Public Financial Management and Corruption

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Public Financial Management and Corruption

• Bill Dorotinsky
• Shilpa Pradhan

May 2, 2006
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Outline

• Introduction
• Definitions and Scope
• Patterns of Corruption and PFM Systems
• Measuring Corruption
• Entry Points and Mitigating Measures

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Rome 70 BCE
From Governors trial on corruption charges
His conduct of his naval affairs was not to
defend the province at all. No, it was to extract
personal financial profit out of what was meant
to be expended on the fleet. The power of your
position..was enormous.Yet it never.crossed
your mind that these assets had not been placed
in your hands just to make it possible for you
to treat any and every mans possessions as your
own personal loot. Conscripted sailors could
buy out their service requirements, and the
Governor simultaneously pocketed the pay and
sustenance allowance for the sailor.
Example of Theft of public funds, bribery, abuse
of office
Cicero, Against Verres
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Introduction

• Governments throughout history have had a public
  financial management (PFM) system
• And corruption has always been a concern
• The development of PFM systems over time have
  been largely due to concerns over waste, fraud,
  and abuse

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Definitions
Public financial management (PFM)
Corruption

• Diversion of public resources for private
  (personal or other non-public) gain, or abuse of
  public authority and position for private gain
• Corruption is not necessarily
• Political leveraging
• Leaky Bucket
• Diversion of public resources from intended to
  another public purpose

• All phases of public resource acquisition,
  safeguarding and use
• revenue collection and administration (tax,
  customs, and non-tax revenue)
• cash management and banking
• debt issuance and management
• asset management (physical and financial)
• budget preparation
• budget execution
• accounting and reporting
• internal control and audit
• procurement
• external audit and legislative oversight.

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Basic PFM Functions
Function
Resource Acquisition
Resource Safeguarding
Resource Application

• taxes (cash, in-kind)
• non-tax revenue (fees, asset sales)
• debt (bonds, loans)
• labor
• land

• Treasury
• National Bank
• Warehouse
• Holding site (e.g. grainery)
• Investments

• Personnel
• Goods and Services
• Capital
• Debt Repayment
• Direct Transfers

Issues

• Skimming Receipts
• Under Collection
• Write-offs of receivables
• Lending
• Abetting draft dodging
• Staff for personal use
• Under pricing assets

• Theft of assets
• Contract steering
• Fraudulent invoices
• Ghost workers
• Kick-backs
• Ghost beneficiaries
• Substandard goods
• Over pricing goods, services

• Theft
• Lending
• Skimming interest
• Favoritism in fund placement
• Unrecorded interest or delayed transfer of
  resources to Treasury

Corruption

• Tax Collection
• Customs
• Debt Management
• Draft Office, Ministry Requisition Office

• Treasury, MoF
• General Services
• Spending Ministries
• National Bank
• Land management agency

• Treasury, MoF
• General Services
• Spending Ministries
• Civil Service Admin
• Public Works Admin
• Procurement Office

Agents

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Basic PFM Functions (2)
Function
Resource Safeguarding
Resource Application
Oversight and Accountability

• Internal Control, Management Control
• Internal Audit
• External Audit
• Accounting, Reporting
• Planning

• Treasury
• National Bank
• Warehouse
• Holding site (e.g. grainery)
• Investments

• Personnel
• Goods and Services
• Capital
• Debt Repayment
• Direct Transfers

Issues

• Theft of assets
• Contract steering
• Fraudulent invoices
• Ghost workers
• Kick-backs
• Ghost beneficiaries
• Substandard goods
• Over pricing goods, services

• Theft
• Lending
• Skimming interest
• Favoritism in fund placement
• Unrecorded interest or delayed transfer of
  resources to Treasury

Corruption

• Bribery
• Favoritism

• Treasury
• Min Finance
• Min Planning
• Internal Auditor
• External Auditor
• Legislature
• Pres./PM-Cabinet
• Procurement Office

• Treasury
• General Services
• Spending Ministries
• National Bank
• Land management agency

• Treasury
• General Services
• Spending Ministries
• Civil Service Admin
• Public Works Admin
• Procurement Office

Agents
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Basic PFM Cycle
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There are many weeds in the untended garden

• PFM system nature and quality will largely
  determine the ease with which public corruption
  can occur
• and also the risk and personal cost of detection.
  
