Treatment of State General Budget Depletion

Paper
Presented by

The Board of Supreme Audit/Republic of Iraq

To

The International Consortium on Governmental,

Financial Management's Annual Conference

To be held in

Florida/USA

From May 18 – 22, 2009

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The role of public budget within economic activity:

Public budget can be defined as an anticipatory process and permission for

state revenues and expenditures, usually for a period of one year,
reflecting state economical and social goals. The public budget is seen
from two main aspects: the first one is in terms of accounting where future
expenditures and revenues are estimated and legislated. The second one is
considered as a state device to achieve its economical and social goals. In
other terms it is an expectation of the amounts that can be collected, and
those amounts to be spent by the state to fulfill its political, economic and
social goals for the coming year, conditioned by people consent through
the parliament. Currently, the public budget is of great importance as it
includes political, economic and social dimensions in the developed and
developing countries despite the variations of its political systems and it
became indispensable mean and a governmental device to achieve its
goals. The importance of state budget can be illustrated by:
1- In terms of political aspect, the budget is of great importance,
especially in countries that adopt democratic and parliamentary
system as this system obliges the executive authority to get annual
approval from legislative authority in order the that the
parliamentarians authorize disbursement and collecting revenues.
This means that the budget is subject to permanent control by the
parliament in addition to granting the legislative authority the
opportunity to discuss government program and make the necessary
amendments and changes.
2- In terms of economic aspect, this aspect is not less important than
the political one, as the state adopt expenditure and revenues policy
resulted by state budget effects upon economic activity. The desired
objective is to increase national income and to raise the standard of
living to the members of the community, in addition to the role of
redistribution of national income through the deduction of part of
the individuals' income through taxes and fees, and to be distributed
again by public expenditures whereas their importance is enhanced
whenever the role of the state economic activity is increased.
Through this intervention the following can achieved:
a- Achieve economic stabilization.
b- Reduce or increase aggregate demand.
c- Stop the continued expansion of inflation and restrain it.
d- Address the economic cycle.
3- In terms of social aspect, where it is considered as a tactic of social
guidance. The goods that the state does not desire them to be
consumed by the citizens then it imposes taxes on them, while in
case state desire to increase the proportion of the population

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 growth, it can reduce the taxes on the tax payer according to the
number of his family members.
4- In terms of financial aspect, the public budget is regarded as a mirror
that reflects the financial state activity, since it illustrates the state
resources that have been procured during the next year, as well as it
clarifies the method of spending and identifies the sectors,
ministries and offices that will be spent on, and all that would
enable the state to realize its actual financial position and find
proper solutions in case that it suffers from financial deficit or
surplus.
Amid the world financial crisis, any economist can not bet that there is
one country apart from what is going on in the world economy and the
collapse that results from this crisis.
The world is a small territory, and there are no secrets at all among the
countries. All papers are exposed and no one has a safety card. Therefore,
what has occurred in the United States of America did start today, but it is
a result of a financial manner adopted for years, synchronizes with the
wrongful pump of money and budget depletion.
Yet, the developed countries have huge budgets that are not affected by the
crisis; therefore, these countries are able to deal with the financial crisis,
program their economy and correct certain methods that have been
adopted previously in a bid to recover gradually and be saved from the
crisis.
In respect to developing countries, the various administrations should
pursue an accurate system adhering the principle of accountability and
responsibility in funds disposal with the ability to mobilize the human
resources and available material possibilities to achieve the specific
objectives for each governmental unit within certain mechanism, and to
achieve the maximum efficiency in rendering the inputs to services and
products within specific time framework and accepted specifications as a
minimum level to increase the revenues and economic production and to
compensate the community for lost opportunities and wasted capacities in
the past, that resulted from the actual and diagnosed factors concerning the
financial and administrative corruption without exploiting the human
recourses in optimal way , beside the absence of clear frameworks to
determine the responsibility and the lack of mechanisms acted according
to law in order to question the officials about achievement rates in their
offices in pursuant to the standards of the efficient administration process
and the prudent decision for linking the spending with results and services.
In addition to that, finding added values that achieve real growth and
maintain the public assets from misuse, abuse and loss and avoiding
depletion of public budget in new assets, which would not be in need if
the existing assets are reformed and used properly. Undoubtedly, these
policies will decrease the pressure on budget and assist in shrinking the

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unemployment and improve the balance of trade by decreasing the
dependence on imports.

