I.  Clarity of Roles and Responsibilities

13. Establishing clear roles and responsibilities for government and the rest of the public sector is a key aspect of fiscal transparency, because it provides a basis on which accountability for the design and implementation of fiscal policy can be assigned. Principles and practices in this regard concern the scope of government and the framework for fiscal management.

The Scope of Government

1.1 The government sector should be distinguished from the rest of the public sector and from the rest of the economy, and policy and management roles within the public sector should be clear and publicly disclosed.

14. The Code includes good practices relating to: (1) the structure and functions of government; (2) the allocation of responsibilities within government; (3) coordination and management of government activities; (4) relations between the government and the rest of the public sector; and (5) government involvement in the private sector.

The structure and functions of government

1.1.1 The structure and functions of government should be clearly specified.

15. This is a basic requirement of fiscal transparency. The general government sector is defined in the United Nations (UN) System of National Accounts, 1993 (SNA) and in the current GFS Manual.⁹ It encompasses all institutions performing government functions as their primary activity. It should include therefore all national and subnational government units, including extrabudgetary funds, as well as all nonprofit institutions that provide mainly nonmarket services and are both controlled and mainly financed by government units.¹⁰

16. Defining the boundaries of government, and of the public sector, is a complex task, and one that is particularly challenging for countries in transition. To help achieve clarity in the description of the structure of government, it is a basic requirement of fiscal transparency that an institutional table should be published showing the structure of government and the rest of the public sector. Such tables are available for most countries in the IMF Government Finance Statistics Yearbook, but they are neither comprehensive nor current. With relatively little effort these tables could be updated. An example of good practice in defining the boundaries of government is the application of the European System of Accounts, 1995 (ESA) to economic statistics in European Union countries.¹¹ Best practice in this area is that there should be full compliance with SNA definitions of economic sectors.

17. Government functions are those related to the implementation of public policy through the provision of nonmarket services, and the redistribution of income and wealth, financed primarily by taxes and other compulsory levies on nongovernment sectors. Separation of these functions from the monetary and commercial activities of government helps to establish clear accountability for the conduct of these very different activities and facilitates assessment of the macroeconomic impact of the fiscal activities of government. Although clarity of roles and responsibilities is required by the Code, the policy question as to whether, and to what extent, government should carry out commercial activities goes beyond transparency and is not addressed; nor is any specific form of institutional separation between commercial and noncommercial activities of government (or the public sector) advocated.

18. All government functions are fiscal activities. However, some fiscal activities are carried out by nongovernment public sector agencies whose primary activity is monetary or commercial. Such activities are referred to as being quasi-fiscal to indicate that they are not the primary activities of the agencies conducting them, and that their fiscal effects are not usually reflected in fiscal reports for the general government (as they would be, for instance, if the commercial or monetary institution was fully compensated from the central government budget for undertaking a quasi-fiscal activity). A central feature of fiscal transparency therefore is the open conduct of all fiscal activity, no matter where it takes place. For this reason, and to establish clear accountability, it is also important to distinguish the government from the central bank, public financial institutions, and nonfinancial public enterprises.¹² Where the central bank, public financial institutions, and nonfinancial public enterprises conduct extensive quasi-fiscal activities, this should be reflected in fiscal reports that cover the public sector.¹³

Allocation of responsibilities within government

1.1.2 The division of responsibilities between different levels of government, and between the executive branch, the legislative branch, and the judiciary, should be well defined.

19. A clear demarcation of roles within government is essential for transparency. At the broadest level, it is necessary to define the allocation of tax powers and expenditure responsibilities between different levels of government and, at each level of government, the fiscal role of the executive and legislative branches. This is often done as part of constitutional law.

