Most OECD countries have MTEFs in place although their coverage and design varies significantly. At their core, MTEFs consist of three elements: forecasts of resource availability, baselines of on-going expenditures and expenditure ceilings.
Whilst the separate elements of the MTEF are crucial by themselves, it is how the elements fit together as a whole to create an MTEF that define their success. Effective implementation of MTEFs has many potential benefits.
MTEFs operationalise high-level fiscal objectives in concrete terms and serves to demonstrate credibility and political will. A transparent and publicly available MTEF serves as the basis for accountability.
They can bring together all expenditures irrespective of their legal funding basis – including entitlement spending authorised in permanent legislation. MTEFs provide an “early warning” of expenditure pressures. They facilitate the funding of new expenditures through reallocations. MTEFs can facilitate the planning and resourcing of multi-year policies that may require an extended time horizon for implementation, such as large capital projects, new programmes, and organisational restructuring. MTEFs eliminate budget games such as starting new programs well into the first year so the full year’s funding requirements do not appear initially. Finally – and crucially – it gives line ministries greater assurance about resources over a multi-year time horizon.
The MTEF is a cornerstone of the budget formulation process. The consideration of budget options should all be reviewed from the medium term point of view. Experience shows that representing policy choices in this way influences decision-making. For example, deliberations over the size of a new policy should be informed by the method of funding – from reduced expenditures in other areas, or from new revenues over the MTEF period. The MTEF presentation brings together the various commitments and constraints in one place, so decision makers can consider how to meet constraints such as fiscal rules, while also looking for initiatives to support.
Resource availability for the medium-term, consisting of economic projections and revenue forecasts, need to be prepared. This is based on the government’s current tax policy and any agreed changes over the time period. These should be updated periodically on the basis of new economic projections.
It is important to be prudent and realistic and not overestimate what is available to spend. Economic forecasts need to be carried out using appropriate economic assumptions. Being too optimistic can create a situation where governments believe they have more resources available to them than is the case. This may result in unrealistic expenditure commitments which may be difficult to roll back.
Independent Fiscal Institutions can be a partner to check the accuracy of economic assumptions and indeed for ensuring accountability for MTEFs in general.
Baselines of government expenditures provide an estimate of all government expenditure over the medium-term. This comprises existing policies and any agreed changes over the time period. New expenditure proposals that do not form part of agreed policies are not included. The result is a detailed picture of spending needs for agreed policies over the period. These are rolling in nature, most commonly for three years beyond the current budget. The estimates need however to be constantly updated. Each policy decision made during the year with a budget impact needs to be reflected in the multi-year baseline. If this is not the case, and it is only updated periodically, the baseline becomes obsolete and it loses its purpose in an MTEF framework. Rather than the updated baseline for (t+1) becoming the natural foundation for the following year’s budget, a new baseline is essentially created ‘from scratch’ each time. Maintaining an up to date – “live” – baseline is crucial. In reality, this can be a complicated and challenging exercise.
Expenditure ceilings set the total amount of expenditures over the medium-term. These are most often rolling in nature for 3 years beyond the current budget with an additional out-year added with each new budget. In other cases, they are fixed in nature, often coinciding with the term of office of a government. A rolling forecast cannot bind a future government but it provides a basis for a new government to make any changes. The ceilings are by definition top-down. In the purest form, there would be one ceiling for each ministry and the responsible minister given flexibility to reallocate within the ceiling. In practice, the ceilings are generally more detailed. They may be divided by the type of expenditure – personnel, other operating expenditure, transfer payments and capital expenditures are common categories. There may be ceilings for specific programmes or areas of expenditures – “ring-fencing.” There may be flexible ceilings for certain categories of expenditures – including unemployment benefits and other cyclical expenditures. The degree of detail in the ceilings tends to be more specific in the near years than the out years.
Institutional responsibility for MTEFs is crucial to their success. The MTEF needs to be fully integrated into the machinery of the annual budget process. There should not be a specialized MTEF unit. The division of responsibility with macro-forecasters needs to be clear with all information on expenditures flowing from the budget office. Constant communication between budget offices and line ministries is needed to reflect changes in government policy and their budgetary impact. The setting of expenditure ceilings is an inherently political exercise, but will be most often be based on proposals from the budget office.
For questions and queries, please contact Brian Finn, Brian.FINN@oecd.org