Why Budget Institutions Cannot Control Government

Spending: Evidence from Latin America

Jon Bischof
Harvard University
Draft: Please do not cite without permission.
March 13, 2008

Abstract
Studies of political institutions have consistently found that hierarchical budget
rules are positively correlated with higher fiscal surpluses. However, this paper shows
that budget rules only affect a small portion of overall fiscal expenditures and that
empirical studies that suggest otherwise misspecify the dependent variable and produce
misleading results. I argue that off-budget expenditures and obligations established by
statute and constitutional mandate have largely sidelined the appropriations process.
Although previous studies have found a positive relationship between budget rules
and overall fiscal surpluses, this variable is an interaction between two separate policy
decisions, making it impossible to distinguish whether the empirical relationship is a
product of lower expenditures, higher revenues, or some combination thereof. Using
cross-sectional and panel data from Latin America (1990-2005), I break down the fiscal
surplus into spending and revenues and show that budget rules have no relationship
with either the level or rate of increase in spending. I conclude by arguing that most
important fiscal policy decisions are made via legislation and that public finance cannot
be separated from normal legislative politics.

Can the formal rules of the budget process explain variation in fiscal policy outcomes?
A growing number of scholars are using differences in budget institutionsthe rules that
govern the formulation, approval, and execution of the budgetto understand why some

Email: jbischof@fas.harvard.edu. I would like to thank Jorge Domnguez, Steve Levitsky, Rich Nielsen,
and David Andrew Singer for their invaluable and extensive comments on this paper, as well as Frances
Hagopian and Carlos Gervasoni for assistance with earlier versions. This paper was presented at the annual
conference of the Midwest Political Science Association in Chicago, April 6, 2008.

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

countries run larger deficits than others (e.g., Alesina and Perotti 1999; Baldez and Carey
1999). Identifying the appropriations process as a common pool problem, this literature
predicts that more hierarchical decision rules that concentrate authority in the president
or finance minister should lead to lower deficits and a more rational allocation of resources
since a single actor will fully internalize the cost of additional spending. A large number of
supporting empirical studies have found a positive relationship between the centralization of
the budget process and primary surpluses in places as diverse as Western Europe (von Jagen
1992), Latin America (Alesina et al. 1999; IDB 1997; Filc and Scartascini 2007), Argentine
provinces (Jones et al. 1999), and Eastern Europe (Fabrizio and Mody 2006), as well as a
broad sample of developed and developing countries (Woo 2003).
This paper uses evidence from Latin America to argue that these findings are misleading. While it is true that a small portion of the budget (primarily public investment) can be
modified from year to year in the appropriations process, the vast majority of spending is
mandated by statutory or constitutional law and can only be modified by legislative majorities or supermajorities. In the first section of my paper I show that the two biggest expenses
in many statessocial security programs and transfers to subnational governmentsare not
even part of the central government budget. I further demonstrate that, even excluding
interest payments, most of the items actually in the budget are specifically mandated by law
or protected by spending floors and revenue earmarks.
In the second section, I explain the robust empirical relationship between budget institutions and primary surpluses in the literature by arguing that the dependent variable has

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

been incorrectly specified. After breaking the surplus into primary spending and revenues
for the budgetary central government, I show that hierarchical budget institutions have no
relationship with spending and a very robust positive effect on revenues. Interestingly, this
finding is even more pronounced for the consolidated central government.
In a third, concluding section I divide the policymaking arena between the budgetary
arena and the legislative arena (where most spending is determined). Given that broad
legislative coalitions are needed to make policy changes in the latter, I argue that research
on fiscal policy cannot ignore legislative politics and must consider variables such as the
partisan powers of the president, party and coalition politics, and the electoral incentives of
individual delegates.

1
1.1

Budget Institutions and Fiscal Outcomes

What Are Budget Institutions?

Budget institutions are the formal rules that govern the formulation, passage, and execution
of the budget. Interest in these rules arises from a conceptualization of fiscal indiscipline as
a special case of the common pool problem. For example, Weingast, Shepsle, and Johnsen
(1981) show that in a legislature with geographically based districts, delegates from each
of the N districts will request public projects long after the marginal social cost exceeds
the marginal social benefit since they internalize only

1
N

of the costs. The Inter-American

Development Bank (IDB) (1997: 99) offers a succinct illustration: if splitting a restaurant bill

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

evenly among nine friends, one is much more likely to order an expensive lobster dish over the
chicken than when eating alone. Thus, rules that concentrate decision-making power in the
hands of a single nationally-oriented official should produce more efficient policy outcomes
since he fully internalizes the entire social cost of marginal increases in spending.
Presidents can be granted a variety of tools with which to control budget outcomes. First
are restrictions on the legislatures ability to alter the presidents initial budget proposal. If
there are no restrictions on legislators ability to amend the budget, then there will be great
opportunity to add particularistic spending and earmarks to the proposal. However, if the
legislature is required to find sources of funding for all new spending (pay as you go), ask
the executive for permission first, or is only allowed to decrease and not to add spending,
then it is much less likely that they can burden the budget with particularistic amendments
without the complicity of the president. Another means of constraining the legislature is the
determined default outcome should it fail to pass a budget. If the presidents budget or
the previous years budget is enacted, then the president has little need to compromise with
the legislature. But if he has to submit a new budget or, at the extreme, if the government
is forced to shut down, then the costs of confrontation may be so great that the president
will offer significant concessions in anticipation of the legislatures demands.
Second, the president can be given a number of proactive powers. If during the execution
of the budget (in the next fiscal year) the president can modify the budget at his own
discretion, then it will be easier to balance the budget even if revenues are lower than
projected (or if any other contingency arises). But if he is unable to do so or needs the

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

Leg. amend power

Reversion outcome

Pres. impnd power

Pres. modify power

(during execution)

Index

Country
Brazil
El Salvador
Chile
Ecuador
Nicaragua
Peru
Paraguay
Costa Rica
Uruguay
Colombia
Dom. Republic
Venezuela
Panama
Argentina
Mexico
Bolivia
Guatemala