Different levels of government

20. The relationship between different levels of government varies widely among countries, from federations in which individual states or provinces have considerable powers, through federal structures with a strong central government, to unitary forms of government. Precise distributions of tax powers and expenditure responsibilities vary accordingly. Fiscal transparency requires that such powers and responsibilities should be based on stable principles and/or agreed formulae, and that they should be clearly stated.¹⁴ They should also be exercised in an open and consistent way. Difficulties in establishing clear intergovernmental fiscal relations are often greater in larger and more diverse countries, particularly those in the process of economic or political transition. However, a number of such countries are attempting to address these difficulties.¹⁵

Roles of the executive, legislative, and judicial branches

21. Relationships between different branches of government are determined at the highest political and legal levels, vary greatly across countries, and are often subject to change as political and administrative systems develop. A number of recent studies illustrate the important influence that budget institutions have on fiscal outcomes.¹⁶ The Code does not advocate a particular structure of government that meets the needs of fiscal management. It only requires that the roles of different branches of government in fiscal management should be clearly defined. For example, there is a need for clarity over the executive's authority to conduct fiscal policy where the budget for the fiscal year has not been adopted by the legislature before the start of the fiscal year to which it relates. It is also important that the legislative and judicial branches play an active role in ensuring the availability and integrity of fiscal information.¹⁷ For example, there should be an active committee of the legislature that oversees the conduct of fiscal policy, and which facilitates civil society input into budget deliberations (e.g., through receiving public submissions). With respect to the judicial branch, taxpayers should be able to challenge the legality of taxation by appeal to the courts. As a rule, fiscal responsibilities should be defined in constitutional or administrative law. Given that these relationships may be emerging or subject to change, a high priority should be attached to clarifying ambiguity where it arises.

Coordination and management of government activities

1.1.3 Clear mechanisms for the coordination and management of budgetary and extrabudgetary activities should be established.

22. The organization of responsibilities among central ministries (e.g., finance, economy, and planning) and spending ministries is a key issue. Countries approach this in different ways. In those countries with a tradition of development or central planning, responsibilities for fiscal management are divided between a finance ministry (responsible for the current budget) and the economy or planning ministry (responsible for the capital or development budget).¹⁸ Other countries divide responsibilities by making specific ministries or departments responsible for different fiscal management functions (e.g., macro-fiscal policy, budgeting, accounting). Countries also differ in the relative power of central ministries and spending ministries. There is no blueprint for an organizational structure that can be applied universally. However, to ensure adequate control over public finances, the division of fiscal management responsibilities should be specified.¹⁹

23. The way in which the term "budget" is defined is also crucial. In some countries, the term is restricted to the estimates related to annual appropriations of funds by the legislature. This concept, however, may capture only a small proportion of total fiscal transactions. Various kinds of operations may be set up outside the annual appropriations process, and are thus referred to as extrabudgetary, and some extrabudgetary funds (e.g., social security funds) are distinct from the general fund of government. Often there are transfers from the budget to extrabudgetary funds, and there is risk to the budget if fund revenue is lower or expenditure is higher than expected. Some countries have set up extrabudgetary funds and channel earmarked taxes to them. Although there may be valid reasons for setting up some funds outside the budget, and for earmarking, excessive use of such arrangements can diminish transparency (as well as reduce fiscal policy control and flexibility).²⁰ It is therefore important that the activities of extrabudgetary funds are subject to the same discipline as budget appropriations. Moreover, there should be rules and regulations regarding the accountability of extrabudgetary fund management, and the accounting and auditing of extrabudgetary funds.

24. It is not uncommon for government agencies to be allowed to use revenue from fees and charges directly for expenditure (e.g., hospital fees and charges that are used by the health administration without first being transferred to the general fund of government). User charges are increasingly being used in OECD countries as part of the control and incentive mechanisms for managers of agencies. Such arrangements should be recorded in gross terms, and reported both in the budget documentation (in aggregate form) and in detail in the annual reports of the agencies concerned, so that the full extent of government activity can be properly established.

25. The relationship between the domestic budget and externally financed expenditure raises transparency issues in many developing countries. Separate, nontransparent processes for determining the size and allocation of external and other budgetary receipts are often the source of financial control problems. Transparency is best served if externally financed expenditure is integrated into budget decision making and reporting.²¹

26. The more general point is that all fiscal activities should be subject to review and priority setting as part of the budget process.²² They should also be open to scrutiny by the legislature and the public. This requirement should apply even to extrabudgetary funds that are independently managed and under separate legislative authority.²³

Relations between the government and the rest of the public sector

1.1.4 Relations between the government and nongovernment public sector agencies (i.e., the central bank, public financial institutions, and nonfinancial public enterprises) should be based on clear arrangements.

