V CONFERENCE EUROSAI - OLACEFS (Lisbon 10-11 May 2007)

V CONFERENCE EUROSAI - OLACEFS (Lisbon 10-11 May 2007) STATE BUDGET CYCLE AND ACCOUNTS IN ITALY: TRADITIONAL AND INNOVATIVE PROCEDURES AND CORTE S INVOLVEMENTS TO SECURE FISCAL SUSTAINABILITY AND ACCOUNTABILITY CORTE DEI CONTI ITALY

SUMMARY 1. THE STATUTORY FRAMEWORK GOVERNING THE ITALIAN STATE BUDGET AND YEAR-END ACCOUNTS 1.1 THE CONSTITUTIONAL PROVISIONS 1.2 STATUTE LAW 1.3 THE STATE BUDGET a) fiscal year b) management principles c) accounting system 1.4 THE LEGISLATIVE INNOVATIONS INTRODUCED IN THE NINETIES: THE BASIC BUDGET UNIT AND THE ADMINISTRATIVE LIABILITY CENTRE 1.5 LEGISLATIVE INNOVATIONS INTRODUCED IN THE NINETIES: COST ACCOUNTING BY COST CENTRE 1.6 THE STATE FINANCIAL STATEMENTS 2. THE CONTROL OF STATE BUDGET EXECUTION 2.1 THE EXTERNAL AUDIT SYSTEM 2.2 THE INTERNAL AUDIT SYSTEM 2.3 EX-ANTE AUDIT 2.4 EX-POST AUDIT 3. NEW DEVELOPMENTS IN THE BUDGET CYCLE 3.1 NEEDS AND IDEAS FOR FURTHER INNOVATIONS 3.2 COURT S GROWING INVOLVEMENT IN THE ASSESSMENT OF THE FISCAL SUSTAINABILITY OF BUDGET AND OF THE ACCOUNTABILITY OF ITS RESULTS 2

1. THE STATUTORY FRAMEWORK GOVERNING THE ITALIAN STATE BUDGET AND YEAR-END ACCOUNTS The approval, structure, timing, principles and the rules for managing and conducting the ex-ante and ex-post audit are governed by the Italian Constitution and by statute, with the details determined by government regulations. Legislative innovations recurrently introduced in the last 30 years have aimed at improving procedures and mechanisms to ensure fiscal sustainability, with particular regard to complying with the specific indicators established by the European Union (budget deficit lower than 3% of GDP and debt/gdp ratio tending to being not higher than 60%). 1.1 THE CONSTITUTIONAL PROVISIONS The Italian Constitution provides that Parliament shall enact specific legislation each year to approve the budget and the annual accounts submitted to it by the Government. The Budget Act and the annexed Finance Act are required to be approved before 31 December of the year (n-1) prior to the year to which the budget refers (n), while the Act approving the year-end accounts is normally approved by October of the following year (n+1). 1.2 STATUTE LAW The statutes governing the State accounts, namely all the provisions governing the recording, management and auditing of State property, together with the resources and the expenditure for achieving its many purposes, dates back to the creation of the Kingdom of Italy (1861), but the basic principles still apply today, even though the legislation has been thoroughly innovated over the past 150 years. The most recent innovations date back to the Nineties, which gave the budget a modern structure and modern rules for managing it in line with (a) the demand by taxpayers to know how and to what extent the money transferred to the government has achieved the purposes for which it is intended, and (b) the need to make the structure of the budget and the State accounts compliant with the European Accounting System (SEC 95 = European Account System EAS). 3

