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16 upper-level local governments (7 metropolitan cities and 9 provinces) and 232 lower-level local governments for cities (Shi), counties (Gun) and districts (Gu) (as of 2004). The act also requires local governments to perform local autonomous and centrally mandated affairs (for example, national highway maintenance, for which central and local governments share the costs). The Local Finance Act 1963, as amended provides local governments with autonomous budget procedures and the power to levy taxes within the limit of the law, independently of the central government. Both acts require local governments to prepare balanced budgets. All local government borrowing must be approved by the central government, thus ensuring conservative financial practices by local government (Kim, 2003a).

Various intergovernmental transfers are provided to minimise a large degree of variation between local governments’ fiscal capacity (Hur, 2003; Kim, 2003b).11 For example, while the ratio of local government revenues to total local government spending is more than 94% for the Seoul Metropolitan Government, the ratio is below 50% for more than 80% (194 out of 248) of the local governments (OECD, 2003). A large portion of this fiscal gap is covered by central government transfers including tax sharing and grants. Three laws govern these intergovernmental fiscal relationships: the Local Share Tax Act, the National Treasury Subsidies Act, and the Local Transfer Fund Act (Box 3). Unlike other OECD member countries, there is an Educational Local Share Tax Act 1971. This law establishes a local educational share tax to be used exclusively for expenditures of local education. In addition, the Special Act on Regional Balanced Development 2003 (which replaces the Local Transfer Fund Act and is to be implemented in 2005), establishes a special fund for regional development.

4. Legal provisions for each stage of the budget cycle

4.1. Budget preparation and presentation by the executive

4.1.1. Institutional coverage of the budget

The purpose of the BAA is “to provide for the fundamental legal framework for the national budget and accounting” (Art. 1). The institutions covered by the national budget include the presidential office, the National Assembly, the judiciary, all central ministries, agencies and commissions (Art. 14). Local governments’ budgets are excluded from the scope of the national budget; they are governed primarily by the Local Finance Act. Public corporations are also excluded from the national budget.

4.1.2. Extrabudgetary funds and earmarking of revenues

The special account budgets (currently 22) have their own revenues earmarked exclusively for specific purposes by their establishing acts.

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Box 3. Korea: Major acts governing the fiscal relationship across government levels

●The Local Share Tax Act 1961 as amended: This provides a vertical taxsharing system designed to equalise vertical and horizontal disparities with respect to tax-raising capacities and needs. The Act sets a fixed percentage (15%, but to rise to 18.3% by 2005) of the total national tax to be allocated to local governments. While 10/11 of the total amount is a general transfer, based on pre-defined criteria, a small fraction (1/11) of the Special Local Share Tax is earmarked, i.e. it functions as a conditional grant.

●The Educational Local Share Tax Act 1971, as amended: The Act sets a fixed percentage (currently 13%) of the total national tax to be allocated exclusively for use for investments in education facilities by local government.

●The National Treasury Subsidies Act 1963 as amended: National Treasury Subsidies are matching grants (conditional grants) provided to local governments for specific projects. They are allocated in line with national policy priorities for each economic sector based on annual evaluations of local needs by the central government. They also reflect nationwide objectives that would otherwise not be taken into account in local government decision making.

● The Local Transfer Fund Act, 1990 as amended (abolished at the end of 2004): The Local Transfer Fund is somewhere between tax-sharing and conditional grants and is often called a “block” grant because of its relatively broad objectives. It was introduced to stimulate local capital investment in infrastructure such as road maintenance, farming and fishing development, water purification, and regional development. It is financed by specific shares of national taxes.

●The Special Act on the Regional Balanced Development 2003: The regional development fund, replacing the local transfer fund, will begin to be implemented in 2005 for the purpose of helping develop underdeveloped regions.