Proposal power

Table 1: Presidential Budgetary Powers

Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes

3
3
2
2
3
3
0
1
3
2
3
3
2
1
0
0
0

2
1
2
2
3
2
2
2
1
2
1
1
2
1
0
2
1

2
3
2
1
1
0
3
2
2
1
1
1
0
1
1
1
1

3
2
2
3
2
3
2
2
1
2
2
2
2
2
3
0
0

10
9
8
8
8
8
7
7
7
7
7
7
6
5
4
3
2

Source: UNDP (2004: 80). Higher values indicate greater centralization in the decision-making process. See Appendix A for
an explanation of the UNDPs coding rules.

approval of legislators (most likely unwilling to cut their own projects), then it will be easier
for deficits to get out of control. Finally, if the president can impound funds rather than
spending the amounts budgeted, he will also be better able to ensure a balanced budget.
In some countries, such as Ecuador, the president can do this by decree; in others he has
no ability to do this or can only do so for non-earmarked funds or if revenues are less than

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Why Budget Institutions Cannot Control Government Spending

projected. The greater his discretion, the greater the level of presidential dominance over
the budget process.1 Table 1 presents an index of these powers for Latin American countries
(with higher values meaning greater centralization in the decision-making process).2

1.2

What Can Budget Institutions Explain? What Should They?

Previous studies which have found that hierarchical budget institutions can restrain fiscal
indiscipline have consistently used consolidated central government primary surplus data,
a measure which includes all spending executed by the central (as opposed to subnational)
government.3 One can immediately see several problems with this choice of dependent
variable. On one hand, it excludes spending by subnational governments, which can account
for as much as half of total public sector expenditures (such as in Brazil and Argentina).
On the other, it includes a number of items, such as social security funds or parafiscal
organizations, that are established outside the budget. Therefore, these studies are using
1

While the exclusive right to draft the budget proposal is also important, there is no variation in this
variable in Latin America and in presidential systems generally. Also, while this literature often highlights
the transparency of the budget process as an important intervening variable, it does not fit neatly into
the common pool framework and never shows up as significant when indices of budget institutions are
disaggregated.
2
Since this paper focuses on Latin America, I have chosen to restrict myself to presidential systems,
which account for all countries excepting a few island nations in the Caribbean. Whether presidential and
parliamentary systems can be compared directly in this respect is unclear. As Kraan (1996: 26) argues, while
bargaining in presidential systems is primarily between the president and the legislature, a vote on the budget
in a parliamentary system is often treated as a vote of confidence in the governmentmaking voting against
the proposal far more costly. For this reason, studies of budget institutions in parliamentary contexts (e.g.,
von Hagen 1992) focus on the relative power of the finance minister vis-a-vis the other spending ministers,
while studies of presidential systems (e.g., Alesina et al. 1999) focus on the the power of the president
vis-
a-vis the legislature. Since the finance minister has little independent power in a presidential system
and the legislature has little independent power in the parliamentary system, these studies must code for
different things or code for both (if using a mixed sample) and assume that they are substitutes. Future
studies should be more explicit in how they handle this discrepancy.
3
These studies include von Jagen (1992), Alesina et al. (1999), IDB (1997), Filc and Scartascini (2007),
Jones et al. (1999), Fabrizio and Mody (2006), and Woo (2003).

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Why Budget Institutions Cannot Control Government Spending

budget rules to explain spending that is not part of the budget.

In addition, there is significant evidence that most items in the budget are inflexible and
not subject to the appropriations process. Government payroll costs, pensions, health and
education spending, subsidies, and other social welfare programs are usually predetermined
by legislation or constitutional mandate even if they are nominally included in the budget.
Finally, these scholars are making claims about spending restraint while using surpluses
as a dependent variable, which is the interaction between spending and the amount of revenue
collected via tax legislation. Therefore it is not clear to what extent the difference between
countries with strong and weak budgetary institutions can be explained by spending
restraint or increased revenue extraction. I develop each of these points below.

1.2.1

What Is Actually Included in the Budget?

While the budget is an important piece of overall fiscal policy, a significant portion of spending executed by the central government in some countries never passes through it. The most
familiar example of this is social security transfers, which are collected as a special tax on
wages or corporate revenues and then sent out to individual citizens according a formula
established by law. Another source of off-budget spending is parafiscal organizations, which
are legitimate public sector institutions that have proprietary sources of revenues not part
of the central government budget. One example is Colombias National Learning Service
(SENA), which uses mandatory employer payroll contributions to provide worker education
programs.4 To make meaningful inferences about the effect of budget institutions, these
4

See Echeverry et al. (2006: 59-60) and http://www.ilo.org/public/english/region/ampro/cinterfor/ifp/

sena/index.htm for more information.

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Why Budget Institutions Cannot Control Government Spending

expenses must be excluded from consideration.

Revenue sharing agreements with subnational governments are a separate component of
off-budget spending.5 Decentralized spending is not included in measures of consolidated
central government expenditures, but it still accounts for a set of allocation decisions that
budget institutions cannot influencedespite having a tremendous impact on the overall
fiscal health of some countries. These transfers are usually constitutional mandates and can
only be modified with large legislative majorities.
In Brazil, the 1988 constitution requires that 21.5% of revenues from the Income Tax
and Tax on Industrial Products be shared with the states and another 22.5% be transferred
directly to municipalities. More importantly, the constitution cedes the collection of the
most lucrative tax, the VAT on goods and services (ICMS), to the states, which accounts for
87% of their total revenues (OECD 2001: 76-77). In Argentina, tax collection is much more
centralized, producing a vertical imbalance of 64.5%. The Coparticipation scheme, written
into the constitution in 1994, requires that the federal government transfer 57% of shared
revenues to the provinces and leaves another 1% to be distributed to them discretionally
(Tommasi et al. 2001: 160-62). The 1998 Ecuadorian constitution requires that 15% of
central government revenues be earmarked for local governments. Similarly, the Colombian
revenue sharing system established in the 1991 constitution put all government revenues
into a shared pool and actually required the portion going to subnational governments to
increase from 21.3% in 1993 to nearly 50% by 2002, an adjustment that was carried out
5

However, in Colombia and Ecuador it may be that these transfers actually are part of the budget; Ive
been having trouble finding information on this. Either way, its totally non-discretionary.