However, the restructuring of the budget was only one phase in a comprehensive process of renewal that has affected four fundamental aspects of the work by every organisation, including government departments: planning, management, audit and the production of the financial statements. 1.3 THE STATE BUDGET The main features of the Italian State budget may be summarised as follows: a) the fiscal year: 1 January - 31 December. With the enactment of the Budget Act Parliament not only adopts the budget for the year (n) but also the multi-year budget covering three fiscal years - (n), (n+2) - of which the second and the third are limited to the principal revenue and expenditure aggregates. b) management principles: completeness, publicity, balance, universality, gross accounting, uniqueness, specification (in terms of functions and objectives), annual budgeting and transparency. In particular, applying the annual budgeting principle, the law permits capital investment expenditure to use the appropriations for year (n) in the following years up to (n+3). c) accounting principle: the accrual-based approach. The budget is managed on an accrual basis (or rather a 'modified accrual basis' taking account of the particular requirements for managing the budget due to the particular characteristics of Italian legislation). With the Budget Act, Parliament also approves a cash-based budget in order to direct cash flow management. The year-end financial statements are drafted in conformity with the budget, and are managed using an accrual basis accounting system, and also indicates cash flow management. 1.4 THE LEGISLATIVE INNOVATIONS INTRODUCED IN THE NINETIES: THE BASIC BUDGET UNIT AND THE ADMINISTRATIVE LIABILITY CENTRE The most important and significant changes and innovations introduced during the Nineties into legislation governing the State budget concern, as already mentioned, its structure, which is currently designed to better match the actual governance of the economy and public finances, and particularly to comply with the community stability and growth commitments stemming from the Maastricht Treaty (1993) which are common to all the 15 member countries of the European Union. 4

The budget is broken down, on both the revenues and the expenditure side, into basic budget units which are established in such a way that each unit corresponds to a single administrative liability centre which is responsible for managing the human, financial and capital resources connected with a given activity or service provided by the public administration. This breakdown strengthens the principle of the liability of the executive officers responsible for managing the budget unit, and it encourages scrutiny of their work and the assessment of performance in relation to objectives. Innovation in budget structure has been paralleled by the administration s reform based on the implementation of two fundamental principles: 1) clear distinction between political and administrative responsibility; 2) management accountability attributed to single administrative liability centres. Clarity of roles leads to clarity for accountability: each liability centre is accountable for the entire management cycle and related results, thereby overcoming the traditional difficulties to identify who had to be considered to be accountable for what. 1.5 LEGISLATIVE INNOVATIONS INTRODUCED IN THE NINETIES: COST ACCOUNTING BY COST CENTRE In order to appraise the economic and financial performance of expenditure management and analyse and appraise public policy, the legislation enacted in the Nineties also introduced a cost accounting by cost centre system to be applied throughout the whole of the government service. The purpose of this system whose implementation is still under way - is to record, analyse, check and monitor costs, performance and the results of administrative activity. It also should make it possible to adopt efficiency and effectiveness cost indicators as parameters for appraising the results achieved by the executive officers responsible for managing the basic budget units. 5

In short, the basic budget unit is an 'expense centre' which shows the financial result of the management; the 'cost centre' records the same data from the economic aspect of the actual use of the resources during the period under consideration. The cost centre must therefore be defined consistently with the administrative liability centre responsible for managing the basic budget unit. Furthermore, the 'cost centre' innovation is a useful tool both for drawing up the budget and for the internal and external performance audit. From the former point of view, cost analysis will enable the different government departments to perform effective self-auditing and correctly allocate the resources when filing the draft budget. From the point of view of the audit, this intends to make it possible to constantly compare budget data with actual out-turn, and to correlate this to the objectives being pursued by the executive officers responsible for budgetary management. Lastly, the cost centre system necessarily involves the drafting of a 'chart of accounts' comprising all the items identifying the use of resources generating a cost to the public administration. The chart of accounts makes it possible to build and structure the 'cost centres' on two different levels: (a) the first is the fact-finding and decision-making level for Parliament and Government, based on aggregate cost analyses at Directorate- General level; (b) the second, more detailed, level is for management and internal audit requirements of individual government departments. 1.6 THE STATE FINANCIAL STATEMENTS The State financial statements comprises: a) a 'financial account' setting out the income and the current expenditure and capital expenditure items during the course of the year; b) a 'balance sheet' setting out the assets and liabilities of a financial and patrimonial nature at the end of the year; c) a table reconciling the financial account and the balance sheets. The financial statements are drawn up by the Ragioneria Generale dello Stato (General Accounting Office) - a department of the Ministry of economy and finance - and submitted to the Court of Auditors for certification by May the following year. The Court issues its assessment of the regularity of the financial statements and on their conformity with the accounting records. This is done before the end of June at a special public hearing of the United Chambers of the Court. 6

