Essay: Budget performance of local government

2.0. Introduction

This chapter presents an overview of the literature that relates to the topic under investigation namely “Budget Performance of Local Government, Indonesia”. This chapter consists of an overview of budgeting process in local government in Indonesia, overview of local government in Indonesia, overview of management accounting, agency theory, accountability, budget as political and managerial dimension, budget and political influence, political institution, budget institution, budget discipline, budget approval and chapter summary.

2.1. Overview of Budget Process in Indonesia

Since Indonesia promulgates the local government autonomy in 2000, some change has been made for the budget system. New fiscal year is established which starts from 1st January and end in 31st December and the new budget system implemented is called performance budget. This new system has three changes if compared to the former system. The three changes consist of changed in the whole budget structure, changed in revenues types, and changed in expenditures discretional allocation. The differences in this structure compare to the former budget systems is additional component of financing. Financing are add up into the budget system in order to accommodate deficit budget which is allowed to implement in this new budget system (Law No. 22/1999). Financing has two functions. The first is to use for implement a matching concept in which revenue has to match to the expenditures within a current year and the consequences are surplus or deficit. The second is to accommodate the surplus or deficit. When the budget is surplus then the local government has ability to invest the surplus to a favorable investment. Similarly, when the budget is deficit then the local government should overcome the deficit through debt raise. Those of decisions related to surplus and deficit are provided within the budget through financing account (Ministry of Home Affair Decree, No.29/2000).

The change in revenue is regarded as the classification of revenue. The first classification revenue is based on the collection responsibility that is local revenue, and intergovernmental transfer. The second classification is based on the purposes of spending, especially for the intergovernmental transfer. Intergovernmental transfer is a specific grant for spending purposes and it depend on local government prerogative, and block grant. Block grant is for spending purpose which is under national program (Law No.22/1999).

The change in expenditure is different to the former budget system. Formerly, these expenditures are classified as routine expenditures and development expenditures. In the new budget system, expenditures are classified as administrative and public expenditures (Ministry of Home Affair Decree No.29/2000). However, since its implementation, the performance budget system has faced twice period of change. The first change started since the promulgation of Ministry of Home Affair Decree No. 29/2000.

In addition, the budget implementation under the new budget performance should be measured using inputs, outputs, outcomes, benefits and impacts. All programs and activities within the budget would be measured not only by the output of the budget, but also the function of the output. For example, spending for road rehabilitation program would be measured not only the number of kilometers that have been rehabilitated, but also the function of the road, and whether or not it is fulfilled the objectives of the program (Ministry of Home Affair Decree No. 29/ 2000).

The second periods in which budget system changed, is due to promulgation of Law No.17/ 2003. It is about Indonesia State Finance, and Law No.33/2004, which is about Indonesia Government Systems as an alteration to Law No. 22/1999. Both of the law (Law No.17/2003 and Law No.33/2004) are basic for the stipulation of all ministry decree so that all ministry decree related to finance and budget should be changed. This includes Ministry of Home Affair Decree No.29/2000.

Following the changes of national regulation, the Ministry of Home Affair Decree No.29/2000 also changed to the Ministry of Home Affair Regulation No.13/2006. The significant changes under this new regulation are related to expenditure classification and performance measurements. The expenditures classification becomes direct and indirect expenditures. Direct expenditures are expenditures that uses for program and activities within the budget, while indirect expenditures is not related to the program and activities such as interest payment, subsidy and grants, allocation for social aids, and another related expenditures based on the local government policy.

There are two types of budget that are main budget (local government budget) and partial budget (local offices and agencies budget). The main budget is the overall local government budget, and the partial budget is an individual local government office or agency budget (Government Regulation No.58/ 2005). Budget formulation goes through the lowest level of local government (village) up to national level. The first stage is called development plan consultation meeting (Musrenbang) which is conducted at the village level with identification of program the village would like to have, usually a small scale infrastructure. The second stage is the meeting at the sub regency level which is larger meeting compare to the first level. This meeting is the first that is attended by local government department heads and/or members of the local parliament and the purpose is to compile the village level meeting results. The third stage is the regency level meeting. In this meeting the various proposals from the sub regency meeting are compiled by the local planning office and discussed at this regency meeting along with the proposals of the local technical offices. This regency level meeting is attended by a large number of people, including local parliament, respected community leaders, academics, and local non government organizations (Law No.25/2004).

The results of all consultative meeting from the first to third stages are expected to be accommodated in the next local budget. According to case study carried out by Asian Development Bank (2007), it is found that because the consultative meeting process is not tied to any allocation, the process in practice results in a wish list, with a very small percentage, if any, of project ideas eventually being funded in that year’s budget. Some local governments are beginning to allocate funds that can be decided upon through this process. Figure 2.1 below shows the annual preparation cycle and the consultative meeting for development planning process.

2.2. Overview of Local Government in Indonesia

Under Law No. 32/2004 on Regional Administration (Article 10), the local governments (province and city/regency) obtained nearly all authorities, except for the following six components that remain under the authority of the national government:

1. foreign policy,
2. defense,
3. security,
4. administration of justice,
5. national monetary and fiscal policy, and
6. religion.

Under this regulation, local governments have broader authority compare to the former system. Table 2.1 provides a list of local government responsibilities according to this law, which includes most service delivery issues related to services to the poor. There are also regulated in this law administration and position of the lowest levels of local government sub-sub regency (Kelurahan), and villages (Desa).

In addition, for the political aspects both the local parliament and the local government can issue their own regulations for conducting some responsibilities to these levels of government. The parliament role has the right to approve local regulation (Peraturan Daerah) and for the local government has the right to establish Head of Local Government Regulation (Peraturan Kepala Daerah) (Law No.32/2004).

Despite the general emphasis on the role of the local government and its new powers, in practice there is still considerable uncertainty and overlap of authority between central and local government. For example, in the education sector, the central government not only prepares the curricula, but it is also involved in school repairs and maintenance projects (ADB, 2007).

Table 2.1 Areas Under the Authority of Indonesian Local Governments

1. Planning and control of development
2. Planning, utilization, and oversight of land use/zoning
3. The conduct of public order and security
4. Provision of public facilities and infrastructure
5. Public health
6. Education
7. Handling social problems
8. Services in the labor sector
9. Facilitating the development of cooperatives and small- and medium-scale enterprises
10. Environmental management
11. Agrarian services
12. Population and civil registry services
13. General government administrative services
14. Investment administration services
15. Conduct of other basic services
16. Other essential matters, as mandated by laws and regulations

2.3. Overview of Management Accounting

It has been argued that management accounting isa neutraldevice of anorganization (Macintosh, 1994). The task of management accounting is to serve management by supplying accounting information and to assist management in performance measurement and in decision making purposes. It should be carried out neutrally,in an unbiased manner, and objectively. However,it is found to be different, in practice since managementaccounting can also be motivated by self interest (Macintosh,1994, Covalevski and Aiken, 1986). Management accounting is also argued to be captive of dominant power groups who see it as a means by which they cannot only consolidate their position of influence but also extend their power base to augment their wealth and power (Markus and Pfefer, 1983).

Since organizations consist of people and organizational subunits which share competitively the use of organization’s resources, powergroups arises which attempt to influence the use of suchscarce resources. Some authors believed (Markus and Pfefer, 1983; Covalevski and Aiken, 1986) that particular and effective way of influencing resource allocation decisions is to do it as unobtrusivelyas possible, such as through the apparently objective mechanism of the budgetary process which tends to legitimate subjective and political decision making processes. Macintosh (1990) pointed out that organizations are driven by a processof bargaining and side paymentsamong coalitions. Decision are not made, they argued, by unitary, rational actors to achieve clear cut goals, but rather, are negotiated settlements arrive at by rival coalitions.

This political view of organizations recognizes organizations as structure of power. Power within organizations can bedownward, upward, and even lateral or sideways (Kaplan, 1984; Markus and Pfeffer, 1983). Power generally refers to the downward power applied by those in formal position andauthority within organizations. Exercising such downward powerleadsto conflict among coalitions. There is an appropriate way for those in organizationsto use power as an organizational weapon to achieve organizational objectives in a desirable way.