Subcategories of special accounts are: 1) government-operated special enterprises (currently five, including the national railroad, the communication service, the government supply and agency operation), 2) government-held and operated special funds (currently one, the fiscal financing special account), 3) earmarked revenues used for specified expenditures (currently 16, including national property management, agricultural and fisheries structural adjustment, military pensions, postal insurance service). The public funds

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(currently 57), which are generally governed by the FAFM,12 also have their own resources, which are to be spent exclusively for specific purposes stated in the individual establishing acts.13 Since the application of the amended FAFM in 2001 and 2003, which requires the National Assembly’s approval of the management plan of all public funds,14 there is less distinction between the special account budget and the public funds because both are now subject to the approval of the National Assembly (Cho, 2004; Koh, 2004). However, public funds still have more autonomy and flexibility in financial management and less scrutiny in the parliamentary approval process than the special account budgets. Therefore, line ministries prefer to establish their own public funds.

The National Health Insurance Fund, established by the National Health Insurance Act, is the only extrabudgetary fund whose budget is not subject to parliamentary approval. All other social security funds, including the National Pension Fund, the Employment Insurance Fund and the Industrial Workers’ Accident Compensation Insurance Fund, are subject to parliamentary approval.

4.1.3. Definition of budget aggregates

The legal framework for the budget does not include definitions for budget aggregates. Until 2003, budget aggregates were calculated ex post, as the sum of ministries’ expenditure. However, a new aggregates system for ministries or sectors was introduced by a State Council decision in early 2004. Spending ministries are now required to prepare their draft budget within the budget aggregates decided by the State Council around April. Spending ministries use the budget aggregate as a binding guideline to prepare their budget request by the end of May, the BAA’s deadline for submitting budget requests to the MPB.

4.1.4. Fiscal rules

The Constitution requires the government to obtain prior approval of the National Assembly for public bond issuances (Art. 58). The government can issue public bonds only up to the limits approved annually by the National Assembly and must return to the National Assembly to get approval for additional borrowing. Apart from this constraint, the government is not bound by any other legally binding fiscal rules such as a cap on the amount of spending or a target for budget deficit reduction.

4.1.5. The timetable for budget preparation and presentation to Parliament

The budget year starts on 1st January and ends on 31 December (BAA, Art. 2). The Constitution and the BAA state the timetable for each major stage of the budget process to be followed by the MPB and line ministries (Box 4). In

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Box 4. Korea: Legal requirements for the timetable for budget preparation and deliberation

●End of February: submission of plans for new and major ongoing projects to the MPB by line ministries (BAA, Art. 25).

●31 March: issue of the budget preparation guidelines, which are approved by the State Council and signed by the President, for the budget preparation for the next fiscal year by the MPB to line ministries (BAA, Art. 25).

●31 May: preparation of the written budget request for revenues and expenditures in accordance with the guidelines and submission of these to the MPB by line ministries (BAA, Art. 30).

●2 October: submission of the budget proposal to the National Assembly (Constitution, Art. 54, requires submission 90 days before the next fiscal year).

●2 December: approval by the National Assembly (Constitution, Art. 54, requires approval 30 days before the next fiscal year).

addition, in order to strengthen the ex ante evaluation process of major new public investment projects since 1999, the implementing decree of the BAA requires ministries to conduct preliminary feasibility studies for roads, railways, airports, seaports and cultural facilities prior to making a budget request to the MPB (Arts. 9-2).

4.1.6. Approval process within the executive

The BAA stipulates several key dates for the approval process within the executive (Box 4). The draft budgets of line ministries are screened for approximately three months from June to August by the MPB. The MPB formulates an aggregate budget proposal on the basis of each written budget request of line ministries. During this process, the MPB reviews the details of individual budget items requested by the line ministries, taking into account past performance, the accuracy of the information, and the potential spending pressures of the projects being reviewed.15 After negotiations and final reconciliation, the draft budget is finalised in late July. For the remaining unsettled projects, the MPB has a series of consultations with spending Ministers to reconcile the conflicts between the MPB and line ministries. Then, the MPB reports the results of consultations to the President and finalises the content of the draft budget. After being officially approved by the State Council and signed by the President, the government submits the draft budget to the National Assembly 90 days before the fiscal year begins.