Emergence and development of public budget in Iraq:

The public budget preparation, approval, execution and constitution-based

control system passed through several phases, the first of which coincided
with the establishment of the national governance, where Iraq's first
budget came along in 1921 pursuant to the General Accounting
Fundamentals Law of 1911 and the regulations of both the British
Mandate Authority and Interim Iraqi Government. By the issuance of (The
Authority System on Financial Issues) No. 1715 of 1924, the provisions of
budget preparation, execution and control became derived from this
System along with the aforesaid Law. Following this phase, Iraq's Statute
(the Constitution) was enacted in 1925, which addressed in (Chapter 6) the
financial issues, the public budget governing rules, the requirements of its
approval, the way of controlling these issues and rules by the Parliament.

The status of the Iraqi budget continued up until the issuance of the Law
of General Accounting Fundamentals No. 28 of 1940, which superseded
the Statute and the Authority System on Financial Issues, although the
annual law of the Iraqi budget included a number of provisions organized
the budget execution and occasionally the disbursement and commitment
related powers. The Law defined, according to Article 2, the public budget
as being a table contains an estimation of revenues and disbursements
during one fiscal year to be identified in the budget law. The Law set up
some key mechanisms for budget preparation and was subjected to as
many as 13 amendments resulted in having it developed and updated till
the Public Budget Law No. 107 of 1985 was issued, where new basis and
principles were brought to develop the budget and limit the stages of its
preparation, approval and execution. The General Budget Law underlined
the responsibility of the Ministry of Finance, the Ministry of Planning and
the Ministry of Trade as well as the Central Bank of Iraq in terms of
preparing the detailed basis for producing their own budgets along with
their role in this regard. It also clarified the controls of budgets execution
and stated the commitment of each performing party and the responsibility
of the Ministry of Finance during the execution stage. Moreover, it
specified certain dates for presenting the trial balances and final accounts,
illustrated the content of the annual report presented by The Board of
Supreme Audit to The Parliament, and determined the responsibility of
any facility, institution and ministry concerned for deviations that may
occur in the budget.

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The Consolidated General Budget Law No. 107 set the state general
budget units in the following two main groups:

1. The centrally-financed government sector budget, which applies the

government accounting system and includes two parts:
a. Current public budget.
b. Investment budget (annual investment program).

2. The consolidated budget of the centrally-financed socialist sector

units, which applies the consolidated accounting system.
The law stated in article no. ( 2 / 1st ,2nd , 3rd ) that the centrally financed
government sector's budget is an allocating, planning budget that includes
all the revenues expected from the financing sources which their
collection is assigned to the ministries, their affiliates and non-ministerial
directorates.
It also includes the approved allocations to be used during the fiscal year
and all the divisions of the budget are subject to the provisions of the
General Accounting Fundamentals Law no. 28 of 1940 (amended) and the
annual public budget law issued yearly annexed with the state public
budget execution instructions.
The said law clearly identified for the public spending units the general
framework of the public budget and the procedures of preparing and
executing it, for its two parts (current and investment), also the external
trade sector and the foreign cash budget.
The said law obliged (in article no. 13) the centrally financed public
spending units, that apply the non- central accounting system, to present
their monthly accounts (monthly trial balances) and the analytical tables of
the expenditures, the revenues, the advances and the trust deposits to the
accounting department in the ministry of finance no later than 10 days
after the end of each month. Article no 14 of the said law stated that the
above mentioned units should present their final accounts (the final trial
balance) for the ended fiscal year to the accounting department in the
Ministry of Finance not later than the end of March of the following year.
This law was in force until issuing the financial administration and public
debt law no. 95 of 2004 by the Coalition Provisional Authority CPA
(dissolved) according to which the stages of the federal budget preparation
was determined as follows:

1. Section no.6 of the financial administration and public debt law

indicated the stages of budget preparation according to economic
development plans, the estimation of this budget revenues depend
on the moderate forecasts of the oil prices, taxes and the other
budget revenues.

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 2. The Minister of Finance issues a report about the financial policy
priorities of the next year for each spending unit in general during
May, this report is to be submitted to the council of ministers for
approval, the Minister of Finance may consult the Minister of
Planning and Development Cooperation concerning these priorities.