27. This is a basic requirement of fiscal transparency. Fiscal responsibilities should generally be carried out by general government, or by public sector agencies outside government under clearly specified and open arrangements. The risk of having to provide financial support to such agencies, when their financial position is unexpectedly weakened as a result of having to meet fiscal policy objectives, is then reduced. A corollary is that if government carries out either banking or commercial functions, the nature of such activities should also be transparent.

General government and the central bank

28. The primary responsibility of the central bank is to achieve monetary objectives. Increasingly, central bank responsibilities are being defined to give them as much autonomy as possible within a framework that ensures appropriate accountability.²⁴ In many countries, central bank laws emphasize the operational independence of the central bank and prohibit or restrict its direct financing of the fiscal deficit.²⁵

29. In some countries, however, a number of activities carried out by central banks are quasi-fiscal in nature. Quasi-fiscal activities may involve operations related to the management of the financial system (e.g., subsidized lending and directed credit) or the exchange system (e.g., multiple exchange rates and import deposits).²⁶ Such operations may be used by governments as a substitute for direct fiscal action, and will have similar economic effects in whichever part of the public sector they are conducted. They clearly need to be taken into account in assessing the overall fiscal position.²⁷ It is also a basic requirement of fiscal transparency that links between fiscal and monetary operations of the central bank should meet the requirements of Sections 1.2 and 1.3 in the monetary and financial transparency code.²⁸ Section 1.2 requires that the institutional relationship between monetary and fiscal operations should be clearly defined, while Section 1.3 requires that agency roles performed by the central bank on behalf of the government should be clearly defined.

General government and public financial institutions

30. Although privatization of state-owned banks has been increasing, they still account for a dominant share of the banking sector in many developing economies.²⁹ Public financial institutions have often been set up to provide assistance of a quasi-fiscal nature, such as a development bank providing loans to specific sectors at below-market rates. Governments also use public financial institutions on a more ad hoc basis to provide quasi-fiscal assistance, for example, through policy directions on lending. A basic requirement of fiscal transparency is that the annual reports of public financial institutions should indicate the noncommercial services that the government requires them to provide.

General government and nonfinancial public enterprises

31. It is also a basic requirement of fiscal transparency that the annual reports of nonfinancial public enterprises should indicate the noncommercial services that the government requires them to provide. Nonfinancial public enterprises in many countries provide noncommercial services, usually through charging less than cost-recovery prices (e.g., providing electricity at below cost to rural consumers). In a number of countries, nonfinancial public enterprises have also been required to provide social services. These noncommercial activities may be financed by cross-subsidization between different groups of consumers and/or by incurring losses that are financed from the budget or by borrowing. In some instances, excessive prices may be charged by certain nonfinancial public enterprises, and the supernormal profits earned transferred to other enterprises or to the budget. This confuses the fiscal responsibilities of government and commercial role of nonfinancial public enterprises, makes relations between government and nonfinancial public enterprises nontransparent, and creates difficulties in holding managers of nonfinancial public enterprises accountable for their performance.

32. Best practice is that relevant disclosure and transparency requirements of Principle IV of the OECD Principles of Corporate Governance should be observed by public financial institutions and nonfinancial public enterprises. Box 3 spells out these requirements. However, a few countries are also moving in a different direction, in that the government is contracting with a nonfinancial public enterprise to provide a noncommercial service in return for an explicit budgetary transfer which reflects the price the government is willing to pay for the service.³⁰ Similar contracts could also be agreed with public financial institutions.

Box 3. OECD Principles of Corporate Governance: Principle IV on Disclosure and Transparency

The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company. 1.  Disclosure should include, but not be limited to, material information on:   the financial and operating results of the company;   company objectives;   major share ownership and voting rights;   members of the board and key executives, and their remuneration;   material foreseeable risk factors;   material issues regarding employees and other stakeholders; and   governance structures and policies. 2.  Information should be prepared, audited, and disclosed in accordance with high quality standards of accounting, financial and nonfinancial disclosure, and audit. 3.  An annual audit should be conducted by an independent auditor in order to provide an external and objective assurance on the way in which financial statements have been prepared and presented. 4.  Channels for disseminating information should provide for fair, timely, and cost-efficient access to relevant information by users.