2.3.1. Budget in Management Accounting Framework

Traditionally, management accounting has merely focused on technical aspects. There are several reasons why management accounting has tended to develop in such a direction. First, this is because management accountinghas been considered asa toolfor organizations that promote effectiveness and efficiency (Covalevski and Aiken, 1986). This view leads management accounting to focus on the technical aspects of managementsuch as mathematical model of PERT, CPM, EOQ,etc. Covalevski and Aiken (1986) points out that the early theorist of management accounting were fundamentally concerned with practical work, which inform leaders of industry on how to increase productivity, efficiency, and ultimately profits. In addition, development of advanced; technology tends to drive management to look after machines and other fixed assets as primary resources rather than human resources. Automation and computer technology, for example, encourage management to treat machines and other fixed assets as superior topeople. Performance evaluation systems adopted and promoted by management accounting placed prominence on the performance of machine rather than people (Covalevski and Aiken, 1986).

With the further development on management accounting, it was finally realized that the early development of management accounting hadbeen in the wrong direction. Elton Mayo and his colleagues (Covalevski and Aiken, 1986) began to incorporate human aspects as a primary consideration of organizational management. It is believed thatthe success of organizations was not on asingle goal achievement.

Therecentdevelopment of management accounting has been into areas which have broadened its scope (Covalevsky and Aiken, 1986). Agency theory, contingency theory, and behavioral theory have had a significant impact on the development of management accounting (Covalevsky and Aiken, 1986). Agency theory seek to explain the relationship between superior and subordinate as a principal-agent relationship. Contingency theory contributes the view that the design of management accounting systems should not depend solelyonone single aspect butshould incorporate technological, environmental, and organizationalaspects. Similarly,the behavioral view has been taken into account in management accounting research. Gul (1994), and Macintosh (1994) demonstrate how individual differences,cognitive style and personality, influence the decision making processes.

2.3.2. Management Accounting Framework

2.3.3. The Role of Management Accounting

Decision making within an organizations has frequently been associated with the allocation of its resources and achieving the organization’s goals in effective and efficient way (Cokins, 2001). Considering the decision making tasks, management accounting seems tohavea significantrole because management accounting covers at least four purposes. This includes supplying accounting information for internal decision makers, facilitating decision making, motivatingactionsand behaviors in a desired direction, and promoting the efficiency of the organization (Macintosh, 1994).

The development of management accounting hasmainly concerned with supply information and facilitate decision making. Asa result,the development leads to emphasis onthe technical aspect, thus seen as a set of techniques and a neutral device for decision making purposes (Macintosh, 1994). However, considering furtherpurposes,that are to motivate actions and behaviorsina considerable direction, management accounting heightens political aspects of organizations. The need to achieve an integrated approach, conflict and/or consensus due tothe different interests of people or organizational sub units has become a primary consideration of management accounting.

Covalevsky and Aiken (1986) pointed out that the role of management accounting in organizations indicates that accounting can be used as a language ofbusiness. It provides accounting data that can be widely interpreted by the users even if they use different languages. The language function ofaccounting facilitates communication and allows negotiation to be achieved among various activities in organizations.

Managementaccounting has also plays important rationale role (Covalevsky and Aiken, 1986). In management control systems, Anthony, Robert N, Dearden, John and Bedford, Norton M. (1984), show that analysis is used to justify particular decisions, rather than guiding the decisions. Similarly Macintosh (1990) shows that analysis were designed to justify decisions previously taken, rather than as an aid in project selection. Based on the studies above,there are considerable facts that accounting numbers not merely provide a rigid interpretation, but invitejudgment and various interpretations to meet rationalization.

Another political dimension of management accounting in organizationsis the idea of management accounting ascontrol systems (Anthony et.al, 1984; Markus andPfefer, 1983). Management accounting as the control systems plays at least three essentialrolesin organizations. Considering acquisition or exercise of politics and powers management accounting is considered first, as a basis of power in the decision making process; second, a source of power for altering organizational performance through formal organizational structure; and third, as a basis of power for enhancing legitimacy of individuals and organizational sub-units’ activities (Markus and Pfefer, 1983).

Management accounting collect and manipulates information which the used in the decision making (Cokins, 2001), therefore people or subunit within organizations that possessed an ability to manipulate the available information as such, they can determine a certain alternative of choice and also provide the opportunity to increase power. Management accounting role in this contextis based on the maxim that information systems is a basis of power (Markus and Peffer, 1983).

An evaluatingand rewarding system whichisobtained through formalsystem is a source of power (Markus and Pfefer, 1983). A formal evaluationsystem is carried out only ifitobtainsa formal authority. People or groups are able to conduct an; evaluation without any formal authority, yet the result can be ignored until it obtains a formal authority or common recognition. An example of how formal authority can delegate power when a salesman in a marketing department may consider that the production departmentwas inefficient in producing a combination of product (based on transportation method). However, as far as there is no any formal authority delegated to him then hehas nosuchability toexercise thepower. Since management accountingconcernswith the performance evaluation and is a rewarding system through formal organizationalauthority,carrying out these activities entails the exercise of power.

2.4. Agency Theory

Agency theory is a theory that explains principal and agent relationship which stems from economics theory, decisions theory, sociology and organizations theory. Principal-agent theory explains construct structure of two or more individual, group or organization (Lupia, 2001). One party could be considered as a principal who make a contract, both implicitly and explicitly, with other party called agent with the expectation that agent will act to do activities as expected by the principal. Lupia and McCubbins (2000) pointed out that delegation of authority happens since person or a group of people act as principal elect person or group as agents to do activities for the interest of the principal. According to Ross (1973) examples of principal-agents relationship is very extensive uses.

Principal-agent relationship occurs when ones activities affect to others or when one depends on others activities (Stiglitz, 1987, Pratt and Zeckhauser, 1985 in Gilardi, 2001). The affects or dependencies are being shape in agreements within institutional structure in various levels, like behavioral norms and contracts.

According to Lane (2003), agency theory is implemented in public organization. Lane (2000) explained that in a modern democracy country there occurs a set of principal-agent relationship. Similarly Moe (1984) explained the use of agency theory in the economics of public sector organizations. Therefore principal-agent relationship framework is an important approach to explain and to analyze public policies commitment. Implementation of public policies which is related to the contractual problems includes asymmetric information, moral hazard, bounded rationality and adverse selection (Lupia, 2001).

Asymmetric information is explained by Gilardi (2001). He states that principal and agent have imperfect information or there are lacking in information own by principal and that of agent. Petrie (2002) in his study on moral hazard states that there is a tendency of an agent, after the contract is entered into, to not promoting the principal’s interest. Gilardi (2001) define adverse selection as the ability of a principal to determine before the contract is entered into.

Gilardi (2001) also states that adverse selection (or ex-ante opportunism, or hidden information) occurs whenever the principal cannot be sure that he is selecting the agent that has the most appropriate skills or preferences and moral hazard (or ex-post opportunism, or hidden action). This occurs whenever the agent’s actions cannot perfectly monitored by the principal.

Lane (2003a), on the other hand, pointed out that adverse selection mean opportunism before the making of the contract between the principal and the agent while moral hazard mean opportunism after making of the contract between principal and agent.

A simple agency model by Carr and Brower (2000) assume that there are two options in occurrence of contract that are: 1) behavioral based, that is the principal should monitor the behavioral of the agents, and 2) outcome-based, that is there is an incentive to motivate the agent in order to achieve principal’s interests. Therefore the authors have similar explanation that are agents behave opportunistically toward principals. This opportunistic behavior occurs since agents put emphasis on their interests while principal may lose the objectives.

According to Andvig et al. (2001), principal agent model is an analytical framework which is useful for explaining an incentive for public institution with two possibilities condition: 1) there are some principals with respective objective may not coherent to each other, 2) principal is also able to emphasis objectives that may away from public interests due to a narrow self interests.

Andvig et. al. (2001) pointed out:;

“Principal-agent models are sometimes constructed for situations where the P-A relationship is not established within a given hierarchy, but where A may be a head of one and P represents another that in some sense has a superior role. For example, a parliament is often considered as the principal of the public bureaucracy, and the voters the principal of the parliament, and so on.”

Christensen (1992), on the other hand, stated that principal-agent theory is able to be an analytical tool for constructing and implementing public budget. In line with Christensen (1992), Smith and Bertozzi (1998) described that:

“Because implicit and explicit contractual relationship pervades the entire budget making process, principal-agent theory can make a major contribution toward developing more inclusive and accurate models of most stages of public budgeting… The application of principal-agent models by practitioners offers a more powerful analytic tool for both preparing and implementing public budget.”

According to Moe (1984), in government organizations, there are some commitment that can be explained using principal-agent relationship which can be traced via budgeting process, voter-legislature relationship; government-legislature relationship, finance ministry and ministry within the cabinet, government staff and public. Similarly, Gilardi (2001) and Storm (2000) perceived that agency relationship as a chain of delegation from public to their representative in parliament, from parliament to government, from government to ministry within the cabinet, from ministry within cabinet to the bureaucrats.