3. During June, the ministry of finance circulates the financial policy

objectives, the time table for budget preparation and the levels of
spending to all the state spending units to prepare, in order to
prepare accordingly, estimations of each spending unit.

4. During July, the spending units submit the allocations applications

to the minister of finance and present a copy of the same
applications to the minister of planning and development
cooperation, the applications include the following:
a. Estimation of the next expenses (the next fiscal year).
b. Estimation of the needs of other costs of the operations.
c. Estimation of personnel needs.
d- Revenues Estimation.
The Minister of Finance may consult the Minister of Planning &
Development Cooperation on estimating the revenues and the
proposals related to the allocations of the Federal Budget. In light of
the discussions with the Ministers, the estimated expenses of the
spending unites in addition to any amount in the contingent reserves
will be determined.

5- The Minister of Finance may prepare a proposal to be submitted to

the Council of Ministers to reach a final decision, in case no
agreement is reached during these discussions between the Minister
of Finance and the Ministers responsible for the spending units
concerning the budget project. Any increase in the total spending
limit should be based on a proposal submitted by the Minister of
Finance and approved by the Council of Ministers.

6- The Minister of Finance prepares the federal budget draft in

September of each year and submits it to the Council of Ministers
for approval.

7- The budget shall be submitted to the legislative authority for

approval on October 10th.

The Current Situation of State's public Budget

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 A large proportion of the (current & investment) State's public Budget
depends so far on oil revenues, and it is expected that this situation will
continue for the next years as the oil revenues have formed (% 95) of the
public budget revenues, which means the state ability to provide public
services such as health, education and security as well as it's investment
decisions largely depends on the oil wealth revenues as a result of
weakness in the other resources of revenues such as customs, duties and
taxes on wealth and income.

The federal public budget allocations of 2008 amounted ID (86683)

billion distributed to ID (61348) billion for the operating expenses and ID
(25335) billion for the investment expenses with proportions of %70,1 and
%29,9 respectively, the said budget revenues have been estimated ID
(80476) billion with a deficit amounted ID (6207) billion. Regarding the
budget of 2009, the total allocations were ID (69165) billion distributed to
ID (54148) billion operating expenses and ID (15017) billion for the
investment expenses with proportions of (%78,3) and (%21,7)
respectively, with a deficit amounted ID (18757) billion is covered by cash
carried forward from the previous years' budgets that have not been
disbursed.

That means a huge waste in using the resources of which are disbursed
on the consumption goods and avoid thinking on reforming the economic
situation in Iraq, if this approach will be followed continuously in the
planning where the investment budget contributes with the little part, then
this will lead to inability to promote the Iraqi economy. Moreover, the
budget has been planned with a deficit (%9) and (%27, 1) of 2008 and
2009 respectively, which leads to the financial resources depletion
including the reserves of the Central Bank of Iraq.

Budget depletion sources:

1- Operational expenses:
a) The state’s responsibility for Provisioning of ration items
which became a public vested right to the extent that the
government was unable to call for the importance of
dispensing with this kind of contingent way of life. The total
share of ration allocation in 2008 budget was 6985 billions ID
and 4200 billions ID in 2009 budget, i.e. 11.3%, and 7.8% of
the total operational expenses respectively.
b) The conditions Iraq experienced, led to allocate a large part
of its resources to pay for the compensation of Kuwait ware,
and for external public debt service, incurred on Iraq due to
the aforementioned conditions. The total amounts allocated in
2009 budget for Kuwait war compensations, foreign loans

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 profits, restructuring external debts according to Paris Club
agreement, restructuring debts of non-Paris club agreement,
as well as auditing fees, tracking funds outside Iraq and UN
Oil for Food program reached ID (2572) billion that forms
3.7 % of the total expenditures.
c) Tax cut and custom abolition, as well as lifting industrial and
agricultural protection contributed mainly to reducing
economic growth in all production sectors and as such Iraq
entered a swirl of stagnation, shrinking of job opportunities,
rise of unemployment, accelerated poverty rates, and slump
of production rates in industrial, agricultural, and service
sectors. The most notable index in this regard is the decrease
of agricultural activity growth rate by 6.1% in 2008; for
example, the areas expected to cultivate wheat decreased by
12% in 2008 compared to 2007; also the productivity of the
standard unit of arable land (1/4 hectare) decreased by 18 %.
Moreover, Iraq imports 80 – 90% of its consumer goods, the
rate is higher for investment goods; unemployment is
estimated by 17 – 20 % in addition to disguised
unemployment.
d) Poor electricity services led to import power and power
generating requirements. The total expenses of importing
electricity power reached 378.5 billions ID, and the cost of
fuel imported for power plants was 807 billions ID in 2008
budget; while in 2009 budget power import costs are 568
billions ID, and power plants fuel costs are 600 billions ID.
These figures constitute 1.9 % and 2.1% of the total
operational expenses in 2008, and 2009 respectively, and this
forms an important element of public expenditure depletion.