33. Serious transparency concerns can also arise over the manner in which public financial institutions and nonfinancial public enterprises are privatized. Privatization should be conducted as openly as is consistent with sound marketing considerations. It is a basic requirement of fiscal transparency that the privatization of government assets should be open to independent audit (e.g., by a national audit body), to ensure that it is carried out in accordance with the law, that the business is properly valued, and that there is competition among bidders. Indemnities given to purchasers should also be disclosed (and included in a statement of contingent liabilities).³¹ INTOSAI has published Guidelines on Best Practice for the Audit of Privatizations.³²

Government involvement in the rest of the economy

1.1.5 Government involvement in the private sector (e.g., through regulation and equity ownership) should be conducted in an open and public manner, and on the basis of clear rules and procedures that are applied in a nondiscriminatory way.

34. The government interacts with the private sector in a variety of ways, and transparency in government operations may be of limited benefit if there is not clarity in all kinds of interaction with the private sector.

Regulation of the nonbank private sector

35. Governments have become increasingly aware of the need for transparency in regulatory practices. General regulatory standards go beyond the scope of the Code, which only requires that government regulation of the private sector should be conducted in an open and public manner. Guidelines for government regulation are provided in the OECD Policy Recommendations on Regulatory Reform, although these are concerned with efficiency as well as transparency.³³ The OECD recommendations relating to the characteristics of transparent regulations are set out in Box 4. Best practice is that these recommendations should be fully implemented.

Box 4. Characteristics of Transparent Regulations

Regulations should have clearly identified policy goals, should be expressed in clear, simple terms, and should have a sound legal basis. Public consultation on new regulations will often be desirable. Procedures for applying regulations should be open and nondiscriminatory. They should apply equally to the public and private sectors, and should contain an appeals process. Overlapping responsibilities among regulatory authorities should be minimized. Regulations and their impact should be reviewed periodically in published reports.

36. There are other activities that the private sector carries out under the direction of or in conjunction with government which should share the characteristics of transparent regulations. These include the imposition of compliance costs of collecting taxes on private businesses and individuals,³⁴ compulsory contributions to private providers of old age pensions, health and insurance, and privately financed infrastructure projects. While these are not regulations in the traditional sense, such activities are often guided by complex rules and reciprocal arrangements about which information should be openly available.

Government intervention in the banking sector

37. Government regulation of the banking sector—and the financial sector more generally—should also be based on clear policy goals. Heavy government involvement in the banking sector is often associated with a failure to impose adequate accounting and disclosure practices, and to ensure that there are appropriate incentives for bank owners, managers, and regulators to manage risks prudently. An appropriate framework for bank regulation, most notably that provided by the Basle Core Principles for Effective Banking Supervision,³⁵ and greater transparency in reporting government involvement in the banking system, including a rationale for each type of intervention, are essential components of a framework that promotes financial sector stability. The monetary and financial transparency code contains detailed good practices for government financial agencies responsible for regulation, supervision, and oversight of the financial and payment systems.³⁶

Direct equity investment

38. Governments also intervene by directly acquiring private equity in companies or commercial banks. All government equity holdings should be identified in the budget documentation.³⁷ The acquisition of new equity should be clearly explained in the budget documentation, and the policy objectives served by government equity holdings should be explained.³⁸