In general, it can be stated that delegations is certainly problematic and entails danger (Lupia and McCubbins, 2000). In a modern democracy, it contains at least, four characteristics delegation of authority that are: 1) existence of principal-agent relationship, 2) possible conflict of interest occur, 3) existence of asymmetric information, and 4) principal may reduce agency problems. Principal itself should pay agency costs to obtain information needed for monitoring agent performance and to determine incentive structure efficiently (Petrie, 2002).

2.4.1. Agency Relationship between Government and Legislative

Agency relationship between legislative and government perceived that legislative would be a principal and government as an agent. Legislative are perceived as a principal due to the representation of people through election process. Election process result mandate to legislative people to produce legislation, to oversight government works and to make sure that all public policies will be implemented as stipulated. Even though in a democratic country, people act basically as principal, in a process of producing legislation, policies and watching government activities, however, people do not have an access. Only appointed people by legislation, will represent the people to ensure the government functioning as expected (Fozzard, 2001 and Moe, 1984).

Lupia and McCubbins (1994) stated that problem faced by legislature can be explained by the occurrence of agency problems. Agency problem at least involved two or more parties which is called principal who has the authority to do works and agent who has the authority delegated from the principal. In the context of policy making, legislature act as principal and delegated the authority to the government or legislature committee to stipulate new public policy. Agency relationship exists when the agent draft the policy and completed when the proposal are accepted or rejected.

Johnson (1994) stated that executive-legislative relationships as self-interest model. Here legislature interest is to be reelected, government intended to maximize their budget, and constituent would like to maximize the public utility. Legislature, for reelected, attempt to find out as much project or program to make them popular in the eye of constituent. Government also proposes programs to improve the agency then the constituent would improve their trust in order to gain more benefit from government without any additional costs.

Agency relationship between executive-legislative has also been pointed out by Andvig et al (2001), and Lupia and McCubbin (2000). They states that legislature as a principal could arise some unexpected behavioral such as moral hazard, corrupted principal, or rent-seeking and other corrupted behavior.

In the budget process, executive proposal embarked executive interest, increase executive’s agency financial or non-financial benefits (Smith and Bertozzi, 1998). On the other hand, legislature as principal also attempts force their self interest into the budget proposal (Keefer and Khemani, 2003; Mauro, 1998; and Von Hagen, 2002). Agency relationship in this context brings about some advantage to the perspective of principal which have power and agents with their information advantage.

2.4.2. Agency Relationship between Legislature and Public

Citizens as voters and legislature as representative of voters may incur agency relationship as well (Moe, 1984; Lane, 2000; and Fozzard, 2001). Lupia and McCubbin (2000) further explains that citizens are principals who elect representatives to serve as their agents in parliament, while Andvig et.al (2001) stated that the voters are principal of the parliament.

In the case of public policy establishment especially for budgeting process mechanism, voters attempt to force their representative to get more benefit from expenditure policy, and as such the price voters will pay appropriate taxes to the government (Andvig et al., 2001). Therefore, the involvement of legislature in government budget decisions is to make sure that they will be representative of the voters.

In fact, there are no guarantees that legislative has similar interest with the citizens or public as stated by Groehendijk (1997):

“Without doubt, the relationship between voters and politicians in a representative democracy can be considered to be a principal-agent relationship. Voters want politicians to look after their interests, and in exchange provide these politicians with their votes and thus with positions. Of course, politicians have their own interests, which may diverge from the voters’ interests.”

Delegation of authority has consequence that agent decision may be out of the principal control (Lupia and McCubbins, 2000). In public-legislative relationship, mostly agents have not been covered by certain rule that make them work under the particular limitation. This condition shows that voters as principal exist as mindless or there have no concern to control the representative. On the other hand, legislature exists as demanding, tendentious, and information for the whole public interest (Lupia and McCubbins, 2000). This stereo type may cause the absence of fence to limit the agents’ unbound activities and in turn there is no gain or benefit retain to the voters as principals.

Elected legislative are able to behave as opportunistic and because of that, the voters have the opportunity to eliminate and gain by making politician tied up with the rule that determine what they can or cannot do in a certain condition. Nevertheless, in establishing public policies for unforeseen and complexity environment, there are no particular and effective contract made. Politicians are not in the position to fulfill all their promises made during the campaign. Therefore, an agency relationship exists in another context and in this case the relationship between voters and politician can be perceived as an incomplete contract (Seabright, 1996)

2.4.3. Agency Relationship in Budget Preparation Process

In a democratic country, legislature can be seen as a principal on behalf of the government, however legislature could also be seen as the agent when they faced with people as voters. The role of each party (legislature, executive and public) has been regulated within the law and order. The budget preparation process, government has the right to develop a budget proposal and submit it to the legislature for legalizations (Acosta et.al, 2007). Before the budget is approved by the legislature, it should first socialize to the public (ADB, 2007). In this relationship, legislature has the mandate from the people through the election process, to accept or reject the budget proposal. When the budget has been approved by legislature then government has the right to execute or implement the budget.

Even though regulation has to order the role of each party toward the budget preparation process, people as voters still in a very weak position (del Valle and Morron, 2001). Only legislature and executive which have a direct role in the budget preparation process play the important role. Mostly, institutionalization of budget is in the hand of both legislature and executive while citizen or people only act as watchers. People basically have the ultimate position as principal in a democratic country; however, they never have the actual access for complaining and even more rejecting the budget (del Valle and Morron, 2001).

Government or executive by nature have comprehensive information for developing the budget (Santiso, 2004). According to Santiso (2004) the budgetary process dominated by executive includes operational, administrative, and resources. On the other hand, legislatures have mostly perceived as mere ‘rubber stamps’ (Santiso, 2004). The legislature limitation may affect their capabilities in conducting legislative, representative and oversight responsibilities which in turn will make political dysfunctions.

2.4.4. Agency Problems for Government

Government or executive has the advantages in acquiring information to those of legislature due to some asymmetric information. These advantages stem from factual condition which is the executive has the rights to implement government functions and has direct access to the public domain in a long term. Executive also has understanding more about bureaucracy, administration, policies, and regulations (Santiso, 2006). Therefore, executives should be given the budget task in conducting the public services. Executive also can propose high expenditure budget but lower revenue budget. This is because easier to achieve low revenue budget but they may be a wide discretion on expenditures target.

Opportunistic behaviors are probably exists within the legislative position both as principal and as agent (Mulgan, 2000). Legislature as principal, on behalf of the government, may create self interest policies which made as if there is an agreement between the legislature and the government. In actual facts, it can be an advantage to the legislature in the long run. Through discretionary power, legislature has the rights to propose policies which are difficult for the government to avoid, even though the policy proposed are not related to the public services (Firdausy, 2004).

As an agent for the public, opportunistic behavior of legislature seems to be apparent (del Valle and Morron, 2001). In the budget process, legislature should be given a brief interest of the constituents through accommodating public needs in the budget. Activities proposed that would be financed by the budget, should be based on preceded scrutinize of public aspiration.

Several conditions may occur which could gain the executive for realizing opportunistic behavior in the budget preparation process. The first is through explicitly related to the legislature budget, and the second is through budget for public services in some type of entrusted things (Mulgan, 2000). In the first condition, legislature would propose revenue oriented budget which is able to absorb their self interest in a short run. This is may cause occurrence of political corruptions on the budget (Garamfalvi, 1997). In addition, in the second condition, a long run self interest should be put into account. Proposed budget enforced by legislative are programs to attract voters in particular region, so that targetable programs proposed would be transparent within the budget and public are able to criticize.

The elaboration above concerning the agency theory may pervade budgeting process in government organizations. The fact that through agency theory, it can be pointed out that executive is an agent from legislature and public; and legislature is an agent from public as voters. Position of legislature as representative of the public, in the occurrences of asymmetry information may cause opportunistic behavior such as adverse selection and moral hazard (Shi and Svenson, 2002)

Government	Legislature
1. Expenditure allocations proposed do not reflect budget priorities. 2. Expenditure allocation tends to reward individual benefit. 3. Excessive allocation on budget expenditure so that target is easier to achieve. 4. Budget allocated to difficult to measure programs.	1. Activities allocated should be agreed when it is related to attract voters. 2. Neglected mission accomplishment on current temporarily issues. 3. Refuse budget allocation which is not related to the interest of legislature. 4. To enforce effective and efficient budget for allocation to legislature programs.