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Why Budget Institutions Cannot Control Government Spending

gradually over the 1990s (Dillinger and Webb 1999: 9-10). Since the amount (and often use)
of these funds is non-discretionary, the central government is only responsible for a fraction
of spending in decentralized states.
To assess the magnitude of the discrepancy between on- and off-budget spending, I collected data from the IMFs Government Finance Statistics, which differentiates between
three levels of government spending: (1) the budgetary central government, which includes
items executed by the central government as part of the budget, (2) the consolidated central government, which includes all items executed by the central government, and (3) the
consolidated general government, which includes all items executed by both the central and
subnational governments.
Table 2 presents the figures from four selected countries in Latin America. In the third
column I list all of the spending items specified for each country at the different levels in the
IMFs codebook. In the fourth column I list the average magnitude of primary spending at
each level in the GFS database for all years available from 1997 to 2000. The results are
alarming: in Brazil and Uruguay less than half of the spending included in the measure used
by other studies (central government spending) is actually part of the budget.6 Furthermore,
items actually included in the budget account only for about a third of total government
spending. This brings in question the accuracy of previous studies and the usefulness of
budget institutions in explaining overall fiscal policy outcomes.
The magnitude of this discrepancy varies widely between countries. The difference be6

If, as they claim, Filc and Scartascini (2007) use general government surpluses as their dependent
variable, this error is compounded.

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Why Budget Institutions Cannot Control Government Spending

Table 2: Primary Expenditures (%GDP) by level of government in IMF Government Financial Statistics
Country

Level of govt

Entities included (cumulative)

Brazil
(1997-1998)

Budgetary Central
Government
Consolidated Central Government

Congress, judiciary, ministries, and presidency

10.06

Federal universities and federal university foundations;

Government agencies, boards, and commissions; National
and regional development agencies; National Highway Department; Technical schools
Federal district and 27 state governments; 5,508 municipal
governments
Legislature, ministries, and presidency; Court of accounts,
electoral court, judiciary, and tribunal for administrative
disputes; National Administration for Public Education
and University of the Republic
FLD (Fondos de Libre Disponibilidad); Social security
funds; Social insurance fund
19 departmental governments

23.29

Uruguay
(1997-2000)

Consolidated General Government

Budgetary Central
Government

Mexico
(1997-2000)

Consolidated Central Government

Consolidated General Government
Budgetary Central
Government
Consolidated Central Government

Nicaragua
(1997-2000)

Consolidated General Government

Budgetary Central
Government
Consolidated Central Government
Consolidated General Government

Administrative agencies; Congress, electoral authorities,

judiciary, presidency, secretariats, and tribunals; Government agencies
Social Security Institute for the Mexican Armed Forces;
Institute of Security and Social Services for Government
Workers; Mexican Social Security Institute
Federal district; 31 state governments; 2,430 municipal governments
Decentralized entities (7), electoral council, general controller office, judiciary, ministries (12), national assembly,
and presidency
General Procurement of Human Rights; Public Prosecutor
Office; Public universities (8); Nicaraguan Social Security
Institute
Regional government of North Atlantic; Regional government of South Atlantic; 152 municipalities

Expenditure

38.23
13.14

29.79
34.72
12.05

14.89

21.28
15.61

18.20
19.20

Figures for local government spending in Uruguay and Nicaragua were not available from the IMF database;
subnational spending estimated by using fiscal decentralization figures from IDB (1997: 157).

tween budgetary and consolidated central government spending is determined by the size of
a countrys social security program and the extent to which spending is executed by extrabudgetary entities. The difference between the consolidated central and general governments
is determined by the depth of fiscal decentralization. In Table 2 I chose four countries that
roughly represent four distinct groups of Latin American countries, ordered by level of discrepancy. The first group of Brazil and Argentina has both significant transfer programs
and fiscal decentralization. The second group of Uruguay, Costa Rica, and Panama has sig-

10

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

nificant transfer programs but is mostly centralized. The third group of Mexico, Colombia,
Bolivia, and Venezuela has limited transfer programs but significant decentralization. Finally, the fourth group of Nicaragua, the Dominican Republic, Chile,7 Ecuador, El Salvador,
Guatemala, Paraguay, and Peru has neither extensive transfer programs nor decentralization;
central government spending is most reasonable as an approximation for budgetary spending
in these countries. Given the comparative data on social spending in Segura-Ubiergo (2007:
13-14), most Western and Eastern European countries likely fall in the first and second
groups.

1.2.2

How Flexible Is the Budget?

Country studies of fiscal policymaking consistently observe that most spending within the
budget is fairly rigid and not amenable to yearly modifications in the appropriations process.
According to a study of budget inflexibility in Latin America by Echeverry et al. (2006), the
only item commonly flexible across countries is public investment and the direct purchase
of goods and services, with overall levels of rigidity in the budget ranging from 84% to 92%
among Argentina, Colombia, Mexico, and Peru. Another report by Lisa Schineller (2006:
56-57) from Standard and Poors measures rigidity at 5055% for Chile, 75% for Costa Rica
and Ecuador, and 90% for Panama and Uruguay.8 These inflexibilities arise from compulsory
payments mandated by law, earmarked revenues that must be spent for a specific purpose,
7

The inclusion of Chile in this group is counterintuitive but probably explained by the 1981 privatization
of the state pension program. This does not mean that the Chilean state does not engage in social spending
but that what they do spend is mostly included in the budget.
8
These papers include interest payments and have differing methodologies, but there are few sources that
measure inflexibility for more than one country at a time.