2. THE CONTROL OF STATE BUDGET EXECUTION In the public sector, auditing plays an essential role in retaining confidence in the sound management of public expenditure and in those who are responsible for it. Auditors are also required to perform their functions independently, objectively and efficiently, paying due consideration to the needs of the departments they are controlling. 2.1 EXTERNAL AUDIT SYSTEM In Italy, external control of the execution of the State budget has been a function performed by the Court of Auditors ever since it was instituted in 1862, and which was confirmed and further enhanced by the 1948 Italian Constitution. For over 130 years, until 1994, the Court carried out the same type of audit of the State accounts: an 'a priori', or 'ex-ante' audit of all the acts of government departments (about five million a year at the beginning of the Nineties) which was a typical regularity or compliance with the law audit. When the law reforming the public administration began (1991) the Court of Auditors, in the annual reports submitted to Parliament, urged the legislator to take action to implement a reform of the audits consistently with the reform of the administration. The renewal of the public administration not only makes it necessary to reform the Budget Act and the accounts structure (budget and financial statements), but also entails a new configuration of the audit functions, particularly those vested in the Court of Auditors as the supreme body responsible for conducting the external audit of the public administration, and for assisting both the Government and Parliament. In the past few years, the Court has therefore undergone a radical renewal, in which its audit function in particular has been redesigned. Firstly, ex ante audits have been sharply reduced and only retained for a limited number of particularly important government acts of major institutional relevance; and at the same time it has been made generally responsible for the ex post audit of public accounts, not only of central government departments, but also of regional governments, local authorities and other autonomous entities and institutions. The Court has therefore strengthened its central position within the audit system and in the overall organisation of the administration, making it an impartial guarantor of the economic and financial equilibrium of the public sector, and in particular of the sound management of public resources in terms of effectiveness, efficiency and cost-effectiveness (value for money audit). 7

The legislator also strengthened the independence of the Court by giving it broader autonomy from the point of view of its organisation, finances and accounting. The outcome of the Court's audit is the issue of the certification of the central government financial statements based on an analysis made during the course of the financial year regarding the regularity of the revenue and expenditure procedures and sound compliance with accounting principles. To carry out the audit of the central government budget management, the Court uses computer technology. This use of computer technologies has enabled the Court to draught a report, to complement the certification document, to provide Parliament with information on various major aspects of central government expenditure management which are relevant to policy decision-making and to public opinion. These include: - analysing the overall out-turn of the public accounts (central government sector and the consolidated accounts of the public administration) in the framework of the macro-economic compatibilities laid down by the European Union; - analysing the process of implementing economic policy measures, and their economic and financial impact, implemented in the budget; - examining the adequacy of the funding available to cover the expenditure incurred by new legislation; - appraising the results of sectorial government policy. The results all of these auditing activities are summarised in reports which are then laid before Parliament. 2.2 THE INTERNAL AUDIT SYSTEM The statutory innovations introduced into public administration of the Nineties also, and consistently, affected the reorganisation and upgrading of the procedures and instruments for monitoring and appraising costs, performance and the results of the activities of the public administration. In 1999 new general principles were laid down, structuring the internal audit around four types: a) Compliance/regularity audit: to guarantee the legitimacy, regularity and soundness of the administration. b) Performance or value for money audit: to ascertain the effectiveness, efficiency and cost-effectiveness of the administration in order to optimise the relationship between costs and results. c) An assessment of the executive officers: in order to assess the performance of the executive grade personnel. 8