2.5. Accountability

Accountability theory is in line with agency theory which explains about how one party have an obligation to account for what one have done as regulated in a contract between both parties (Mulgan, 2000). Accountability refers to a relationship between one party, which has an accountability hold, and has the rights to investigates for information about activities conducted by another party (Mulgan, 2000). Accountability also brings about the rights to make remedy and sanction. As the relationship between principal and agent, agents are being accountable to principals.

Some argue (Uhr, 1993; Mulgan, 2000) that accountability is not similar to responsibility, and responsiveness. Responsibility refers to the capacity for individual choice and action exercised without reference to another person. Responsibility brings a wider perceptive because it is not related to person or party. For instance one has a responsibility to dedicate to his or her country.

Responsiveness refers to willingness of a person to fill another person wishes (Mulgan, 2000). Here, there is a relationship of one activity to another similar to principal-agent relationship however, there may no accountability. For instance, responsiveness of sellers to consumers in which the seller try to satisfy the consumer need but the seller has no accountability to the consumers. In this case, responsibility may encourage accountability.

Also some argue (Uhr, 1993; Acosta, 2007) that accountability differs from regulation or control. Regulation is to regulate people to have good behavior, while accountability is inquires through person activities that already taken place. Contrary with the arguments, relationship between legislature and government are regulated by law and this encourages accountability. Similarly, relationship between public as voters and legislature present accountability. Therefore it can be said that regulation even it is not the same, encourages accountability.

Accountability is not merely a compulsion to report about what have already been done but even to prevent and reducing probability about one party who have been trusted to conduct their tasks then abusing this authority delegated to them. If this happened, then accountability costs will incur. This is because activities should be investigated in finding on whether information reported are sufficient and activities have been done correctly. On the other hand, party entrusted with accountability should prepared abundant information to make sure that the accountable party is satisfied (Mulgan, 2000).

Appropriate accountability should implement so that both parties have trust and goodwill. By having a trust, there will less accountability cost, and by keeping their goodwill may cause reducing cost of information reporting (Flack, 2007).

Based on the explanation above, it is possible to state that accountability has two function (Mulgan, 2000). First is trust and goodwill which refers to the existence of complying with certain rules, and an obligation to present sufficient information for one party to another. Second there is an existence of conduct in effective and efficient way the activities assigned.

2.5.1. Accountability in Government Organizations

Accountability works in government organizations described by some authors (Santiso, 2006; Mulgan, 2000; Del Valle and Morron,, 2001) consist of relationship among executive, legislature and public. This accountability seems to be more complex than that of implemented in private sector which is mostly appear in contract between and agent and principal or exist in two parties. Accountability in government organization does not only happen between public, legislature and government, but also within the government organization itself. Government organization usually consists of national government and local government. Even though there are many types of government systems and organization, generally, the organization could be classified as several tiers. The first tiers could be national or federal government and the other second or third tiers could be state and local or sometimes province, regency and municipalities (ADB, 2007).

In a democratic country which has presidential government systems, in the local government, governor (in provincial level) and mayor (regency and municipality) and local parliament are also appointed through election process (Law No.32, 2004). In the position of local government, there is an existence of complex accountability. In the first stage, the head of local government which are appointed through the election process should have accountable to the local people. Besides, local legislature as representative for local people, are accountable to the legislature. In addition local government as subordinate of national government, are also accountable to the national government.

Flack (2007) who conducted a study on the role annual reports of accountability systems, shows that the annual reports have both functional and symbolic role in the system of accountability. Functional role refers to the role as a means to communicate a wide range of information about of the activities and the performance of the public organization to the interest group or public. Symbolic role means that the financial reports also serve as an important signal of assurance to those who receives them (Flack, 2007).

Financial reporting system is reporting system implemented based on government regulation (Government Regulation No.24, 2004; Government Regulation No.8, 2006). Local government offices and agencies are classified as reporting and accounting entity. A reporting entity is an office or agency which is obliged to produce financial statement includes balance sheet, budget realization statement and financial disclosure statement. An accounting entity is the entity which has a main task to consolidate all financial statement that come from the reporting entities, and produce balance sheet, budget realization statement, cash flow statement and financial disclosure statement for entire local government.

The financial statement from local government is subject to financial audit. The audit which is conducted by local audit board (Bawasda) can be considered as an internal audit while the audit which is conducted by national audit board (BPK) would be considered as an external audit. Internal audit focuses on management and financial audit for the reporting entities within a local government. External audit focuses on financial audit for an entire local government and this is a compulsory based on the law.

Another task to make local government budget execution is more credible and reliable is the role of parliament to oversight the work of local budget. Even though budget is a regulation which has been agreed and signed up by local parliament itself, in the implementation process it still a need to guard so that the budget would be on the right track.

Basically there are two arena in which the local parliament plays the oversight role that are in the beginning of fiscal year before the budget get an approval, and in the mid of fiscal year in which budget being altered due to some budget adjustment is made.

Accountability is an order from the law which in formed through formally producing financial statement and performance statement and the reports should be audited by authorized offices local and national. According to the law that change in budget is an adjustment needed for changes in revenue estimation either from local own revenue, or intergovernmental transfer so that there are no big changes from the main budget. In fact (Firdausy, 2004) there some new allocation take place in the adjustment process and could make the main budget have shifting to far from the final budget.

Local government accountability, actually, could not only be looked at the audited financial statement and performance statement produced, but also credibility and reliability of the local government works in the eye of voters. Many voters are difficult to access the audited financial statement of the local government.

Even though the voters are very weak in accountability position (Peters, 2002), however, the existence of non government organization that specialized in local budget watch, seems the concern of people to how the local government managing the public money.

Budget performance refers to end result of budget process. Through long passage of public budget process the result would be directed to answer the question of what the money actually has gone, are they used for delivery a proper public goods, are the local development are able to improve the social and economy condition?

2.6. Budgeting as a Political and Managerial Dimension

The thoughts of behavioral aspects of budgets have been developed since 1952. Argyris (in Macintosh, 1985) conducted a studyabout the role of budget in the manufacturing company and it is found that the budget were use as:

1. a pressure device
2. a source of motivation
3. a means of isolating problems, and
4. a basis for instituting improvements.

Formerly,Argyris(in Macintosh 1985) pointed outthattraditionalbudget were perceivedby management and the workers in different ways. From the management side, they perceived that budgets are able tobe used to motivate the workers to increase their productivityand to achievegreater efficiency. On the other hand, the workers perceived that the budgets are no compromise things; "they were geared with result only, with no discussion of the process; they emphasized past instead of future performance; they were based on rigid standard; they were used to apply pressure for increase higher goals; they insulted a man’s integrity rather than offering him motivation, and they include unrealistic goals that were almost impossible to meet" (Argirys, in Macintosh, 1985).

In addition, different individuals in organizationshave different perceptions about the budgets. Argirys’ study (in Macintosh, 1985) showed that budgets were viewed differently by budget people, factory supervisor, and frontline foremen and workers. To the budget people, budgets are viewed as a device to motivate the work of force to increase productivity and to achieve greater efficiency. They alsobelievedthat budgets present a challenging goal to front-line.

Contrary to the budget implemented in government organizations, the budget can be seen as products of law, and government should implement the budget under a regulated environment (Hogye, 2002). In such working environment, managerial decision for decision making depends on what kind of budget concept is believed. Mostly, governments are likely to use line item budget, so that government with the wide organizations can easily control financial transactions within the organization (Santiso, 2004).

Many countries have a history of budgeting as a process driven by technocrats, with minimal political involvement and parliamentary oversight (Santiso, 2006). Nevertheless, in the need of increased allocation efficiency, the importance of political input is essential (Santiso, 2006). Basically, to promote efficiency in delivering public service, legislative play an important role. When the elected people in parliament are not involved in the budget process, then the budget contains just a wish list, however, when the parliament involved too deep into the budget preparation, then the budget becomes difficult to implement (ADB, 2007).

Under these circumstances, it may an ‘off-budget’ implemented without any consideration of the budget constraints. If this happened, it shows that the government has a weak accountability, inefficient budget, and absence of political influences (del Valle and Morron, 2001).

In some cases, aggregate fiscal discipline may be compromised due to strategic over-commitment (Santiso, 2006). This refers to operational inefficiency resulting from chronic imbalances in expenditure components. For example, a long-term fiscal imbalance due to an excessive wage bill, which leads to government inefficiency, may only be resolved through the exercise of political will (ADB, 2007).

