — "The OBL should require the government to publish long-term fiscal projections based on a range of macroeconomic, demographic, and other assumptions, along with an estimate of the present values of the main lines of the projections." ### Use of Accounting Standards - The FRA currently states the government will follow local generally accepted accounting principles (GAAP), except where the Act provides otherwise; the main exception is nonrecognition of the physical assets of Group A. - The current treatment of interest costs, leases, and PPPs raises the question whether accounting has diverged from local GAAP in unintended ways. - Three options for referring to international accounting standards in the OBL: - Option 1: Continue to refer to Icelandic GAAP, modify for the public sector where necessary, and ensure fewer unnecessary exceptions. - Option 2: Refer to International Financial Reporting Standards (IFRS), modified for the public sector where necessary. - Option 3: Refer to International Public Sector Accounting Standards (IPSAS), which are based on IFRS but already modified for governments. - Rationale for IPSAS: - Attractive for a small country. - IPSAS do not need modification to apply to governments. - Adopting IPSAS would reduce workload on the Government Financial Reporting Committee and help ensure reporting follows good practice. - Adopting international standards without modification would help make the setting of numerical fiscal targets more credible. - Recommendation 5.11: Accounting Standards — "The OBL should require ministries, institutions, and the government itself to prepare financial reports that comply with International Public Sector Accounting Standards." ### Timeliness of Reporting - Improving timeliness strengthens transparency and budget integrity. - Current reporting is quicker than in some countries but not at the frontier of advanced reporters. - Accelerating production, consolidation, and audit of government accounts would: - Give the government, Althingi, and the public reliable data by the time of the Budget Orientation debate. - Provide a firmer basis for the Government’s Medium-term Fiscal Strategy. - Give ministries a clear picture of the final stock of retained revenues and carryovers for preparing budgets for the following year. - Recommendation 5.12: Timeliness of Reporting — "The new organic budget law should require the government to publish audited annual financial statements no more than four months after the end of the financial year." - Figure 5.4: Lags in Publication of Audited Annual Financial Reports (In months) — comparative lags shown for: - United Kingdom, Canada, Iceland, Australia, France, Sweden, New Zealand, United States (figure indicates numerical lags including values such as 20, 7, 7, 5 1/2, 4 1/2, 3 1/2, 3 1/2, 2 1/2 months as presented in the source figure). ### Summary of Relevant Recommendations (selected) - 5.8 Leases & Public-Private Partnerships — Recognize assets and liabilities associated with leases and PPPs in budgets and accounts. - 5.9 Interest Costs — Recognize inflation-linked increases in principal of indexed debt; calculate interest cost using the effective interest rate. - 5.10 Long-term Fiscal Projections — Publish long-term projections with present-value estimates. - 5.11 Accounting Standards — Prepare financial reports in compliance with IPSAS. - 5.12 Timeliness of Reporting — Publish audited annual financial statements within four months after year-end. *Source: _cr1204 - 126. Recommendation 5.8: Leases and Public-Private Partnerships. The government* ### 140. Under a procedural fiscal rule, the OBL would require each new government to ### _cr1204 - 140. Under a procedural fiscal rule, the OBL would require each new government to ### Procedural fiscal rule: requirements and desirable indicator properties - Under a procedural fiscal rule, the OBL would require each new government to specify its numerical fiscal objectives in a Statement of Fiscal Policy together with the relevant indicators to measure performance and ensure compliance. - Experience suggests the most effective and durable fiscal indicators: - ensure fairness between generations (sustainability). - provide an unambiguous guide for setting the annual fiscal stance (operability). - allow fiscal policy to stabilize macroeconomic fluctuations (counter-cyclicality). - facilitate multi-year expenditure planning and minimize sudden and disruptive changes in the levels of taxation or expenditure (medium-term). - can be clearly explained to policy-makers and assessed by the public (simplicity). ### Trade-offs in choosing fiscal indicators - Indicators that secure sustainability (debt ratio and overall balance) tend to be acyclical or even procyclical and may require abrupt changes in revenues and/or expenditure to stay on a sustainable debt path. - Indicators that serve stabilization (balance over the cycle or expenditure rules) may deviate from sustainability and be derailed under extreme shocks. - Incorporating countercyclical features typically requires estimating the output gap, which in Iceland has proven technically challenging given structural changes, asset price distortions prior to the crisis, and severe contraction of potential output during the crisis. - Complex indicators (e.g., structural balance with debt brakes) tend to be non-transparent and can struggle to garner political commitment and public credibility. ### Fiscal objectives appropriate for Iceland (examples) - Balance over the cycle or over a specified time horizon: - Allows automatic stabilizers and discretionary stimulus; requires precise dating of the cycle or specification of a time period (example: 7 years as in Sweden). - Augmented