Government expenditure can be identified within two broad categories: discretionary spending, which receives its authorisation from the government’s annual budget, and mandatory spending, which often receives its authorisation outside the budget. Even though mandatory spending involves significant sums, the scrutiny it receives in the budget process can differ from that of discretionary spending because authorising legislation has been enacted in advance of the budget.
However, as populations age and public debt increases, the impact of mandatory spending on the budget is increasing. If large portions of the budget are pre-allocated through processes that are largely outside of the budget, governments risk limiting their flexibility to respond to unforeseen expenditure demands. Such considerations impact on a government’s ability to restore public finances and contribute to long-term fiscal sustainability.
In recognising this challenge, this report considers five dimensions which are relevant to the fiscal management of mandatory spending, based on the national and federal budgets in eight OECD Member countries (France, Germany, Ireland, Japan, Korea, the Netherlands, the United Kingdom and the United States). The comparative analysis of these dimensions identifies key considerations in the context of restoring public finances by highlighting ways to strengthen the governance and institutional arrangements that apply to mandatory spending in budget processes.
1. Defining mandatory spending
The concept of mandatory spending in budgeting is generally understood to refer to spending that is authorised by existing legislation, or where the government has entered into an obligation to make a payment. However, a single international definition does not exist, which limits data collection and analysis across countries. In the absence of an international definition, a clearly articulated national definition is the next best option to understand the composition of the budget in a national context.
2. Governance arrangements
In the eight OECD Member countries in this report, mandatory spending is generally included within fiscal rules and/or expenditure ceilings in some form. The comparative analysis showed that including mandatory spending within the fiscal framework helps to maintain visibility of the government’s total spending commitments and protects against off-budget spending.
The administrative responsibility within government for mandatory spending is frequently assigned to government bodies that are separate from the ministries that advise the government on mandatory spending policies. While the arrangements are mostly designed to provide operational separation from government ministries, the bodies should remain accountable to parliament and the financial statements should be subject to external audit in compliance with whole-of-government policies.
3. Mandatory spending and the budget process
Mandatory spending can contribute to macroeconomic stability and social protection both of which are crucial elements of the annual budget. This underscores the principle that budget formulation should cover all forms of spending, including mandatory spending to ensure that decision makers have full awareness of budget allocations.
4. Methodologies and tools to review mandatory spending
Based on experiences in the eight Member countries, the OECD found that mandatory spending in budgeting can benefit from regular review as much as any other category of spending to restore public finances on a sustainable footing. Such reviews can take a variety of forms, but three approaches are particularly relevant to mandatory spending:
Spending reviews: A spending review analyses expenditure based on existing policy settings to identify potential savings to support aggregate fiscal control. In the Netherlands for instance, there is a requirement to conduct spending reviews at least every five years of the same policy area and to advise parliament of instances where spending has not been reviewed.
Legislated adjustment mechanisms: A few OECD Member countries specify in legislation how the government will respond to increases in mandatory spending. In doing so, the governments have identified in advance how they will adjust, or correct, for excess spending. In the United States, the sequestration requirements for excess spending under the Pay As You Go Act provides a specific example of such a mechanism.
Reviews of legislated policy settings: The enabling legislation for mandatory spending specifies the policy settings for the expenditure. In cases where the policy settings are not fiscally sustainable, there are several examples of how governments have reviewed the settings in an attempt to restore the affordability of the policies. For instance, France, Germany, Netherlands, United Kingdom and United States, have made changes to the policy settings for state pensions in a move to improve fiscal sustainability.
The specialised nature of mandatory spending also underscores the importance of high quality and accessible guidance on appraising and evaluating spending. In the United Kingdom, the Central Government Guidance on Appraisal and Evaluation (Green Book) and the Guidance for Evaluation (Magenta Book) provide publicly available guidance. Similar examples are available in Japan, where budget guidelines include rules stating that mandatory spending should be reviewed thoroughly.
5. Accountability and oversight
Within the eight OECD Member countries, ministries of finance and relevant government agencies are obliged to keep parliaments updated on developments in mandatory spending. Examples include reporting on liabilities from mandatory spending in financial reports, long-term fiscal statements, and other reports, such as the actuarial assessments. Given the materiality of mandatory spending on public finances, independent assessments by fiscal councils can also provide important insights on macro-fiscal forecasts and fiscal risks.
The analysis in this report contributes to themes being developed in the OECD’s Restoring Public Finance initiative, particularly regarding the sustainability challenges facing public finances. It also identifies three potential areas for further analysis, specifically on developing a standardised definition of mandatory spending to allow for cross-country comparisons. Second, to consider how governments control the creation of mandatory spending, as mechanisms, such as fiscal-impact analysis, are not necessarily requirements for decision making purposes. Finally, the analysis briefly considered ‘rigid spending,’ which is related to mandatory spending in that it refers to expenditure the government cannot easily change or reform within a defined period, however it involves separate governance and budgetary control processes, and warrants further analysis in the context of fiscally sustainable budgets.