d) Strategic control and evaluation: to appraise the adequacy of the decisions adopted for the implementation of the plans and programmes in terms of the consistency between actual outturn and the set objectives. Different structures were made responsible for these controls, whose constitution, tasks and hierarchal dependency were established by law. The Court of Auditors may also use the findings of internal audits in the performance of its own external audits. Furthermore, as an external auditor, the Court ascertains the adequacy and the effectiveness of the internal controls (carrying out a systems audit). 2.3 EX-ANTE AUDIT Even though, as mentioned earlier, the ex-ante audit by the Court of Auditors has been reduced, it is still important to the work of the Court. This audit is performed on: the most important measures and administrative directives issued by the government, such as the programming documents, instruments implementing European Union legislation, and measures allocating and distributing funds. the most important supply contracts and awards of tenders; measures taken in relation to State property. orders issued by the Minister of the Treasury relating to the State budget (variations, short term debts, etc). Apart from the subject-matter, what should be emphasised are the main characteristics of the ex-ante control performed by the Court: a) Type: the audit of legitimacy, in other words the statutory compliance(including the Budget Act) of the instruments and measures. No assessments are made as to the merits of the measures, which are political and/or administrative decisions. b) Formal aspects: when the Court has ruled the measure lawful it applies a 'visa' to clear the measure. If the Court rules that the measure is not lawful, it withholds clearance and it must give a reasoned explanation for so doing. c) Substantive aspects: the measure subjected to audit by the Court becomes effective and put into force only after the 'visa' clearance has been issued. d) Timing: the Court has a maximum of 60 calendar days from the date on which the measure is received to carry out the audit. No account is taken of time needed for the administration to respond, but this may never exceed 30 days. e) Government initiative: if the Court of Auditors has declared a measure to be unlawful and has refused to give it clearance, the government may issue a 9

resolution requesting the Court to 'clear' the unlawful measure. f) Guarantees: this request, which obliges the Court to issue 'qualified clearance' to a measure which it deems to be unlawful', is perfectly consistent with the theory (and in Italy with the practice) of an audit which, while retaining the features of independence and safeguarding the public interest, may under no circumstances hamper the implementation of the 'political program' for which the government has obtained a vote of confidence in Parliament. This has a 'political' consequence, indicated below. g) Political aspect: the Court must notify Parliament within 15 days of the measures which have been 'cleared' at the request of the government. It is therefore Parliament's task to take the 'political' decision whether or not to ratify the government measure that the Court of Auditors has ruled to be unlawful. For further information here, there are three or four such cases each year. 10

A PRIORI AUDIT PROCEDURE RECEIPT OF GOVERNMENT S DECREE Examination by the Corte s audit office Visa of the Corte s audit office Refusal of visa Letter of observation by the Corte s audit office Government s answer Visa of the Corte s audit office Refusal of visa Examination by Corte s State Audit Chamber Visa of the Corte s State Audit Chamber Refusal of visa Council of Ministries resolution to endorse the Government s decree Decrees examination by the United Audit Chambers Visa of the Corte s United Audit Chambers Visa and registration with reservation Information to Parliament by the Corte s United Audit Chambers Sixty calendar days within which the Corte s audit procedure has to be concluded (not considering the time no more than thirty days for the Government s answer). 11

2.4 EX-POST AUDIT The ex-post audit conducted by the Court of Auditors takes two forms: 2.4.1 recurrent/mandatory audits: this audit deals with the following: - state financial statements, which the Court is required to certify for the accuracy and completeness of the accounting results set out in the balance sheet and financial account. Together with the certification, the Court grants and submits to Parliament a wide-ranging report on the audits and inspections conducted during the course of the year on different Ministries, and the assessments of the Court regarding the macro-economic aspects of government policy. - civil service staff costs - the university systems; - the state of public IT; - the off-budget revolving fund management; - elementary education. The results of all these audits are submitted to Parliament in separate reports. 2.4.2 programmed audits: this kind of audit is based on annual programmes resolved by the Central Performance Audit Chamber of the Court (or by the Regional Chambers for audit programmes concerning regional and local governments and administrations). Lastly, it should be emphasised that in addition to certification, the ex-post audit is essentially a performance or value-for-money audit, which is based on the principle of 'collaboration' (not punishment) with the government department being audited. This kind of audit is designed to underpin the political scrutiny of the government department being audited, and to propose corrective measures for introduction by the organ of the administration to guarantee its regular and cost-effective management. 3. NEW DEVELOPMENTS IN THE BUDGET CYCLE 3.1. NEEDS AND IDEAS FOR FURTHER INNOVATIONS The last years experience points at growing difficulties for parliamentary approval of the finance law related to State budget, owing to two main causes: 1) the overload of tasks and expectations placed on the financial manoeuvre both in the phase of its drafting and of parliamentary discussion, amending and approval; 2) the lack of an organic discipline of fiscal federalism, i.e. of relationships between State and autonomous territorial entities which manage large and 12

