Zero-Based Approach to Government Budgeting
For Latvijas Banka Monthly Newsletter, In Focus, March 2016
Zero-based budgeting involves the following three key elements: (i) spending is justified by objectives rather than the previous year's budget; (ii) alternative scenarios are provided; (iii) spending is planned from zero. The theory was developed in the US towards the end of the 1970s and was welcomed by the private sector. Zero-based budgeting was introduced in public administration by Jimmy Carter's government, but the concept was abandoned once the economy started to recover. It was brought into the limelight again after the 2008 financial and economic crisis. The idea, however, has returned to the public sector only in the US, while Europe is still discussing its merits. Meanwhile, on 1 March 2016 Latvia's Cabinet passed a decision on reviewing the government budget and two working groups were established: one for reviewing the government expenditure, with a particular focus on the sector of education, and the other concentrating on the health area spending. One of the tasks is a broader implementation of the principles of zero-based budgeting.
Latvia's medium-term and annual budgets are built using both the incremental approach as well as some elements of zero-based budgeting which are applied to certain items, such as contributions to the EU budget, debt management and partly also social budget. Nevertheless, looking by sector, baseline items are most often carried over by default, without any analysis whether the allocated funding has produced the targeted outcomes or not. As a result, on average budget expenditure outpaced economic growth in the last 10 years. Given the ever-growing urgent needs, this is not a sustainable combination. Moreover, according to COFOG[i], Latvia's general budget is significantly overfunded on several levels. In comparison with the average figures of Germany, United Kingdom, Ireland which are the most popular emigrant destinations as well as with Estonia and Finland mentioned as best examples with regard to achievements in education or innovations, Latvia spends more than 125% of the sample group's spending in the sectors of education, excluding secondary education, construction as well as housing development and culture. At the same time, it remains unclear whether the spending and the chosen solutions are the most effective. For example, Latvia's spending on education at 5.7% of GDP exceeds the EU average of 5.0% of GDP, yet the proportion of 15-year-olds with insufficient skills in reading, mathematics and science is also significantly above the EU average. This means that higher spending has failed to produce better results.
Although the targeted medium-term budgetary deficit is low, the fiscal discipline needs to be tightened in times of economic growth, in order to achieve a balanced or a surplus budget. Latvia's general government budget ran a surplus only once within the last 20 years. Moreover, macroeconomic improvement has decelerated this year.
[i] Classification of the Functions of Government