While politics and the sensible stewardship of public resources may often conflict in the short run, in the long run they are both absolutely essential in achieving the goals of government in a sustainable and legitimate manner. Ideally, both politicians and the public should realize that unconstrained and non prioritized expenditure will ultimately undermine these goals (del Valle and Morron, 2001).

The central issue therefore is establishing appropriate institutional and legal frameworks to ensure that political involvement is harnessed to promote reprioritization, while maintaining fiscal discipline (Acosta, 2007). Budget reform should ideally address not only the efficacy of public sector managers in attaining operational efficiency in service delivery, but should also consider the interface between budgeting and politics to ensure outcomes which are efficiently allocated and fiscally responsible (Acosta, 2007).

In a democratic system, the role of government, its objectives, policies, priorities and the specific programs it runs are fundamentally political and not managerial issues (Hogye, 2002). However, since budgeting is about resourcing government’s strategic objectives and priorities, it has a considerable policy dimension (especially in resource allocation during budget preparation) but also has technical or managerial elements (Flack, 2007), for example the budget execution certainly needs a financial management mechanism.

2.7. Budget and Political Influence

Most government system deals with the tension between short term political interest and the need for fiscal stability and public services delivery in the long term which is in line with government policy (Lassen, 2001). Public expenditures should concentrate on the need for short term and long term purposes so that public could accept and give their support. In the short term public expenditures could be an operational budget while the long term could be a capital investment or capital budget.

Public budget has wide implications for the economic development in which the budget is expected to be the instrument for economic stimulant. Through the budget, government exercise the allocation, stabilization and distribution function. This is an economic policy which basically is the product of political process by which competing interest in budgetary institution may come to an agreement.

It is possible to note that financial management and budget are not be insulated from political influence. The challenge is to manage the interface between budgeting and politics by designing and implementing institutional and legal frameworks which will improve the quality of political participation and promote fiscal responsibility (ADB, 2007).

Political decision-makers should be held responsible for the authority conferred on them. While institutional arrangements vary from country to country, in general Cabinet is collectively accountable for the objectives of the government as a whole, for policy co-ordination across government, and for legitimizing budget decisions which reconcile competing claims on limited public sector resources (Campos and Phradan, 1996). Ministers are individually accountable for programmatic decisions in budget formulation.

The executive should be accountable to the parliament for implementing the approved budget. In developing countries, especially, parliaments tend not to exercise effective fiscal oversight, merely rubberstamping the actions of the executive (Hogye and McFerren, 2002).

Even today, the decisions surrounding budget making and implementation are often shrouded in a veil of concealment. The budget process, rather than being a focus of public debate and scrutiny, is often non-transparent with virtually no input from the organs of civil society (del Valle and Morron, 2001).

Many countries have a history of budgeting as a process driven by technocrats, with minimal political involvement and parliamentary oversight (del Valle and Morron, 2001). Nevertheless interest of increased allocation efficiency is necessary (Campos and Phradan, 1996). When government do not consider the important of a longer term of sustainability, then the formal budget more likely as politically acceptable wish list (Acosta, 2007). On the other hand, when politician neglected difficult decision in the budget process, the result in the formal budget allocating more resources than the government is likely to have at its disposal (Acosta, 2007). Difficult decision always faced by government is budget constraint which will determine what service delivery actually happens. Besides inefficiency, this undermines accountability and democratic process, since specifying unrealistic budgets is in effect an abdication of political power to bureaucrats.

While politics and the sensible stewardship of public resources may often conflict in the short run, in the long run they are both absolutely essential in achieving the goals of government in a sustainable and legitimate manner. Ideally, both politicians and the public should realize that unconstrained and a non prioritized expenditure will ultimately undermine these goals.

The central issue therefore is establishing appropriate institutional and legal frameworks to ensure that political involvement is harnessed to promote reprioritization, while maintaining fiscal discipline. Budget reform should ideally address not only the efficacy of public sector managers in attaining operational efficiency in service delivery, but should also consider the interface between budgeting and politics to ensure outcomes which are efficiently allocate and fiscally responsible (Acosta et al, 2007).

The behavior of politicians and their short time horizons are often a reflection of the incentives that they face. The problem is known generically as the “tragedy of the commons”. When a resource is owned in common, each user, acting in individual interest, will over-exploit the resource, even though it would be in the collective interest to restrict use of the resource to a level more sustainable in the long term. The budgeting analogue of this incentive problem has each individual minister trying to demand the largest possible claim on the common public resource pool, even though she may prefer government as a whole to maintain aggregate fiscal discipline in the interest of long term sustainability. It is in the interest only of the Minister of Finance to ensure aggregate constraints are not violated. As Brumby (1998) points out, this may or may not be valued by the Prime Minister and the electorate, which creates room for opportunistic behavior

2.8. Political institutions

Generally, political institution in democratic setting is classified as two governance model. First, majority of the people would delegate the authority for decision making process. Second, consensus model in which decision should be made by as many people as possible. Acosta (2008) who quote Lijlhart (1999) explains that:

“Broadly speaking, political institutions in democratic settings can be grouped under two governance models. The first type, emanating from a Hobbesian tradition, seeks to privilege the will of “the majority of the people”, by delegating decision-making abilities to a centralised authority. The alternative or consensus model, emerging from a social contract tradition, defends the principle that decision making should be made by “as many people as possible”, therefore privileging the notion of representation over resoluteness”

Political institution describes by Acosta et al (2007) is an institution that consist of electoral and party system rules which formed various political configuration and policy coalitions. This political institution gives more space for the Politian to establish coalition for stipulating and achieving the political purpose via public policies construction. In budget process, elected politician who have seat in the parliament, strives to maximize budget allocation for the interest of the constituent, for instance reducing tax burden, income distribution and public infrastructure development. In addition political institution plays important role to promote the political party interest by struggle to make budget allocation rules in favor of constituent aspiration to attract them for the interest of next election period.

In addition, political institution according to Santiso (2006) is constituted of organization, a set of regulation to rationalize political activities. Relation to budget process parliament as the hold the accountability or principal, firstly, to ensure that local government comply with the national regulations, secondly, to establish local regulation, and thirdly to make specialization for the organization through establish of particular committee or commission for finance and budget that is responsible to scrutiny, and to oversight the budget process (Acosta and Renzio, 2007).

The mechanism to local parliament budget process is to establish general policy and budget direction together with policy for budget priority and ceiling before the budget initiate (Firdausy, 2004). After finished initiating the budget draft, the government will submit the budget draft that later become budget proposal. The budget proposal will then pass through the parliament for approval (ADB, 2007).

The critical works is on the budget approval process. Before any approval is given by the parliament, the parliament has to do a recess time first (ADB, 2007). In the recess time, parliament will collect information concerning constituent aspiration for budget planning. After the recess time, the parliament will debate about the content of the budget. This is usually tough because information collected are mostly about a whish-lists and it also incorporate self interest of the parliament for the political purposes (ADB, 2007).

However, currently, the local political arena in Indonesia has changed. The arena now not only played by the political parties within the parliament, but also head of regencies (ADB, 2007). Head of regencies or provinces now have been appointed through election process so that they have political position.

Related to the budget process, there is a notion that the public budget should go through and cannot be stopped or stuck. Because once the budget is stuck, public service delivery cannot run, local economic and social development will ease and therefore the local government cannot function. According to the law (Law No. 32, 2004), when the budget is stuck due to disagreement between local parliament and government, the budget will still be able to work under the head of province (governor) or head of regency (Mayor) regulations or decree. This rights are under the prerogative of local government.

Another factor that plays an important role within the budget approval process is the role of national government through intergovernmental transfer and sector allocation. There are four types of intergovernmental transfer under the law: tax share, revenue share, general allocation fund, and specific fund. Even though the intergovernmental transfer has been regulated by the law, however, local governments still have problem to access the information (Firdausy, 2004). Some transfer such as part of revenue share, part of tax share and specific allocation fund still are not transparent (Firdausy, 2004) and limited to access the information.

In Indonesia, President is the head of government (presidential systems) who leads cabinet and bureaucracy and called executive (Law No.32, 2004). Parliament consists of people that are elected from election process, appointed leaders to lead operational of legislative activities. There are also fractions within the parliament which involved parties that have seats post election process. Therefore, there is a different political power own by president and parliament as a legislature (Law No.33, 2004).