growth-based balance: - Responds to deviations of actual output growth from trend growth; requires a nominal balance below medium-term target when real GDP growth exceeds trend. - Relatively simple because it does not rely on an output gap measure. - Can be supplemented with an adjustment coefficient to correct past slippages; the higher the adjustment coefficient, the less countercyclical the rule. - Expenditure growth limit with a debt or deficit brake: - Ceiling set at or just below long-term real growth includes countercyclical element and accommodates inflation shocks. - Revenues vary freely; simple expenditure ceilings are not anchored to deficit/debt targets and may permit deficits/debt to rise. - Adding a debt brake preserves countercyclical benefits; rate of expenditure growth can be adjusted for consolidation needs and budgetary rigidities. ### Simulation design for Iceland - Baseline assumptions: - (i) New fiscal policy objectives will be introduced in 2013 and commence in 2014, when output is expected to be at its potential level; - (ii) Targeted debt ratio of 60 percent of GDP will be achieved in 7 years; - (iii) The 2014 projected general government debt ratio of 96 percent of GDP combined with a consolidation horizon of 7 years implies the authorities should set as a fiscal objective an average surplus of at least 1.5 percent of GDP over the consolidation period. - Common features of simulated indicators: - (i) flexibility: allowing automatic stabilizers to be accommodated; - (ii) simplicity and transparency—use of a concept of long-term growth (2.3 percent of GDP for 2000-2010) rather than potential growth; - (iii) institutional coverage of the general government sector; - (iii) an automatic adjustment mechanism ensuring fiscal stance returns to required sustainability level. - Table A.2 (summary of simulated fiscal indicators): - 7-year rolling surplus: Fiscal Indicator = Overall Balance; Institutional Coverage = GG; GDP Indicator = Average 7-yr growth; Adjustment Mechanism = Automatic: 7-yr horizon; Expenditure Adjustment = No. - Augmented growth-based balance: Fiscal Indicator = Overall Balance; Institutional Coverage = GG; GDP Indicator = Long-term growth; Adjustment Mechanism = Automatic: 50% of slippage; Expenditure Adjustment = No. - Limit on real spending growth with deficit brake: Fiscal Indicator = Primary Expenditure; Institutional Coverage = CG/GG; GDP Indicator = Long-term growth; Adjustment Mechanism = Automatic: 50% of slippage; Expenditure Adjustment = Yes. - Shocks applied: - Growth shock, interest shock, combined shock scenario, contingent liability shock of 30 percent of GDP, and a boom-bust scenario. ### Simulation results and interpretation - General findings: - A rolling surplus or an augmented growth-based objective is more likely to provide a reliable anchor for debt sustainability than a real expenditure limit. - Under the baseline, debt declines faster under an expenditure limit—since the expenditure ratio declines as the economy recovers—but most shock scenarios would derail spending and undermine the fiscal balance, slowing debt reduction. - The expenditure limit helps reduce debt rapidly under a boom-bust scenario, but needs to be supplemented with a stringent correction mechanism (deficit brake) to avoid reversal during a bust. - The rolling surplus and the augmented growth-based objective behave similarly, both succeeding in bringing down the debt ratio to 60 percent of GDP in 7 years under all scenarios except a contingent liability shock. - Unlike the expenditure limit, the rolling surplus and the augmented growth-based objectives require abrupt spending adjustment under all shocks, which undermines medium-term planning. - Assessment criteria (Table A.3) used to score indicators: - Fiscal Discipline: - Long-term debt sustainability: General government debt below 60% of GDP by 2024. - Prudent fiscal stance: 1.5% overall surplus and deficit not exceeding 0.5% (1% Primary surplus Target (Sweden) cited as example). - Adjustment to Shocks: - Counter-cyclical fiscal policy: Positive correlation between output gap and cyclically adjusted balance; Balance over the cycle (UK) cited as example. - Corrects for slippage: Targeted surplus restored within 3 years of slippage; Debt brake rule (Switzerland) cited as example. - Operability: - Simple to calculate: Compliance does not require great forecasting precision or use of output gap or structural balance; Rolling average surplus (Iceland LG) cited as example. - Facilitates multi-year budget planning: Primary expenditure does not have to be reduced by more than 1.5% of GDP in any given year under shock; Nominal expenditure ceiling (Finland) cited as example. - Trade-offs emphasized: - Rolling 7-year surplus and augmented growth-based balance provide relatively good policy guidance by maintaining a prudent fiscal stance (a fiscal surplus). - Augmented growth-based balance is more likely to preserve sustainability due to quick reaction to potential slippage in the previous year, but this rapid adjustment comes at the expense of economic stability. - Rolling 7-year surplus preserves economic stability better than the augmented growth-based balance. - A ceiling on real expenditure growth with a deficit brake provides a smooth expenditure path but could deviate from sustainability, especially if growth is below long-term trend for a long time. - These trade-offs need careful consideration before selecting a numerical fiscal objective in Iceland’s first Statement of Fiscal Policy following adoption of the OBL. *Source: Excerpt from IMF staff simulations and analysis in the referenced IMF PDF chapter.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1204.pdf_