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4.1.7. Documents to accompany the budget law

The draft budget has five main contents (BAA, Art. 19) as follows:

●General provisions: This provides general guidelines for the national budget, including the maximum amount of national bonds or borrowing, the maximum amount of temporary borrowing, and other matters necessary for budget execution (BAA, Art. 26).

●Revenue and expenditure budget: It is a key component of the budget proposal, which shows the detailed estimates of revenues and expenditures.

●Continuing expenditures: The BAA stipulates the operational procedures for continuing expenditures (Art. 22) when the government needs to make payment over several years, but not more than five years.

●Expenditure to be carried over to the following fiscal year: This is applied where an apportionment of any expenditure is not expected to be completed within the fiscal year due to the nature of the project. The BAA requires such expenditure to be specified in the budget and to be carried over to the following fiscal year with the prior approval of the National Assembly (Art. 23).

●Future liabilities that could be borne by treasury (contract authorisation):

The government is allowed to make contracts for projects in which it is necessary to incur a liability within a given fiscal year. The draft budget must include an estimate for such contracts, which is then approved by the National Assembly (Art. 24).

Medium-term macroeconomic framework and fiscal strategy. The BAA does not require the budget document to include any information on medium-term budget aggregates since the current budget process is essentially geared to a single fiscal year. However, the BAA states that the MPB can make a medium-term fiscal plan to strengthen the efficiency and sustainability of fiscal management (Art. 16). In accordance with this provision, medium-term fiscal plans have been announced since the 1970s. The medium-term fiscal plan, the main contents of which are the overall deficit of the consolidated central government and the fiscal strategy for a five-year period, constitutes informal guidelines, not legally binding limits. Details are not provided on the macroeconomic framework underlying the forecast and on the fiscal aggregates other than the overall deficit.

The BAA does not specify which organisation is responsible for the macroeconomic projections underlying the budget preparations. However, the GOA assigns the MOFE to make projections of the macroeconomic outlook in the process of formulating annual economic policies, with the MPB to provide inputs into that process.16 The budget document contains macroeconomic forecasts only for the budget year. The public does not have access to the

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macroeconomic model underlying those forecasts, nor the key parameters that influence the projections of the fiscal aggregates.

New measures versus existing expenditure policies. The BAA requires line ministries to submit the major new and existing expenditure programmes to the MPB by the end of February (Art. 25). The MPB uses this information as a reference to evaluate the intensity of expenditure pressures for the next fiscal year. However, the budget appropriations do not formally distinguish new measures and existing expenditure programmes even though the MPB includes the list of new expenditure programmes as a reference for parliamentary review.

Performance-related information. The BAA does not require the budget documents to include performance-related information. However, in 1999, some experimentation with performance-oriented budgeting began. In 2004, the MPB issued guidelines for performance-oriented budget information to 26 line ministries or agencies. The selected pilot projects are narrow in focus and are not yet formally integrated with the budget preparation processes. Comprehensive performance reports are not presented to the National Assembly for review.

Tax expenditures, contingent liabilities and fiscal risks. On the basis of a procedure prescribed by the Special Tax Treatment Control Act 1965, as from 1999 the MOFE began to report tax expenditures to the National Assembly. The ratio of tax expenditures, including exemptions and deductions to total tax revenues has been around 13% over the past few years despite the government’s effort to reduce tax expenditures (OECD, 2004). Tax expenditures are mainly made to provide incentives to investment, to smallor medium-sized enterprises, for research and development, and to stimulate the economy.

Information on the total size of government guarantees is required to be reported separately to the National Assembly on an annual basis (BAA). There is no quantification of the likely liability resulting from government guarantees. Other implicit liabilities of the government, for example in the National Pension Service are not disclosed. Nor does law require a statement of major fiscal risks in the budget document.

Other information required by law. The BAA requires the draft budget to include the information set out in Box 5.

4.1.8. Budgets of Parliament and other constitutional bodies

The BAA provides special budget preparation procedures for the National Assembly, the Supreme Court, the Court of the Constitution, and the National Election Commission, which are constitutionally independent organisations. If the requested amount is to be reduced, the MPB is required to hear the