Parliament authorities are established to approve regulation and oversight implementation of the regulation. Law and regulations are mostly initiated by government and discussed and approved by parliament. In national or sub national level, there are also legislative body which is called local parliament that has authorities to make, approve, and establish local regulations (Law No.33, 2004). In the law and order hierarchy, it has been settled that law and regulation subordinate should not against the superior or higher level of the regulations. The order of the laws involves the constitution, law, government regulation, president’s regulations and decrees, ministry’s regulations and decrees, in the national level, and local regulations, governor’s and Mayor’s regulations and decrees.

Figure 2.4 describes political institution related to budget process from the national level to the local level according Law No.32, 2004.

2.9. Budget Institutions

Budget institution have been explained by Wildavsky (1961) as a sub-set of political institution which shape and regulate the process of generating and allocating public resources for carrying out government function broadly conceived. Budget institution pervades formal systems which enable people and institution to develop budget. Even though budget can be seen as planning which have been assign with number according to traditional perspective, in fact budget are formed by political fight (Acosta, 2008). As a subset of political institution, in the simple budget there exist in a complex relationship. At least there are three institution incorporated in the budget establishment process, public as voters, parliament as representation of people, and government. Each of this institution involved in the budgeting process, and there may have different interest which may conflict one to others.

Some author (Alesina et al., 1999; Scartascini and Filc, 2004, Samuels 2003, Von Hagen 2002) conducted woks on budget institution shows that there are significant relationships between hierarchical budget set-up process and budget discipline. Hierarchy of budget process significantly affected the construction of budget rules that may limit expenditures capabilities, the higher the hierarchical budget set-up process the more budget discipline created. In addition when budget set-up process centralized to the hands of the government, presence of budget restriction may limit the parliament to extend their spending line, eliminating of off budget items.

Similarly Wehner (2004) who conducted a research on the role of parliament in the budget set-up process, shows that budget process highlights the important of accountability function that parliament perform, and the role of parliament depends upon characteristic of political and institutional environment. Campos and Pradhan (1996) pointed out that institutional arrangement in different countries affect incentives that govern the size, allocation use of budgetary resources, with the aim of assessing the strengths and weaknesses of different system in terms of maintaining overall fiscal discipline, allocating resources to priority areas, and achieving operational efficiency

Campos and Pradhan (1996) look at how institutional arrangements in different countries affect incentives that govern the size, allocation and use of budgetary resources, with the aim of assessing the strengths and weaknesses of different systems in terms of maintaining overall fiscal discipline, allocating resources to priority areas, and achieving operational efficiency.

Another important factor highlighted by Campos and Pradan (1996) is that in budgetary process the role of donors play important role to make budget policy. Donor contributes to provide positive incentives for fiscal discipline policy, imposed spending cuts that undermined prioritizations and promoted fragmentation of budget systems through multiple projects.

In Indonesia, political institution related to budgeting process works almost half year process. The first stage is to pervade people aspirations by conducted local meeting. Local meeting is called “development planning conference”. The conference will be held in village, sub regency and regency level in which the conference involves societies, non-government organizations and local government in regency/city level. This stage has been schedule in the beginning year January to March prior to budget year.

The second stage is a development plan conference in the province level. In this stage all the first stage conferences are compiled and communicated to the provincial level to accommodate provincial planning that will take effect in regency/city levels. This stage has been schedule in March to May prior to budget year.

The third stage is to conduct a national development conference. This stage consists of wider conference because it is participated by all provinces, regencies and cities for the whole countries. The aim of the conference is to provide development planning coordination for the whole country.

Based on explanation above, it can be said that the budget process involved broader environment. The first layer is the government who has the authority to initiate budget. In the budget set-up process includes adoption of sets of budget rules, translate planning and forecasting programs and activities, and budgeting for revenue and expenditures. The next is the submission to the parliament for discussion and approval. Before parliament gives an approval, budget would be analyzed to ensure that the budget has fulfilled the budget rules and accommodate public expectation.

After the budget has been approved by the parliament, a regulation will be established and the budget will be implemented. In the implementation process, the government’s role is to maintain and control the budget. Figure 2.5 below summaries the national financial system.

2.10. Budget Discipline

Budget discipline refers to a rule that emphasized on a directive of the budget revenue and expenditures to achieve the desire outcomes. Posner (2005) in his study stated that the role of budget discipline is to guide and direct the allocation decision to accomplish the priority. Bekim (2005) used similar term by referring budget discipline as budget rules to attain budget priority. While other authors (Acosta et.al, 2007; Acosta & Renzio, 2006; Santiso, 2004; Santiso, 2007; Campos & Phradan, 1996) pointed out that fiscal discipline in budget process as a set of rule to match the revenue and the expenditure. It seems that the term fiscal discipline is used for broader aspect of budget in which budget discipline is more specific to the budget policy to match the priority.

Budget formulation deal with the need for expenditures which is mostly exceeded the capacity of the revenue (Firdausy, 2004). Therefore preside over the budget is always needed to ensure that the revenue which always limited, are able to fulfilled the necessity expenditures which are always biased.

Campos (1996) also point out that there are many claimants to the budget. This includes interest groups, legislators, and line ministries. Each has different preferences over the manner in which the budget is to be allocated, that is the composition of spending, and each exerts pressure on the government to bias spending in the direction of their preferences. Given taxes are collected from the general public, the tax burden of a claimant’s spending priorities, which is spread across many groups and individuals, is likely to be considerably lower than the total social cost of the implied programs.

On the other hand, the benefits accrue mostly to the claimant. Consequently, a claimant will always demand a level of spending on its desired programs that exceeds the level that is socially optimal. For these reasons, constraints on the aggregate level of spending and deficits over the medium term become important. Without any constraint, meeting the demands of disparate claimants is likely to result in large, unsustainable deficits that translate into an unstable macroeconomic environment-high inflation, high interest rates, burgeoning current account deficits-which can ultimately retard growth (Campos, 1996).

Another key element of the internal structure and organization of a legislature that affects its policy impact is the institutionalization of rules and procedures (Puente, 2000). This is particularly important in budgeting where, in most nations, an annual budget process lends itself to routinization and stable practices for consideration and approval. Some parliamentary systems have budget rules that strongly favor the government such as a rule that allows the government to demand a vote on its original proposals regardless of changes made by parliamentary committees (Puente, 2000). Other rules, such as the requirement for offsets – that budget amendments must be “deficit neutral” – are self-imposed constraints on legislative activity that reduce discretion but may enhance fiscal responsibility. In general, the lack of institutionalization of regular, systematic procedures for considering and modifying budget proposals would tend to reduce legislative influence.

According to Indonesia Law (Law No.32, 2004; Government Regulation No.58, 2005) process to determine budget policy and ceiling and priority enact in mechanism as describe in Figure 2.6 below.

Some author (Santiso, 2006; Acosta, 2007) use operational variable of this rule is budget deficit, and debt in one dimension, and credibility and accountability in another dimension in which indicators used to measure is preference of majority of the people that can be observed by looking at the changes in per capita sub national spending, controlling for disparities in poverty and population (Mejia et.al. 2006). To measure credibility of government policies is budget volatility (Knack et.al.) indicator which looks at the variability over time of budgetary allocations.

Another author that slightly different emphasize is Penner (2006) who writes:

1. Changes in the rules should be motivated by a desire to simplify and expedite. Complexity is not the only problem facing the current system, but the process has become like tax law in that it is too complex for ordinary people to understand. Specialists and IRS enforcers can help make tax law work, but budget process law is different. It will work only if it has moral authority, and no one will know this if it is too complicated to understand. Many of these complications result from the belief that promulgating new rules can solve every budget problem, especially those problems that involve gaming the numbers. This is futile, however. Gaming has exploded in quantitative magnitude as the rules have become more complex, and can be limited only by embarrassing the gamers. If they are beyond embarrassment, gaming will continue regardless of the rules and will have to be accepted.
2. To the extent possible, the rules should be ideologically neutral. When deficits were large, they threatened a debt explosion that could become economically dangerous. It was therefore appropriate to employ a system of rules that was biased toward deficit reduction. However, there is now no reason for rules favoring larger or smaller surpluses or larger or smaller government. The rules should simply assist in making rational choices regarding the allocation of resources given the tastes— presumably derived from its constituents—of a majority of the legislature.
3. Rules that impose a lot of political pain will be broken. Rules can only nudge Congress toward rationality. They cannot bludgeon Congress into it.
4. It must be technically possible to implement the rules. This seems obvious, but Congress has had impractical rules in the past and even recently contemplated rules that cannot possibly work. Such rules set quantitative targets for the budget balance and enforce them with automatic mechanisms, such as sequesters of spending like those included in recent “lock box” legislation. As discussed previously, such a process failed under Gramm-Rudman. Congress must focus rules on legislative decisions and not on targets that are ruled mainly by economic conditions. That does not mean that it is inappropriate to have quantitative goals. It just means that they should not be enforced too rigidly or promised too fervently.
5. Whatever the process, there must be an escape clause for emergencies, even if such escape clauses are abused from time to time.