11

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

or spending floors that mandate that the state spend a certain percentage of fiscal resources
in one area at the expense of others.
One of the biggest single expenditures in the budget is defined benefit pension systems for
the private sector and civil service. As Echeverry et al. (2006: 95) note, not only are outlays
determined by a legal formula, but the responsibilities of the state begin when employees
decide to retire and do not end until their rights expire, leaving future financing requirements
difficult to estimate. In 2003, pensions accounted for about 20% of the Argentine budget,9
17% of the Colombian budget, 9% of the Mexican budget, and 21% of the Peruvian budget.
These obligations can only be modified outside the budget process with the passage of a
new law or constitutional amendment. Moreover, shedding these liabilities is a lengthy and
expensive process that stretches over numerous fiscal years: even if the president can gather
a sufficient legislative coalition to privatize the pension system, the transition costs from
continuing to pay benefits to current retirees while losing contributions from employers and
employees that move to the new system can be enormous. For example, Guidotti (2006:
79-81) estimates that Argentinas 1993 pension reform cost the Treasury 2 2.5% GDP
annually from 1993-2000 and identifies it as one of the factors leading up to the countrys
2001 fiscal and economic meltdown.
In an extreme case, the Brazilian pension system (which accounted for 10.5% of GDP
in 1999) can only be modified by amending the constitution, preventing the government
from reducing incredibly generous benefits to civil servants equal to 100% of their last basic
9

Most other sources put this figure at 30%, but this depressed number may be due to approximately 45%
of the budget spent paying down the countrys debt after the 2001 crisis. Abuelafia et al. (2005: 21) put
pensions at 39% of primary expenditures and 34% of total expenditures for 2004.

12

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

salary (OECD 2001: 97-103). Although the Brazilian presidency has the strongest budget
prerogatives in the region, they could not help President Cardoso to muster the two-thirds
of representatives required from both houses of Congress to amend the constitution. His
proposed reform package was only approved in 1998-99 after two of the most important
measuresthe capping of benefits at 70% of previous wages and the immediate application
of higher retirement ageswere removed.10
Pensions are the largest component of a hodgepodge of transfers that the state can be
legally obligated to send to various public and private entities. Recipients include households, enterprises, provinces (in addition to revenue sharing agreements), universities, and
international organizations. The World Bank (2003: 76) estimates these to account for 26%
of the Argentine budget. Echeverry et al. (2006: 62-3) find that transfers to the provinces
in Colombia (mostly for health and education) account for 37% of primary expense, while
other transfers (excluding pensions) accounted for another 12%.11 These are also mandated
by law and cannot be altered in the appropriations process.
Another major category of inflexible spending is the payroll for government employees.
While the Brazilian and Mexican governments (among others) were able to implement hiring
freezes and voluntary retirements to slow the growth of personnel expenses, there are significant legal and constitutional hurdles to reducing the number and wages of current employees
in the short term. In Mexico, for example, article 75 of the constitution establishes a public
employment contract as an acquired right that cannot be rescinded.12 As Echeverry et al.
10

Meaningful changes were not made until 2003 during the Lula presidency. See OECD (2005: 54)
I had to do a bit of calculation on my own here, but all the necessary pieces are in the tables on pp.
62-63.
12
This only applies to workers represented by the monopoly Federaci
on de Sindicatos de los Trabajadores
11

13

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Why Budget Institutions Cannot Control Government Spending

(2006: 104) note, the president would need a law passed to modify the current labor regime
if major changes are to be made.13 Brazils 1988 constitution also has strict limits on the
firing of public employees (OECD 2001: 46-47). Of course, de facto rigidity can also come
from more familiar sources such as labor union resistance, especially when civil servants are
protected by a single monopoly labor union or federation (Murillo 2000).
This is not to say that significant reductions cannot be achieved, but they require consultation with the legislature and cannot be made at executive whim. In exchange for taking
over early from the failed Alfonsn administration in Argentina, Carlos Menem demanded
that the lame duck Radical-dominated congress grant him special powers and increased flexibility in overhauling the state. The 1989 State Reform Law (Law 23,696) weakened existing
labor contracts and delegated to Menem sweeping decree powers allowing him to liquidate
a significant portion of public enterprises and adjust the wages and number of civil servants
in the National Public Administration (Ozlak 1997: 91-92). Oszlak (2001: 2-3) documents
a breathtaking reduction of federal employees and finds that 125,000 workers were forced
into early retirement and another 240,000 public enterprise employees were transferred to
the private sector via privatization. However, this delegation of powers is highly unusual
and the product of economic crisis; it was rescinded in the second Reforma del Estado law
after the necessary changes had been made (Rinne 2003: 44-47).
Payroll costs are a much greater part of the budgets of Central American countries, which
al Servicio del Estado (FSTSE), not the small group of semi-independent professionals known as empleados
de confianza (confidence employees). These workers are hired for their skills and experience and, although
fairly well paid, do not have the right to organize. They usually leave when a minister resigns and must seek
employment in another agency. See Gault and Amparan (2003).
13
In fact, Zedillo was unable to pass exactly this type of reform through the legislature in the 1990s. See
Heredia (2002).

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Jon Bischof

Why Budget Institutions Cannot Control Government Spending

have generally not established extensive social programs, than more developed countries.
Compensation of employees accounted for over 30% of the Nicaraguan and Guatemalan
budgets in 2003 and over 40% in Costa Rica, the Dominican Republic, and El Salvador.14
In most other countries in the region this component was around 20% of the budget (World
Bank WDI).
Finally, significant portions of spending that should theoretically be flexible can be made
rigid by legal or constitutional spending floors and revenue earmarks. Some laws actually
require spending to increase to a certain level far above past outlays or to increase at a
certain rate. These restrictions force the government to allocate a certain portion of the
budget to a specific program or sector and remove a large portion of spending from the pool
of resources that can be modified during the budget process.
Health and education spending are the most common targets of this protection, and
examples are legion in Latin America. In Argentina, the Education Finance Law (Law
26,075) requires education, science, and technology spending to increase to 6% of GDP by
2010; in order to meet this goal, the government had to increase education spending by
17% between 2006 and 2007 (CIPPEC 2006: 14-15). In Ecuador, the constitution requires
that 30% of government expenditures be destined for education, while the rate of increase in
health care expenditure cannot fall below the rate of increase of overall expenditures (World
Bank 2005: 54). The Social Development Law in Mexico prohibits social spending by the
federal government from declining in real terms from year to year. In addition, the General
14

Costa Ricas inclusion in this group is surprising, but their spending on payroll was one of the highest
at 43%, a number that I have confirmed with other sources. It may be that much of their social spending is
off-budget.