⁹ See IMF (1986). Some differences exist between the SNA and the GFS, but the revised GFS Manual will be harmonized with the SNA. The revised GFS Manual is expected to be available in mid-2001. In the meantime, a revised draft GFS Manual has been posted on the IMF's external website for comment. See http://www.imf.org/external/pubs/ft/gfs/manual/index.htm.
¹⁰ See Chapter 2 of the current GFS Manual, Coverage of the GFS System, for detailed discussion of the definition of the general government.
¹¹ ESA is harmonized with the SNA. See http://www.europa.eu.int/comm/eurostat/.
¹² In the Code, and hereafter in the Manual, references to public financial institutions do not include the central bank. Given the particular significance of the central bank for fiscal analysis, it is important to distinguish it clearly from other public financial institutions.
¹³ See paragraph 126 for further discussion of reporting on public sector finances.
¹⁴ However, the intergovernmental framework should not be so inflexible as to constrain effective macroeconomic management by the central government.
¹⁵ Mozambique has recently set up a new institutional framework for intergovernmental relations with relatively clear and simple rules. See the ROSC for Mozambique, Fiscal Transparency Module, paragraph 5, at http://www.imf.org/external/np/rosc/moz/index.htm.
¹⁶ See, for instance, von Hagen (1992); Alesina and Perotti (1995, 1999); and Stein, Talvi, and Grisanti (1998). These studies suggest that fiscal performance in Europe and Latin America is strengthened by budget procedures that concentrate power in the executive (and, within the executive, in the finance ministry), and are more transparent.
¹⁷ The Code is silent, however, on whether the legislature should have the power to amend the budget presented by the executive. This goes beyond transparency. See Alesina and Perotti (1999) for a discussion of the effects of different legislative budget amendment powers.
¹⁸ See paragraph 108 for discussion of the need to integrate current and capital budgets.
¹⁹ The framework for fiscal management is discussed in paragraphs 40-41.
²⁰ The channeling of earmarked taxes to extrabudgetary funds is common where there is a strong link between taxes and benefits, emphasis on which may result in earmarked taxes being more easily accepted than regular taxes. Also, activities undertaken through extrabudgetary funds should often be less influenced by the short-term considerations that affect the budget, and may even be governed by separate legislation. Social security has these characteristics.
²¹ Reporting of externally financed transactions is discussed further in paragraphs 136-137.
²² Or through more extended reviews linked to medium-term budget targets or longer-term sustainability.
²³ The new budget laws in Moldova and Latvia go as far as to incorporate extrabudgetary funds as special funds in the annual budget.
²⁴ In Sweden, the central bank undertakes no quasi-fiscal activities, and its independence is assured under amendments to the 1997 Sveriges Riksbank Act. See the ROSC for Sweden, Fiscal Transparency Module, paragraph 5, at http://www.imf.org/external/np/rosc/swe/index.htm. The Bank of Korea is prohibited by the Central Bank Act from direct financing of the fiscal deficit. See the ROSC for the Republic of Korea, paragraph 6, at http://www.imf.org/external/np/rosc/kor/index.htm.
²⁵ Although it is still possible for the central bank to buy government securities in the open market, or to influence the demand for such securities in other ways (e.g., by requiring their use in meeting reserve requirements).
²⁶ Box 10 contains a more complete listing of the different types of quasi-fiscal activity.
²⁷ Reporting of quasi-fiscal activities is discussed in paragraphs 70-77, and a discussion of how they can be incorporated into assessments of the overall fiscal position is contained in Box 18.
²⁸ For detailed discussion, see http://www.imf.org/external/np/mae/mft/index.htm.
²⁹ See Goldstein (1997).
³⁰ In the United Kingdom nonfinancial public enterprises operate on a commercial basis, with the costs of noncommercial activities being compensated for and reflected in the budget. In France, some quasi-fiscal activities are being replaced by explicit subsidies. For example, airlines are explicitly contracted on a competitive basis to maintain some noncommercial routes and the cost of maintaining postal services in rural areas in now explicit. See paragraphs 2 (including footnote 2) and 9 of the ROSCs for the United Kingdom and France respectively, Fiscal Transparency Modules, at http://www.imf.org/external/np/rosc/rosc.asp.
³¹ See paragraphs 62-66 for a discussion of contingent liabilities.
³² See INTOSAI (1998) at http://www.nao.gov.uk/intosai/wgap/bestprac.htm.
³³ See http://www.oecd.org/subject/regreform/ for additional detail.
³⁴ See paragraphs 46-47 on accessibility and understandability of tax laws; paragraph 55 on taxpayer rights; and paragraph 142, which refers to transparency of tax compliance costs.
³⁵ See Basle Committee on Banking Supervision (1997). See also http://www.bis.org/publ/bcbs30a.htm. This is one of the core standards promoted through the Financial Sector Assessment Program (FSAP). In the FSAP, staff of the World Bank and IMF consider observance of relevant financial sector standards as an input in to a broader examination of financial sector stability.
³⁶ See http://www.imf.org/external/np/mae/mft/index.htm.
³⁷See paragraphs 81-82 for a discussion of reporting information on the stock of financial assets, including equity investment in private companies.
³⁸ This should definitely be done when new equity is acquired. There should also be periodic reviews of all equity holdings, and the reasons for retaining equity positions should be given, especially where governments are in the process of privatizing assets.