Considering all the elaboration above, the budget discipline variable is the set of rule to match the revenue and expenditures with the emphasize on the local government priority.

2.11. Budget Approval

Budget approval is a process to legitimate the local budget (Law No.58, 2005). This process determines the budget process proceed to implementation stage. Figure 2.7 describes the process which started from the proposed budget draft along with other documents submitted to the parliament, discussion or debate and end with the agreement or the approval from local parliament.

Prior to the submission of the budget draft to local parliament, at least there are three activities involved: to determine the local fiscal capacity, to enact of budget ceiling and priority and to consider national priority (Law No.58, 2005)
According to this law fiscal capacity, the revenues stem from several sources that are:

1. Local own revenues consist of local taxes, charges, profit sharing from local enterprises
2. Transfer from provincial government in the form of tax sharing and specific grants and subsidy.
3. Transfer from national government namely balancing funds which contain three main revenue classification: tax and revenue sharing, general allocation fund and specific allocation funds

Revenue sources stem from different level of government. The managing of revenue is separated in different authority or office. For local own revenues, it is carry out in a particular Local Own Revenue Office, while other revenues such as transfer from national and province is carry out in different office. Due to the high specialization of managing the revenue, the comprehensive skill and knowledge are needed (Firdausy, 2004).

Projection of expenditures allocations depend on revenue projection that become constraint to the budget, and short term planning established. Generally, there are two classification of expenditures used according to budget rules: indirect expenditure and direct expenditure. Indirect expenditure pervade allocation for line item budget in which item is fixed and could not be avoided such as government employee salaries and wages, local government liability bill, etc. Direct expenditures refer to local expenditure for public service and investments. When expenditures allocation exceeded the revenue or deficit occur, local government will use financing to overcome such deficit (Government Regulation No.58, 2005).

Local taxes and charges are revenue resources that are controllable and precisely estimated and projected by local government. Other revenue sources such as transfer from national and provincial government are out of the local government control, because all revenue transfer are decided by higher level of government. Therefore most effort for local government is to force local taxes and charges to increase budget constraint. Nevertheless, characteristic of local taxes as a small coverage tax is difficult to extent through intensification, because tax effort from the policy may cause disincentive for the economy and business. Therefore it is very restricted to establish local tax intensification policy (Firdausy, 2004).

Different to revenue allocation, which are always limited to extend, expenditure allocation are mostly wish by both parliament and government. The parliament are eager to add new expenditures allocation due to their related credibility of their political position in the eyes of voters. Similarly to the government, expenditure allocation is a weapon to legitimate their wide range of public service and local investment so that mission accomplish will be attained in effective and efficient way (Firdausy, 2004).

2.12. Ealier Research

Earlier researches related to political influence and budget process conducted in Indonesia and other countries can be seen in the table below:

No	Authors	Titles	Finding
1	Andres Meiji Acosta and Paolo de Renzio (2007)	Aid, Resources Rent and Politic of the Budget process	This study finds that politically uncontested executive authority actually has counter-productive effects on increasing deficits in the context of aid dependent and resource rich countries. Moreover, increased levels of political (partisan) competition have a moderating impact on the size of deficits. A second finding is that aid flows and resource revenues seem to have opposite impacts on fiscal performance, with resources improving the likelihood of obtaining fiscal surpluses and aid flows increasing the likelihood of deficits
2	Andres Meiji Acosta, Vicente Alborno, and M Caridad Araujo (2007)	the Political Economy of Budget Process: the Case of Equador	In the end, the greater agenda setting powers of the executive contributed to more sustainability of the budget process. From a political standpoint, the budget became less efficient as more budget reallocations took place during approval stage. Despite some important electoral reforms aimed at adjusting the proportionality of the electoral system, the budget did not become more representative. And finally, constitutional reforms contributed to greater earmarking and therefore more rigid (less flexible) budget outcomes.
3	Adiwan F Aritenang, 2008	A Study of Indonesia Regions Disparities: Post Decentralization	This research uses Indonesia disparities in the province level. Using regression analysis we will overview Indonesian provinces disparities and poverty rate to overview the economic growth after decentralization. Overall, this research aims to shows the economic performance of Indonesia regions and highlight determinant factors that impacts poverty rate.

No	Authors	Titles	Finding
4	Ed Campos and Phradan (1996)	Budgetary Institution and Expenditure Outcomes: Binding Government to Fiscal Performance	Australia and New Zealand radical reform, Australia reform focus on strategy priority and decentralized to line agencies, New Zealand reform geared with fiscal discipline and enhancing technical efficiency and that the mechanism of transparency and accountability central for the reform; Indonesia and Thailand reasonably effective in instilling aggregate fiscal discipline, Indonesia more emphasized on prioritization to protect basic social services, Thailand centralized systems which does not capitalized on the superior information at line agencies and lower level of government; Ghana, Malawi, and Uganda central role of donor, lack of transparency and accountability
5	Ezzamel, Mahmoud et al, 2007	Experiencing Institutionalization: the development new budgets in the UK developed bodies.	The findings point to a process of nested translations, from mission through aims and objectives to targets, with accounting numbers present only in the last stage whereby time-bounded targets are formulated and used to assess achievements. Because of the negotiations around the diverging interests of actors, the translation process is neither linear nor stable
6	Shi, Min & Jacob Svenson,	Political Budget Cycles: a Review of recent development.	First, new theoretical explanations (models) have been proposed where political budget cycles arise as the result of a moral hazard problem between the government and the electorate. Second, more sophisticated empirical methods, in particular, time series methods appropriate for dynamic panel data regressions, have been adopted in cross-country analyses. Last but not least, the focus of recent studies has shifted from industrialized countries to all (including developing) countries, and from the existence of political budget cycles to the magnitude and composition (revenue vs. spending) of these cycles.
7	Mack , Janet & Christian Ryan, 2002	Reflection of theoretical underpinnings of the general purpose financial reports of Australian government departments	The findings of this paper indicate that general-purpose financial reports are used to satisfy financial accountability and public accountability rather than decision making – indicative of users having an accountability focus rather than a “decision-useful” focus. This provides systematic empirical evidence against the current financial reporting model used internationally in the public sector.

No	Authors	Titles	Finding
8	Norton, Andy & Diana Elson, 2002	What’s behind the budget? Politics, Rights, and Accountability in the Budget Process	Model 1, bureaucratic discretion under governance by the formal political system, model 2: formal governance plus technocrats consulting the public, model 3: share decision making with a citizen on budget formulation and execution, and model 4: from rights to statutory entitlements a specific basic for claim, backed up, by mechanism of redress. The first model is a significant foundation for an accountable policy process, but most systems will benefit from adding in elements of all or some of the other three models. Citizen-led action, such as some gender budget initiatives, often seek to build on elements of all four models.
9	Nye, Robert K (2007)	Revealing Indirect Links Between Budget Execution and Mission Effectiveness	The findings indicate that information sharing and political support for an agency’s mission influence budget execution, contributing to perceptions of increased mission effectiveness.
10	Lewis, Blane D., 2005	Indonesian Local Government Spending	Among other things, the evidence suggests that: post-decentralization local government spending is partly responsive to increasing needs and partly the subject of elite capture; local government taxation has become more aggressive under decentralization and appears to be mostly driven by local bureaucratic expectations related to routine overhead budgets; and the increased savings of local governments during the post-decentralization period is determined to a large degree by delayed central government transfer payments.
11	Plekanov, Alexander, 2005	Are sub national government budget constraint soft? Evidence from Russia.	The estimated spatial lag econometric models support the view that budget constraints of Russian regional governments were soft

No	Authors	Titles	Finding
12	Santiso Carlos (2004)	Budget Institution and Fiscal Responsibility: Parliament and the Political Economy of the Budget Process in Latin America	It assesses the constraints to and conditions for enhancing the role of parliaments in public budgeting in a framework of fiscal responsibility. It underscores the risks of excessive executive discretion, when executive prerogatives are not adequately balanced by mechanisms of internal restraint and external scrutiny. it argues that more purposeful contribution of parliament to the oversight of budget might help countries seeking greater accountability in the management of public finance. Ultimately, the governance of the budget reflects a delicate balance between executive power and legislative oversight. The key challenge of legislative budgeting in Latin American is how to retain the advantages of strong executive authority required to ensure fiscal discipline while providing the institutional checks and balances that guarantee effective accountability.
13	Uddin, Shahzad, & Mathew Tzamenyi	Public Sector Reform and the Public Interest: a case study of accounting control changes and performance monitoring in a Ghanaian state-owned enterprise	Budgeting remind politicized, delayed, directionless, and ineffective. Reporting to the monitoring agency did not make any positive changes to accountability and performance and was thereby unable to serve public interest.
14	De Castro, Fransisco & Pablo Hernandes De Cos, 2002	On the sustainability of the Spanish public budget performance	Our results show that a structural break seems to have taken place gradually in the Spanish budget performance, allowing to verifying the inter-temporal borrowing constraint in a «strong sense», which means that no problems in marketing public debt are expected to arise if fiscal variables follow the pattern of the past in the future.