• PFM system conditions enable corruption to
  flourish
• PFM systems where corruption can flourish are
  characterized by high informality and the absence
  of an ethos of professionalism in the public
  finance cadre

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Better PFM systems have lower perceived corruption
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PFM Characteristics Enabling Corruption

• absence of rules and procedures for routine or
  annual processes (e.g. budget formulation,
  execution), or general disregard for rules and
  procedures where they exist
• absence of records, record-keeping, for key
  transactions, or inability to access the
  information in a timely way for management
  control or audit
• highly inaccurate, untimely, non-user friendly
  reporting, recording, or absence of procedures
  for testing accuracy
• absence of controls on spending, goods, stores
  and equipment, or absence segmentation of key
  duties/roles in expenditure chain (the latter
  increases the opportunity for individuals to
  engage in theft or corrupt practices, while
  segmentation requires collusion and raises risk
  of detection and prevention)
• excessively complex or rigid procedures that
  impede routine program operations and create
  incentives for special spending procedures or
  breaking rules
• absence of sound, time-bound, explicit plans for
  using funds (budgets, necessary for management
  control and accountability)
• excess fragmentation of funds, procedures for
  accounting, reporting (making information
  consolidation, reporting and management control
  difficult)
• absence of staff or qualified public finance
  staff, or adequate training, no standardization
  of PFM positions across government (no cadre of
  PFM staff or professional ethos, inadequately
  compensated staff)

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PFM System Principles Countering Corruption

• Comprehensiveness
• - include all revenue and expenditure, all
  agencies, in common treasury, reporting,
  budgeting systems
• Accuracy
• record actual transactions and flows, report
  accurately
• Annuality
• funding allocations, budgets, and reports should
  cover a defined (stated) period of time (e.g. one
  year budget, multi-year forecasts) (with explicit
  accounting standards)
• Authoritativeness
• only spend as authorized by law (budget and
  finance laws, statutes authorizing ministries and
  programs), and according to established
  procedures
• Transparency
• information on spending is public, timely,
  understandable rules are explicit, and publicly
  available

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Measuring Corruption Potential

• Directly measuring corruption is not feasible
• no direct measures of bribery, asset theft,
  contract steering, cash theft, etc.
• External audit capture only some corrupt
  practices
• PFM system quality can be measured and monitored
• There is now an internationally-accepted set of
  actionable PFM performance indicators (PEFA)
• See www.pefa.org
• PFM system quality assessment measures corruption
  potential

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PFM PEFA Indicators

1. Transparency of taxpayer obligations and
   liabilities
2. Effectiveness of taxpayer registration and
   assessment
3. Effectiveness of tax collection
4. Predictability of funds for commitment
5. Recording/management of cash, debt and guarantees
6. Effectiveness of payroll controls
7. Competition, value for money and controls in
   procurement
8. Effectiveness of internal controls
9. Effectiveness of internal audit

1. Orderliness in annual budget process
2. Multi-year perspective

1. Accounts reconciliation
2. Resources received by service delivery units
3. Quality and timeliness of in-year budget reports
4. Quality and timeliness of annual financial
   statements

1. External audit
2. Legislative scrutiny of budget
3. Legislative scrutiny of external audit reports

Cross-cutting Indicators

1. Aggregate expenditure out-turn
2. Composition of expenditure out-turn
3. Aggregate revenue out-turn
4. payment arrears
5. Classification of the budget

1. Comprehensiveness of information
2. unreported government operations
3. Transparency of inter-governmental fiscal
   relations
4. Oversight of aggregate fiscal risk
5. Public access to key fiscal information