2-Investment Expenditures
a- Budget preparing stage
The budget preparation and execution process was accompanied with
many deficiencies since 2004 either in the stages of establishing
investment budget, approving the infrastructure projects, or in the stage of
financing, executing and follow up, in addition to the valid database of
projects carried out by Iraqi side, or American Contract Office or by donor
countries. These defects can be shown as follows:

First- selecting investment projects by spending units and unifying them

on ministries level is done on package of needs and not conducted
on a sound bases related to the general economic indicators, as
well as estimating projects coasts and making economic and
technical feasibility studies due to the lack of specialized and

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 efficient staff and not selecting the projects based on economic
and social priorities , moreover the lack of coordination between
the ministries as for specifying site locations, eliminating legal
and physical obstacles and providing the operational services for
the projects after being accomplished.

Second- Not documenting and listing the executed projects or the ones to
be executed by the donors as there is no precise documentation to
such projects in the sub administrations affiliated with the ministry
or even at the ministries to be taken in consideration when
selecting such projects and the absence of Iraqi rule in identifying
projects priorities according to comprehensive plan.

Third-There are many parties to identify the projects and there is no

coordination with each other, so while the concerned ministries
are planning for investment projects geographically distributed all
over the provinces, the provincial councils are planning for
projects on there own point of view without coordination with the
concerned ministries, which effected negatively financing and
implementing these projects.

B- Implementation and Financing Stage

There were many defects in budget financing and executing process
indicated by the Board of Supreme Audit as follows:

First- A low rate of Implementation for investment projects was indicated

during this year despite providing allocations and finance as a result
to projects maladministration which caused the annual allocated
funds to be frozen.

Second- Despite the low rate of Implementation and frozen accounts, the
public expenditures units administration conduct a reconciliation for
the unspent financial allocations by the end of financial year and
charge them as a final expenditure through accountant transactions
in the financial records against no actual spending on the projects at
the same financial year, so virtually the funds were not spent and
more funds will be added for the same projects next year although
not all financial allocations were spent last year, therefore big
amounts are being frozen at the public spending units without actual
achievement at the projects which led to the lag of economic growth
rate, while those funds were used for operational aspects which
exceeded the allocation.
Third- The shortage and inefficiency of the technical and accounting staff
which implement investment projects, was reflected on the

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 credibility of the contracting companies' demands against the
projects they accomplished.

Fourth – There were serious violations of the rules and instructions that
control contracting procedures which made it easy to manipulate
and not to compete as complied with the laws, and those violations
were as follows:

1- Overstating the estimated coasts of the bidding projects.

2- Not fully committing to the procedures of public tenders in terms
of publishing, studying, and analyzing bids technically,
financially and legally
3- Not receiving sufficient guaranties from the contracting
companies according to the valid instructions.
4- Awarding contracts to the contracting companies despite they
were lagging and poor implementation of previous projects
5- Multi financing and implementing similar projects within
provinces development projects by provincial councils and sub
offices in the provinces affiliated with the ministries
6- Maladministration of funds by the ministry of Finance as the
actual achievement of the projects and their contribution in
infrastructure reconstruction not corresponds with the cash flow
from MoF to the spending unites
7- There are large frozen funds at the Iraqi Trade Bank and the
corresponding banks concerning to letters of credit to import
investment projects implementation necessities for many years
due to maladministration of the letters of credits by the
beneficiaries

C – Follow up stage:
Logically, the implementation of investment projects follow up covers the
below mentioned aspects, but actually it was not applied:

First – Verifying the actual achievement of the projects and if it is

appropriate with allocated funds

Second - Checking accomplishment stages in accordance with the time

tables approved by the Ministry of Planning and Development
Cooperation.
Third: Verifying authenticity of documentation and recording of the
financial spending at project level, these data issue from public
spending units to central party in the concerned ministry and
Ministry of Planning and Developmental Cooperation to be taken

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 into consideration upon approving the investment budget for the
next year.
Fourth: Inventory and documenting the projects executed by donors to be
taken into consideration upon preparing the investment budget.