15

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Why Budget Institutions Cannot Control Government Spending

Education Law compels the state to spend the equivalent of 8% GDP on education, 1% of
which must be destined toward scientific research and technological development (Echeverry
et al. 2006: 85-87). Brazil is one of the most notorious cases of earmarking since the aggregate
value of restrictions is enormous and written directly into the constitution. An amendment
approved in 2000 required aggregate federal health spending to grow by 5% in real terms
from its 1999 level in fiscal year 2000 and for further yearly increases in line with GDP
growth thereafter. The constitution also establishes a minimum per pupil spending floor for
the first to eighth grades and requires that minimum pension payments to be adjusted by
the same rate as any minimum wage increase (OECD 2005: 28; Alston et al. 2005: 52-54).
The same inflexibility can also be imposed by earmarking specific sources of revenue toward a program or sector. In Ecuador, 15% of oil revenuesthe main source of income for
the governmentare earmarked for various sectoral organizations as well as health, education, and road maintenance. The same can be said for about 21% of tax revenues (Meja
Acosta et al. 2006: 53-56). In Brazil, 18% of taxes are automatically set aside for education
spending, in addition to a special financial transactions tax (CPMF) earmarked for health
care and a contribution from fuels (CIDE) reserved for transportation infrastructure and
subsidies for the energy sector (Alston et al. 2005: 51-54).15 Of course, one cannot forget
the sometimes massive earmarks for transfers to subnational governments that consume a
large portion of revenues in decentralized countries, but this is usually not incorporated into
central government spending figures. Table 3 presents cross-sectional data on the magnitude
15

However, the Brazilian Congress failed to reapprove the CPMF in December 2007, so the provisional
part of its name may finally have kicked in after 13 years.

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Why Budget Institutions Cannot Control Government Spending

Table 3: Earmarked Spending (as a percentage of primary spending) in Selected Latin

American Countries
Country
Earmarked Spending
Colombia
81
Brazil
80
Argentina
60
Guatemala
55
Costa Rica
45
El Salvador
12
Honduras
11
Peru
1
Source: Singh et al. (2005: 34)
of this inflexibility, but these figures include all transfers to subnational governments.16
The consequence of this inflexibility in the budget is highly pertinent to the study of
fiscal rules: by predetermining most of the expenditures according to legal formulas and
earmarks, rigidity undermines the entire logic of the appropriations process. As Wildavsky
(1992: 273) writes in his classic study of the American budget:
Budgeting and entitlement are incompatible concepts. Budgeting refers...to the allocation of limited resources for financing competing purposes. But if budgeting is
supposed to be resource allocation, then entitlement is mandatory resource segregation...Basically, entitlements are about budgeting by additioneach sum for every program added to othersnot budgeting by subtraction, in which programs are eliminated
or reduced, or where more for one means less for another.

Given these rigidities, the prerogatives of the president within the budget process seem
disconnected from most spending decisions. These reservations bring into question the usefulness of the common pool framework in conceptualizing fiscal policymaking, requiring
reconsideration of how fiscal policy is negotiated and how fiscal outcomes can be improved.
16

Earmarked transfers in Peru are larger than what is presented in the table but small overall and offbudget. Echeverry et al. (2006: 121-22) document that 2.4% of revenues collected by the central government
are transferred to the tax administration office (SUNAT) and central bank and another 5% is sent to the
municipalities. The rest of municipal resources are own revenues.

17

Jon Bischof

1.2.3

Why Budget Institutions Cannot Control Government Spending

Should the Dependent Variable Be Surpluses or Spending?

The third major concern with existing studies is the use of fiscal surpluses as a dependent
variable while drawing conclusions about how the rules of the budget process can restrain
excessive spending. Since the surplus is the interaction between two separate (both in time
and in decision-making authority) policy decisions, one cannot distinguish whether the positive coefficient estimated for these rules represents a decrease in expenditures, an increase
in revenues, or some combination thereof. While it could be argued that deficits are an
interesting variable in themselves given their relation to a countrys debt burden, common
pool models attempt to explain levels of spending, not deficits.17
Retrenchment achieved through tax increases would not fit into this framework. For
example, when Brazil under President Cardoso turned around chronic public sector deficits
by increasing the tax burden about 7% GDP over his mandate rather than cutting spending,
OECD analysts (2005: 26-32) worried that this would depress growth and push more workers
into the informal sector, arguing that retrenchment without expenditure reductions was
short-sighted and unsustainable. Furthermore, tax bills are not part of the budget process
and often subject to different requirements for approval. For instance, in Mexico the revenue
law must be passed by both houses of Congress and is subject to presidential veto. The
budget law, however, is considered at a later date by only the Chamber of Deputies. Because
it is not approved by both houses, the president technically does not have the ability to veto
under the 1917 constitution (Weldon 1997: 238-39). Therefore one would have to code an
17

For instance, Weingast, Shepsle, and Johnsen (1981: 645) assume away the deficit implications of spending with a tax system that covers all expenditures.

18

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

entirely new variable to measure the effect of institutional rules on tax law and, by extension,
the surplus. The magnitude of this problem will be tested in the next section when I reanalyze
the empirical relationship between budget institutions and fiscal policy.

Remeasuring the Effect of Budget Institutions

Why does the empirical literature on budget institutions consistently find a positive impact
on overall fiscal outcomes if most spending is not affected by these rules? In this section
I attempt to improve the estimate of the effect of budget institutions by modifying the
dependent variable to reflect the realities of the budget process and the exact claims of
the common pool literature. While it would be difficult to find detailed expenditure data
for all countries and classify each item by level of flexibility, it is fairly straightforward to
address the other concerns laid out in the previous section by using the expenditures of the
budgetary central government as a dependent variable. After respecifying the dependent
variable, I use bivariate correlation plots and time-series cross-sectional data to show that
budget institutions have no effect on spending at any level of government.
The methodology employed in this section has limitations. While the IMFs Government
Financial Statistics is the only source that breaks down fiscal data thoroughly enough to
allow accurate comparisons between countries and across different levels of government,
missing data is a significant problem.18 Given that this study focuses on presidential systems
18

ECLACs (2006) Statistical Yearbook of Latin America, in contrast, has little missing data but uses
different levels of government for each country and only has consolidated central government or consolidated
public sector figures.