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Over-all PFM System Features
PFM Indicators and Corruption
Indicator Corruption Relevance
PI-5 Classification of the budget Enabling factor through transparency of government spending. A good budget classification enables good information on government activities for costing and budgeting, for planning, for monitoring and control of spending, and for auditing and accountability.
PI-6 Comprehensiveness of information included in budget documentation The more information included in budget documents (greater transparency), the greater the ability of stakeholders to evaluate budget credibility, policies and intentions, and hold Government to account ex poste.
PI-7 Extent of unreported government operations A highly relevant issue for enabling corruption is the absence of reports on spending for some types of operations, frequently a characteristic of extrabudgetary funds, state-owned enterprises, and autonomous agencies. Related to this is the use of different accounting and auditing systems that make consolidation of accounts difficult, and opens reporting to errors.
Honduras 14 of spending was recorded ex ante
and ex poste as assignaciones globales
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PFM Indicators and Corruption
Budget Execution - Expenditure
Loan guarantees were non-transparent in
Macedonia, issued by the Minster of Finance.
Macedonia changed its budget law, requiring all
guarantees to be approved by Cabinet and
Parliament. Requests for guarantees stopped.
Indicator Corruption Relevance
PI-16 Predictability in the availability of funds for commitment of expenditures Predictable flow of funds to spending units is critical for plan fulfillment and accountability, and unpredictable funds flow leads to arrears and opportunities for discretionary decision-making and corruption in payment of government liabilities. Cash flows should be forecasted and monitored, and variations from predictions understood. Information needs to flow regularly to spending units on fund availability for program operations and fulfillment of plans.
PI-17 Recording and management of cash balances, debt and guarantees Absent records of debt incurred, there is no way of monitoring total debt and any irregular debt issued outside formal procedures, or debt improperly contracted or contracted at excessive rates. A formal system, with authorized officials, for contracting debt and issuance of guarantees is critical for accountability and minimizing opportunities for corruption or favoritism. Consolidation of cash balances is important for efficient cash management, and also safeguarding cash from improper transfer, theft, or lending. A single treasury account simplifies recording of payments and monitoring for irregularities, enabling better management control and accountability.
PI-18 Effectiveness of payroll controls Absent payroll controls, funds can easily flow to fictitious employees, and nepotism and favoritism can be rampant. Important elements include the degree of integration and reconciliation between personnel and payroll records to detect anomalies, timeliness of changes to personnel records and payroll records, effective internal controls in personnel and payroll record management, and payroll audits to identify control weaknesses and ghost workers.
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A Framework for assessing reform strategies
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Key Challenges
Type of States Key Challenges
Fragile States (Guinea-Bissau, Haiti, Equatorial Guinea) Low political leadership and managerial commitment to anti-corruption reforms Absence of rules and regulations (authoritativeness) governing the budget process Poor quality fiscal information Civil Society is not engaged in the budget process Absence of internal and external oversight
Reforming States (Ghana, Armenia) Improving the accuracy of fiscal information Disregard for rules governing the budget process Limited transparency of budgetary information Ineffective internal and external audits Sustaining political commitment to reform
Capable States (Brazil, South Africa) Increase performance orientation in public spending, increase coordination and integration between central institutions Strengthening transparency, external audit and external scrutiny of public spending Strengthening accountability and enforcement
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High Level Focus Sequencing of Interventions

• Implement complex PFM systems reforms with a
  performance orientation
• Strengthen transparency, accountability and
  enforcement
• Sustain commitment for reforms

Capable States
Reforming States

• Refine basic PFM systems
• Progressively introduce complex PFM System
  reforms
• Strengthen commitment for AC reforms

Fragile States

• Build internal demand for information
• Develop basic PFM systems

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Fragile StatesAssessing Detail Interventions

• Key Issues that increase the risk of corruption
  in budget formulation
• Adhoc budget formulation and delays in budget
  formulation,
• Limited or no involvement of key actors in
  budget formulation
• Incomplete budget classification, budget
  classification system does not facilitate a
  direct link between programs and executing
  agencies and does not conform to international
  standards
• Budget not comprehensive and budget documents are
  incomplete

Budget Execution
Budget Formulation
Accounting and Reporting
External Audit and Oversight

• Suggested mitigating measures
• Increase internal demand for information
• Strengthen the ability of the PFM system to
  capture the budget information
• Authoritativeness Review the legislative
  framework for budget formulation to establish a
  timetable, with clear mandates for key actors
  (Political leadership commitment is key)
• Comprehensiveness
• Annual budget document to include all sources of
  revenues, expenditures
• Strengthen budget classification economic,
  administrative and functional

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Fragile StatesAssessing Detail Interventions
Authoritativeness in budget execution Establish
budget execution procedures

• Key Issues that increase the risk of corruption
• Cash management on a day to day basis
• Absence of clear rules and controls during budget
  execution
• Absence of payroll control
• Absence of internal audits

Budget Execution
Budget Formulation
Regular reconciliation of Government accounts
with bank data Regularity, timeliness of reports
Accounting Reporting
Establish external audit capacity
External Audit and Oversight