The financial phenomenon and challenges of 2009 and the subsequent

years:
A- Insufficiency of oil revenues that cover the expenses of public
budget.

B- The high operational costs in addition to surplus and huge limpness

in the state structure.

C- There lack of flexibility in economizing the operational costs.

D- There lack of necessary resources for investment expenditures by

2010.

E- Continuity of supporting state companies, providing free services

and social subsidies in perpetuity to decrease the poverty.

F- Retardation of public financial management in budget preparation,

execution, reports and information systems.

G- The tax system is weak in terms of bases, diversity and collection

efficiency.

H- The separation between public budget and its economic and social
functions with absence of national strategy and identifying
priorities, besides there are no sectors' strategies.

I- The current deficit of budget would deplete all surpluses and

government reserves of 2010 if the oil prices remained at its current
levels.

Mechanisms and proposed solutions to tackle the budget depletion

1- Financial solutions

A- Enhancing the tax revenues through:

First- Broadening the tax base.

Second- Diversify taxes

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 Third- Imposing local taxes, according to the province under the
valid laws, to decrease the dependency on central
government's budget.

Fourth- Developing the efficiency of tax body and tax collection.

B- Developing of fair prices policies for public services (water,

electricity, telephone, etc.) and activating its collection
mechanisms.

C- Updating the public financial management in terms of

preparing, executing and following up the budget and financial
reports to improve the performance level through:

First- Pursuing the functional and geographical classification for

the budget.

Second- Defining financial ceils for the economic sectors

according to priorities.

Third- Merging funds financed by donors in the state budget.

Fourth- Improving cash management procedures with follow up

the unused balances in bank accounts for spending units.

2- Economical solutions

A- Contribution of foreign investment in manufacturing industries

for the productive projects such as: oil refineries, power
generation stations and number of service projects of high
technology.

B- Encouraging local investment in agricultural sector, provide

facilities, and support agricultural production needs

C- Encouraging the investment in tourism and transportation

sectors.

D- Activation of the Investment Act in a way that ensures

transferring the modern technology and technical expertise to the
country.

E- Accelerating the issuance and activation of hydrocarbon law.

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 F- Issuing a special legislation concerning (privatization of public
sector's projects), provided that it includes privatization patterns
that match with the nature of economic activity with necessity of
forming commissions for organizing, supervising and control
over these projects.

G- Accelerating the determination of self-financed companies that

have financial problems and ceasing the financial support for
these companies from the state budget.

H- Establishing joint venture investment companies with certain

rate of government participation to absorb the surplus of human
resources in the state institutions and companies and assisting
the state budget, in the future, with tax revenues imposed over
the profits of these companies.

I- Emphasizing on activating the role of specialized banks

(agricultural, industrial and real estate) according to each work
scope.

J- Activation the role of National Investment Commission and the

General Directorate for industrial Development in respect of
identifying the investment priorities through making an
investment map and considering that as a guide for both of the
state and the local and foreign investor.

3- Other solutions

Represented by decreasing the dependency on one source of revenues

by finding alternatives such as:

A- Gas alternative

Gas represents energy with dimensions that has not been fully
exploited like oil, yet the future aspiration implies the recognition of
its importance. Some specialized studies indicate that natural gas
contributes by 23% of the total domestic energy consumption; and
its share is expected to double in the coming years. Moreover,
studies refer that gas is defined in certain countries as a commercial

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 product, so it would possibly easy to monopolize and Iraq is one of
these countries.

B- Religious tourism
Iraq is one of the most important Arabic and Islamic countries in the
field of religious tourism where its land contains sacred shrines for
Muslims and the remains of many non-Muslim like Jews, Christians
and others. Large number of Arab and foreign countries pilgrimage
to these shrines. In a specialized study on the proceeds of religious
tourism, this field study proved that these proceeds may exceed the
proceeds of oil, if not parallel to it. Their proceeds, whether by
foreign or local currencies, constitute an important figure in the
formation of complementary alternative to oil revenues, so it can
reduce the burden of spending.

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