19

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

Latin America, the GFS database had complete data for only 15 countries for any extended
time period19 after 1990 (in this case I chose 1997-2000):20 Argentina, Bolivia, Brazil, Chile,
Colombia, Costa Rica, Dominican Republic, El Salvador, Guatemala, Mexico, Nicaragua,
Panama, Paraguay, Peru, Uruguay, and Venezuela. Thus we are left with insufficient degrees
of freedom for cross-sectional analysis.
Therefore, I primarily restrict myself to the simple bivariate correlation plots presented
in the other empirical studies without the accompanying cross-sectional regression. While I
also present panel regressions with robust controls, the fact that budget rules rarely change
over time means that this technique will depress the standard errors and overestimate the
statistical significance of my results. Although both methods produce identical results, future
work will have to employ a cross-regional analysis in order to fully exploit the GFS database.
The results from these simple plots, however, cast doubt on findings that hierarchical
budget rules can restrain spending. Figure 1 presents a bivariate plot between the UNDPs
index of presidential budgetary powers and primary balances for the budgetary central government of the 15 included countries. It appears that, even when restricting the dependent
variable to this narrower definition of government, the relationship between budget rules and
primary surpluses remains strong, with a correlation coefficient of 0.42. However, when the
dependent variable is broken down into primary spending and revenues in Figure 2, there
appears to be a slight positive correlation with primary spending (0.08) and a strong positive correlation with revenues (0.31). This implies that whatever relationship hierarchical
19

An average of several years is necessary to smooth out differences in political budget cycles across the
countries.
20
Although they began data collection in 1973, the IMF changed its coding scheme in 2001 and only
recoded data back to 1990.

20

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

Figure 1: Scatterplot of Presidential Budgetary Powers and Average Primary Balance for
Budgetary Central Government, 1997-2000 (correlation=0.42)

URU

BRA

PAN

DOM
4

CRI

GUA

CHL

NIC

Primary Balance 19972000

PAR

SLV

VEN

ARG

PER

BOL

MEX
COL

10

Presidential Budgetary Powers

18

Figure 2: Scatterplot of Presidential Budgetary Powers and Average Primary Spending (left,
correlation=0.08) and Average Revenues (right, correlation=0.31) for Budgetary Central
Government, 1997-2000

CHL

CHL
20

VEN

16

VEN

URU

10

DOM

NIC

PAR

MEX

18
16

SLV

URU

PER

PAR

BOL

DOM

SLV

14

12

COL

COL

12

PAN

PAN

BRA

CRI

NIC

GUA

CRI

GUA

10

14

BOL

MEX

BRA

ARG

ARG

Primary Spending 19972000

Government Revenues 19972000

PER

6
Presidential Budgetary Powers

10

10

Presidential Budgetary Powers

21

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

Figure 3: Scatterplot of Presidential Budgetary Powers and Average Primary Balance for
Consolidated Central Government, 1997-2000 (correlation=0.45)

NIC

PAN

SLV

CRI

CHL

PER

VEN

BRA
2

Primary Balance 19972000

DOM

MEX
1

COL

BOL

ARG

URU

10

Presidential Budgetary Powers

Figure 4: Scatterplot of Presidential Budgetary Powers and Average Primary Spending (left,
correlation=0.12) and Average Revenues (right, correlation=0.30) for Consolidated Central
Government, 1997-2000

URU

BOL

PAN

COL

CHL

CRI

25

BRA

PAN

CHL
20

Government Revenues 19972000

20

BRA
VEN

VEN

NIC

CRI

BOL

COL

PER

NIC

15

DOM

SLV

PER
15

Primary Spending 19972000

25

URU

MEX

MEX

ARG

SLV

DOM
8

Presidential Budgetary Powers

10

ARG

10

Presidential Budgetary Powers

22

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

budgetary institutions has with primary surpluses, there is no evidence they are associated
with lower spending.
Despite large discrepancies between the two measures, Figures 3 and 4 show almost identical results for the consolidated central government,21 with budget institutions having a
strong positive association with primary surpluses and revenues and a weak positive relationship with primary spending. While I have already discussed why this more expansive
measure is problematic for the study of budget institutions, there does not seem to be any
room for confusion as concerns the relationship of these rules with government spending.
While these contrary findings appear persuasive, unfortunately I have insufficient degrees
of freedom to draw conclusive inferences. Moreover, I have not added any controls to factor
out other economic and demographic explanations of fiscal policy outcomes, creating danger
of omitted variable bias. One alternative is to add a time-series component to the data to
increase the number of available observations. While not unprecedented in this areaone
prominent example being Hallerberg and Mariers (2004) paper on budget institutionsthis
estimation technique is also imperfect. Since budget rules rarely vary over time, it is unclear
whether I am truly gaining more information by estimating how the same rules affect fiscal
outcomes year after year or whether this artificially increases the degrees of freedom and
thus deflates the standard errors. However, because this method will be biased toward type
I error (false positives) and I am only positing a negative result (that budget rules do not
depress spending), this estimation problem is actually working against me. If it is possible to
replicate the negative result from the bivariate plots in this unfavorable situation, it would
21

Guatemala had to be dropped from these plots due to missing data.

23

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

provide strong reinforcement for my finding.

To estimate these models, I use time-series cross-sectional data for the same fifteen Latin
American presidential democracies from 1990 to 2005.22 Using TSCS data involves numerous
estimation problems, which data limitations allow me to address with varying degrees of
success. To correct for differences in heteroscedasticity across panels and contemporaneous
correlation of the error terms, I estimate the coefficients with pooled ordinary least squares
(OLS) and the standard errors with panel-corrected standard errors as recommended by
Beck and Katz (1995).23 Because the panels are unbalanced, I use pairwise rather than
casewise estimation of the interpanel covariances.24 Given that serial correlation of the
errors is a common problem with time-series data, I used Woolridges (2002) test for firstorder autocorrelation in the panels; I had to reject the null hypothesis that there was no firstorder autocorrelation for all three of my initial regressions.25 I correct for this by assuming
common AR(1) correlation within all panels.26 Finally, given the additional degrees of
freedom offered by panel regression, I include an extensive battery of controls from other
papers that use fiscal outcomes as a dependent variable.27
The results from models (1) to (3) exactly match the findings from the bivariate plots.
Budget institutions have a significant positive effect on budget surpluses even after specifying
an extensive set of controls. But when the surplus is broken into primary spending and
22