growing shares of public resources and whose cooperation is therefore increasingly essential for respecting European Union obligations. In other terms, planning and control of State budget alone are not sufficient to ensure fiscal sustainability and accountability as this budget relates only to a diminishing share of public finance. Particular importance, therefore, is attributed to developing an adequate system for monitoring decentralised revenue and expenditure. Even more than with inadequacy of regulations and procedures, major difficulties, however, mostly have to do with behaviours which have lied dormant a long time. And behaviours are more difficult to be corrected than regulations. As rules are concerned, substantially agreed lines for innovation include, among other measures: a)a more compact and simplified finance law, made of few articles, as well as the formal involvement of regional and local governments already in the preliminary works for budget and finance law; b)a new budget structure based on items related to wider missions, to ensure the possibility for both management flexibility and policy monitoring and analysis. 3.2. COURT S GROWING INVOLVEMENT IN THE ASSESSMENT OF FISCAL SUSTAINABILITY OF BUDGET AND OF THE ACCOUNTABILITY OF ITS RESULTS A procedure which, although not established by any law, has become usual, relates to the systematic Court s involvement in the appraisal of the annual Government macroeconomic and financial scenarios and medium term objectives (Document of economic and financial planning) and of the proposals for budget and finance law: the Court is requested by the joint Budget Committees of the Senate and the Chamber of Deputies to comment, prior to parliamentary discussion, on transparency and reliability of data, assumptions and forecasts and on feasibility of budget and public finance objectives. In these occasions, the Court gives its views on the reasonableness of both the projected additional yield from taxes and from other revenue sources and the projected reduction of expenditure. The Court also gives its evaluation on the adequacy of proposed measures to comply with fiscal sustainability as requested by the European Union, considering the situation and the evolution of both the budget deficit and the public debt. The Court makes its evaluations obviously paying attention not simply to the arithmetic of the indicator, but mainly to the courses of the actions planned to make possible its achievement. The less than 3% of GDP indicator for budget deficit, in fact, suffers from its static nature, from its limited scope and from being restrained to the short run and consequently from being unable to help to identify 13

economic risks in the longer run caused by external, but also internal events. Moreover, the single indicator may be the result of radically different policies whose internal and external coherence needs to be checked. In addition, the Court draws attention on the likelihood of changes in the wellestablished behaviour of social, political and administrative actors: an example is the judgement of unlikeness of a reduction in expenditure for public employment in consideration of the systematic past failures in achieving set targets in this area. Apart from the growing involvement in the a priori budget evaluation, subsequent financial and/or performance auditing will obviously continue to be carried out to assess the degree of targets achievement and highlight actual results related to more specific objectives (such as reduction of tax evasion and avoidance, reduction of expenditure for health services, pension plans, public employment, external consultancy, intermediate goods, etc.). This new role of the Court is progressively increasing as a result of two major developments: 1) need for independent and neutral assessments in an institutional context characterised by heated confrontation between sharply split political party alliances, even on the degree of reliability of disclosed information on the situation of public finances; 2) growing demand for a. accessibility to reliable and transparent information on budget contents and issues; b.government and administrative accountability to be secured also by the intervention of public auditors who, being both independent and neutral as well as competent, are capable to regularly and timely provide citizens with the information needed to be able to properly understand the real situation, perspectives and risks of public finance and debt and correctly assess public management results compared with objectives and resources employed. 14