• Key Issues that increase the risk of corruption
• Irregular reconciliation of Bank accounts with
  government accounting data, existence of multiple
  accounts or the Single Treasury Account is not
  respected
• Accounting books remain open for a long time
  after year end
• Fiscal reports not being produced in a timely
  manner, are inconsistent and incomplete

Key Issues that increase the risk of
corruption External audits weak, non-existent or
politically captured
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Reforming StatesAssessing Detail Interventions

• Budget formulation
• Budget regaining its role as a primary resource
  allocation mechanism, budget increasingly
  realistic with actual expenditures closer to
  budgeted but budget still not a policy
  instrument
• Comprehensiveness of the annual budget document
  increasing
• Extent of unreported government operations is
  still high
• Budget classification may not be along
  recommended economic, administrative and
  functional (including sub-functional lines)
• Public Access to key budget information is limited

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Reforming StatesAssessing Detail Interventions

• Key Issues increasing the risk of corruption in
  budget execution
• Weak cash planning and management (planning not
  based on realistic budgetary requirements of line
  ministries, no systematic review of cash
  forecasts) affecting predictability of funds for
  commitment
• Weak internal controls during budget execution
  (controls on commitments may be poor or
  disregarded, weak controls on payments)
• Weak quality of internal audits not conforming to
  international standards
• Weak coordination between key actors during
  execution

Budget Execution
Budget Formulation
Accounting and Reporting
External Audit and Oversight

• Suggested mitigating measures
• Recording and management of cash balances, debt
  and guarantees
• Strengthen internal controls that manage risks,
  are comprehensive and are widely disseminated and
  understood
• Strengthen internal audit process

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Reforming StatesAssessing Detail Interventions

• Key issues increasing the risk of corruption
  (Accounting and Reporting)
• Accounting procedures are not uniformly observed
  during record keeping
• Weak internal accountability for not conforming
  with accounting procedures
• Reconciliation is not regular and comprehensive
• Inaccurate and inconsistent in-year budget
  reports
• Inaccurate and inconsistent annual statement

Budget Execution
Budget Formulation
Accounting and Reporting
External Audit and Oversight

• Suggested mitigating measures
• Streamline, disseminate and train staff on
  accounting principles
• Incremental implementation of FMIS
• Regularity in reconciliation of Bank accounts
  with government accounting books
• Regularity and reconciliation of suspense
  accounts and advances
• Consolidated annual statements are prepared which
  include full information on revenues,
  expenditures and financial assets and liabilities

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Capable StatesAssessing Detail Interventions

• Budget Formulation
• Generally high capacity of PFM systems and
  reliable tracking of public expenditures, well
  established and respected legal framework for the
  budget process, budget fairly comprehensive,
  integrated budgeting
• Budget Execution
• Fairly high adherence to well-developed Internal
  controls, good cash planning and management,
  internal audits functioning but may be limited to
  financial and compliance audits.
• Accounting and Reporting
• Accounting standards adhere to established
  standards, timely accounts reconciliation,
  regular and accurate fiscal reports produced and
  made available to all key internal actors, and
  may be available to civil society
• There is room for improvement in the basic PFM
  systems and processes..

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Capable StatesAssessing Detail Interventions

• Key issues increasing the risk of corruption
  (External Audit, Oversight and Accountability)
• External audit institutions are not independent
  and do not have clear mandate
• Scope and coverage of external audit is limited
• Audit reports not submitted to the parliament
• Ineffective follow up of audit recommendations
• Civil society engagement in budget formulation
  but not in audits

Budget Execution
Budget Formulation
Accounting and Reporting
External Audit and Oversight

• Suggested mitigating measures
• Authoritativeness Legislative mandates for
  independent external audit institutions with
  clear mandates, coverage and scope
• Develop clear and timely follow up procedures
• Timely submission of audit reports to the
  parliament

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Back to the Basics..

• Mitigating the risk of corruption in public
  expenditures, is as much about strengthening
  technical capacity of PEM systems as about
  changing institutions, both formal and informal,
  within which the system operates.
• Improvements to PEM system performance occur in
  incremental steps with the fundamental elements
  of expenditure management strengthened before
  more complex reforms can be undertaken
• Sustaining reforms requires (i) commitment from
  stakeholders in the budgetary process, in
  particular the implementers of the budget, and
  (ii) capacity of key budgetary departments.
• Reforming the PFM systems can be a large and
  complex undertaking which requires strengthening
  the interlinkages between the different elements
  of the system and the principles underlying the
  PEM systems.

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• Q A