The exact country years included in these regressions can be found in Appendix B.
For replication purposes, this technique can be performed with the Stata command xtpcse.
24
This is the pairwise option in Stata for xtpcse.
25
This was performed with the Stata command xtserial. (This command does not come with Stata.
Type findit xtserial to download this command into the program.)
26
This is the corr(AR1) option in Stata for xtpcse.
27
Summary statistics and definitions for all variables can be found in Appendix B.
23

24

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

Table 4: Panel Regressions for Budgetary Central Government, 1990-2005

Presidential
Budgetary Powers
Inflation
Financial Market
Development
Trade Openness
GDP Growth
Per Capita
GDP
% Population
Over 65
% Change in
Terms of Trade
Grants
Unemployment
Agriculture
(%GDP)
constant
R2
Obs.

Primary Surplus
(1)
0.50***
(0.14)
0.00***
(0.00)
0.09*
(0.04)
0.04*
(0.01)
0.02
(0.05)
0.00
(0.00)
0.33
(0.20)
0.01
(0.02)
0.00
(0.00)
0.04
(0.09)

1.22
(2.50)
0.24
239

Primary Spending
(2)
0.13
(0.23)
0.00***
(0.00)
0.14**
(0.05)
0.00
(0.02)
0.10
(0.05)
0.00*
(0.00)
0.09
(0.29)
0.00
(0.03)

0.03
(0.13)

8.81*
(3.93)
0.33
241

Revenues
(3)
0.53**
(0.20)
0.00
(0.00)
0.02
(0.02)
0.03**
(0.01)
0.09**
(0.03)
0.00
(0.00)

0.01
(0.02)
0.00**
(0.00)
0.12
(0.07)
0.19
(0.10)
13.02**
(3.16)
0.48
233

Spending First Diff.

(4)
0.16
(0.10)
0.01***
(0.00)
0.08*
(0.03)
0.03**
(0.01)
0.01
(0.04)
0.00
(0.00)
0.32*
(0.16)
0.02
(0.02)

0.05
(0.05)

2.31
(2.60)
0.46
223

*p < 0.05; **p < 0.01; ***p < 0.001. Panel corrected standard errors in parentheses
with common AR(1) correlation assumed within panels.

25

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

revenues, it once again appears that these rules actually have a negligible effect on spending
and a significant positive effect on revenuesthe 0.50% estimated increase on surpluses for
an additional rank of hierarchy is replicated not on the spending side (which has an estimate
indistinguishable from zero) but entirely on the revenue side.
However, before placing too much confidence in the estimates in regression (2), one must
ask to what extent surpluses are comparable to spending levels in time-series cross-sectional
data. A surplus is a flow variable (the amount of debt a country cancels each year), and
it is easy to imagine a country moving from the bottom quartile to the top quartile of the
distribution from year to year. The level of spending as a percentage of the economy, however,
is closer to a stock variable with a large inertial component: it is difficult to imagine
Guatemala (at 10% GDP) and Brazil (at 40% GDP) switching places in the distribution
within any time frame. Therefore, serial correlation of the errors within the panels should
be more severe in regression (2) and make our estimated coefficients less reliable.
To correct for this, I used the first differences in spending (P SP EN Di,t P SP EN Di,t1 )
as a dependent variable in regression (4), which is the increase in spending from year to year.
This variable is closer to a budget surplus analytically and suffers from much less serial
correlation.28 Given the common pool problem identified in the literature, it should be the
case that countries with more hierarchical rules have smaller spending increases from year
to year since logrolling is controlled. However, from regression (4) we can see that countries
with stronger rules actually increase their spending at a faster rate, although this difference
28

Indeed, the Woolridge test failed to reject the null hypothesis that there was no autocorrelation within
the panels (p = 0.38).

26

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

is not statistically different than zero.

Overall, there does not seem to be any evidence that budget institutions are a constraint
on spending. The empirical work in this section, though imperfect, shows that estimates
in previous studies that suggested otherwise were misleading since the dependent variable
did not measure what the budget institutions theory claimed to explain. Why budget rules
would be correlated with higher revenue extraction at all is an interesting question, but
speculation to this regard is beyond the scope of this paper.

Conclusion: From the Budget Arena to the Legislative Arena

In 1980, the Chilean military junta under Augusto Pinochet dismantled the countrys public
pension system and introduced a new, mandatory private sector system with competing
joint stock companies. There had been almost no public debate beforehand, although many
academic experts and officials in the social security administration opposed the reform, in
addition to traditional right wing parties. Those already in the old system were allowed to
remain, but the lower contributions required in the new plan triggered a massive transfer
of individuals to the private system. The new program remains in place today and covers
almost all of Chiles insured (Mesa-Lago and Muller 2002: 690-91). This initiative came
after the military had already dismissed one-third of the countrys civil servants in 1974 and
dramatically decreased the size of government (Larran 1991).
The speed and decisiveness of fiscal reforms under Pinochet is remarkable, but Chile was
not a democracy in the 1980s. Although many democratic constitutions try to streamline

27

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

decision-making authority over government spending by creating a separate, more centralized

budget arena, the introduction of entitlement legislation, automatic revenue transfers, and
spending floors from the congress has pushed the vast majority of fiscal policy back into the
legislative arena. To succeed in this arena, aspiring reformers need more traditional assets
such as popular mandates and strong, disciplined legislative coalitions. When presidents in
democratic countries pursued sweeping reforms, they were forced to rally large legislative
coalitions to draft new laws, pass constitutional amendments, and to delegate decree powers
to them. Some, like Carlos Menem in Argentina, succeeded; others, like Fernando Collor
de Mello in Brazil and Carlos Perez in Venezuela, failed miserably. In order to centralize
decision-making power over welfare programs and subnational transfers in the same way that
some presidents are budget dictators, one would need to create a real dictator. It should
not be surprising, then, that Mesa-Lago and Muller find that the depth of pension system
reform and the strength of democratic institutions are inversely related.
This paper found that off-budget expenditures and obligations created by statute and
constitutional mandate have mostly sidelined the appropriations process in determining fiscal
outcomes. Meaningful fiscal policy overhaul has not been accomplished by tinkering with
individual appropriations demanded by particularistic legislators but by tackling the massive
legal obligations accumulated in the construction of the modern welfare state. As the World
Bank (2003: 76) observed in its study of fiscal policy in Argentina:
Major policy initiatives tend to be taken outside the confines of the budget process...In
fact, Congress main influence on spending is through substantive legislation, not
through the annual budget law...[it does this] by passing laws dealing with pensions,
health care, taxation, and other issues. In both the Government and Congress, budgeting is regarded more as a means of financing ongoing activities than as an opportunity
28

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

to define national priorities and policies.

In conclusion, scholars who want to explain fiscal policymaking cannot ignore normal
legislative politics, which, apart from structural conditions, is one of the most important
factors in explaining variation in policy outcomes. There is already evidence that the process
of pulling policy back into the legislative arena described in this paper is a product of power
struggles between the executive and congress: Huber et al. (2001) find that U.S. state
legislatures are most likely to exercise statutory control over the bureaucracy when there is
divided government. While the president has clear incentives to assert control over policy,
he is likely to face resistance in a democratic system. Furthermore, the very nature of
entitlement spending, which implies enduring social contracts between the government and
various consistencies, has lead most democracies to protect these outlays from the pressures
of the appropriations process. Although the formal rules of the budget process impact some
types of spending, this paper has argued that their ability to explain overall policy outcomes
is minimal.

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Appendices
Appendix A: Coding of the UNDP Index of Budgetary Powers
The UNDP index of the presidential budgetary powers is composed of four separate measures of
executive control:
The first measures on a scale of zero to three the legislatures ability to amend the presidents
proposal. If zero, the legislature can increase or decrease spending without restriction; if one,
it cannot increase spending without finding new sources of revenue; if two, it needs the
presidents approval to do so; if three, it is categorically prohibited from increasing spending.
The second measures how favorable the reversion outcome is to the president if the legislature
fails to pass the budget. If zero, the government shuts down; if one, the previous years version
if enacted; if two, the presidents version is enacted.
The third measures the ability of the president to unilaterally impound spending after the
budget is approved. If zero, he cannot impound funds; if one or two, he can only impound
funds if revenues are less than projected or only for non-earmarked expenditures, respectively;
if three, he can impound funds by decree (without restriction).
Finally, the fourth measures the presidents ability to modify the budget after it is approved
by the legislature. If zero or one, he cannot (but in the former case the legislature can); if
two he can do so with legislative approval; if three, he can do so by decree.
The resulting variable, PRES, has a range from zero to eleven, with higher scores meaning higher
presidential dominance over the budget process.

Appendix B: Variable Summary Information

Country Years included in Panel Regressions: Argentina (1990-2004), Bolivia (1990-2005),
Brazil (1990-1994, 1997-1998), Chile (1990-2005), Colombia (1990-2005), Costa Rica (1990-2005),
Dominican Republic (1990-2005), Ecuador (1990-1994), El Salvador (1990-2005), Guatemala (19902005), Mexico (1990-2000), Nicaragua (1990-2005), Panama (1990-2001), Paraguay (1990-2005),
Peru (1990-2005), Uruguay (1990-2005), Venezuela (1990-2005).

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Jon Bischof

Why Budget Institutions Cannot Control Government Spending

Table 5: Variable Summary Statistics

Variable
PRES
PBAL
SPEND
PSPEND
DPSPEND
REV
INTEREST
GRANT
INFL
FINMKT
OPEN
GDPG
PCGDP
POP65
TRADE
UNEMP
AGR

Obs.
272
241
241
241
223
241
241
239
272
272
272
272
272
272
272
272
266

Mean
6.65
3.42
14.71
12.13
0.17
15.55
2.57
0.55
122.18
35.97
60.68
3.50
5889.05
5.35
4.61
9.96
11.67

Std. Dev.
2.03
3.58
5.83
5.58
3.39
4.82
2.59
1.33
719.08
14.16
33.88
3.75
2421.65
2.36
0.15
4.43
5.83

Min
2.00
-32.26
4.08
1.74
-42.66
4.06
0.01
0.00
-1.17
10.62
13.75
-11.03
2056.75
2.73
3.93
1.60
3.83

Max
10.00
11.29
65.23
65.22
9.07
32.97
25.33
11.92
7485.49
93.66
198.77
18.29
12895.70
13.23
5.24
22.00
27.78

34

Jon Bischof

Why Budget Institutions Cannot Control Government Spending

Table 6: Variable Definitions

Variable
PRES

Source
UNDP (2004)

PBAL

IMF GFS (2007)

PSPEND

IMF GFS (2007)

DSPEND
REV
INTEREST
GRANT

IMF
IMF
IMF
IMF

INFL
FINMKT
AGR
OPEN
GDPG
PCGDP
POP65
UNEMP

World Bank WDI

World Bank WDI
World Bank WDI
World Bank WDI
World Bank WDI
World Bank WDI
World Bank WDI
Political Risk Services
(various years)
World Bank WDI

TRADE

GFS
GFS
GFS
GFS

(2007)
(2007)
(2007)
(2007)

Definition
An index of the legislatures ability to amend the presidents
budget, the reversion or default outcomes in the event of
legislative rejection, the presidents ability to unilaterally
impound spending after approval, and the presidents ability
to modify the budget after the legislatures approval
Revenues less expenditures less interest payments on government debt for the budgetary central government
Expenditures less interest payments on government debt for
the budgetary central government
First differences of PRISPEND variable
Revenues for the budgetary central government
Interest payments on government debt (% GDP)
Noncompulsory transfers received by government units from
foreign government units or international organizations
Inflation, consumer prices (annual %)
Liquid liabilities (M3) as % of GDP
Agriculture, value added (% of GDP)
Imports plus exports (% of GDP)
GDP growth (annual %)
GDP per capita, PPP (constant 2000 international dollars)
Population ages 65 and above (% of total)
Open unemployment in urban areas (% of total labor force)
Change in net barter terms of trade (2000=100)

35