No	Authors	Titles	Finding
15.	Larcinese, Valentino, Leonzio Rizzo and Cecilia Testa	The power of the purse: what do the data say on US federal budget allocation to the states?	We find that socio-economic characteristics are very important explanatory variables of spending allocation to states. However, these characteristics are not sufficient to explain the disparities in the allocation of federal monies. Some states receive a disproportionate amount of money for reasons essentially linked to politics and the budget allocation process. In particular we find that the overrepresentation of small states determined by the Senate and Presidential election systems has an important impact on federal budget allocation. States whose governor has the same political affiliation of the President receive more federal funds in the form of procurement and defense spending. On the other hand, the political alignment between governor and majority in the House and/or Senate does not affect the allocation of federal funds. We do not find any evidence that marginal states receive more funding; on the opposite we find that safe states tend to be rewarded. Finally, the appropriation committee membership affects the distribution of broad spending categories like total expenditure per capita and direct payments to individuals, while senior members have a disproportionate impact on grant allocation.
16	Yarahuan, Gabriela Pérez , 2007	Social Development Policy, Expenditures and Electoral Incentives in Mexico	In the programs analyzed here I find that political variables have had limited influence on the distribution of resources of federal programs at the municipal level between the years 1999 and 2005 and that programs differences in this respect may depend on program characteristics, specifically rules of allocation.
17	Peralta Susanna, 2006	Budget Setting Autonomy and Political Accountability	We show that the greater autonomy improves selection (i.e. voting out bad incumbents), while it decreases discipline (i.e. giving incentives to the bad incumbents). Electoral turnover is expected to be higher with greater economy. We analyze the effect of tax setting autonomy on expected voter welfare.

No	Authors	Titles	Finding
18	Puente, Jose Manuel, Aberaldo Daza, German Rioz, Alesia Rodriguez, 2006	The Political Economy of the Budget Process in the Andean Region: The case of Venezuela	Firstly, from the general policymaking as well as budget-making perspective, was mainly characterized by the effects of the first oil boom and displayed a period of strong Presidential power within a cooperative system strongly influenced by a corporative arrangement in a limited political competitive context. It was marked by the decline in oil revenues, and as presidential power weakened Congress’ greater power became evident despite the prevailing non-cooperative system and fragmented political context. Third period was typified as a period of increased polarization and constitutional reform, which provided the basis for a constitutional and informally powerful President with no political competition. Secondly, in general the Executive branch is the leading actor in the budget-making process. The Executive has a number of bargaining advantages over Congress during the process. However, budget allocations are also the product of legislators’ pursuit of (re) election and power, as well as the demand of interest groups. Thirdly, besides fundamental economic variables, such as oil income, macroeconomic adjustment programmes and others; it is found that political variables such as electoral year, the power of the Executive vis-à-vis Legislative among others, are important determinants of budget (re) allocations and fiscal performance. Fourthly, as has been shown by the political economy literature, political institutions affect the ‘rules of the game’ under which different actors interact, by placing constraints on the whole budgetary process and distributing power and responsibilities among different actors.
19	Gomes, Ricardo Correa, 2006	Stakeholder Management in the Local Government Decision-Making Area: Evidences from a Triangulation Study with the English Local Government	A power-influence model has been built up in which a stakeholder’s participation in local government decision-making is depicted. The model indicates a set of stakeholder influences that are both technically and institutionally-based. Influences stem from both powers and interests which induce a stakeholder to participate in this process. Finally, the model indicates the whole set of categories representing stakeholder influences for which local government has to be held accountable.

No	Authors	Titles	Finding
20	World Bank (2007)	Public Expenditures Review Analysis	Most local governments have difficulty managing the increasing flow of funds. Since decentralization, personnel spending has crowded out capital investment in public services. Development expenditures are concentrated on government apparatus, to the detriment of other areas for which it is more urgently needed. Contrary to the needs identified, local governments spend little on training, while a major share of their capital investment goes to buildings, vehicles, and equipment. The allocation of funds for general public administration needs to be scrutinized. A reorientation of expenditure toward building the capacity of existing staff is urgently needed.
21	World Bank (2007)	Aceh Public Expenditure Analysis	PFM: Indonesia has made progress in reforming its public finances and increasing transparency but the reform agenda remains large include: budget flexibility, procurement and corruption, and accountability and transparency. Fiscal decentralization and regional inequality: intergovernmental transfer use for moving priority from allocation for poor to spend effectively.
22	World Bank (2005)	Papua Public Expenditure Analysis	Local own source revenue (OSR) mobilization remains low. Despite the large amount of overall resources available, budget deficits are common and borrowing is on the rise. Development spending has been boosted by the Dana Otsus. Expenditure priorities have, however, hardly changed. The bulk of local spending is allocated to routine expenditures, with unspecified routine spending increasing disproportionately

No	Authors	Titles	Finding
23	Firdausy, 2004	Indonesia	As local autonomy and fiscal decentralization proceeded, the composition of local government financial revenue sources changed. Law 25/1999 provides that local governments can collect revenue from local revenue or income, central-local balance fund, local borrowings, and other legal revenues in the region. Local revenue is from four sources: regional taxes, user charges, revenues from local state-owned companies and local asset management companies, and other legal local revenues. The central-local balance fund consists of local revenues from taxes on land and building construction, taxes on land and building construction rights, revenue from natural resources, general allocation fund, and specific allocation fund.
24	Asian Development Bank, 2007	Fostering Public Participation in Budget Making: Case Studies from Indonesia, Marshall Islands and Pakistan	The initiative of Kebumen and Makassar local governments to devolve a certain percentage of development funds to lower levels is an encouraging sign that the musrenbang (bottom-up planning) process can be made more effective. However, the local governments face significant challenges in: (i) increasing the capacity of lower level officials to handle the management of these funds; (ii) aggregating the high level of demand for very limited funds; and (iii) monitoring the use of these funds to ensure against improprieties. A new pilot project could be designed to usefully explore ways to support this process so that success stories could be shared more broadly.
25	Ilyas Saad, 2001	Indonesia Decentralization Policy: the Budget Policy and Its Implications for the Business Environment	local governments at the kabupaten and kota level have received an allocation of funds from the central government that exceeds routine expenditures. However, this level of funding is substantially less than the total transferred into the regions during the period before regional autonomy. It is a different matter, however, at the province level where the allocation of funds from the central government is much smaller than their routine expenditures. The size of the budget allocation is one the key reasons given by local bureaucrats to explain why local governments, both at the kabupaten and kota level as well as at the provincial level, have been working hard to increase local revenues by imposing more local taxes and levies.
No	Authors	Titles	Finding
25	Piet Supriadi, 2003	Public Sector Reforms in Indonesia: a Case Study	Finding: 1) slow progress of civil service reform, 2) competency and skill of civil servant is weak, 3) Human resource development less anticipative, 4) The groundswell for political reform has lost some momentum as vested interests have begun to fight back. 5) The costs to society of the wage and pension bill, leakages of public funds in the pockets of public officials and missed development opportunities as a result of weak governance may have raised the costs to Indonesia to unbearable level, measured in significant percentages of GDP. 6) financial reporting system less transparent, 7) law enforcement is weak, and 8) The attention and efforts to do public service reform will be likely slowing down because all attention will be focused on preparing next election which will be conducted in May 2004.
26	Sanusi, Anwar, 2008	Government Reorganization to Improve Public Services: a Lesson from Some Local Government in Indonesia	The finding shows that corruption and inefficiency continue to threaten higher quality public services. Local and intergovernmental fiscal and financial structures: intergovernmental funds are not always distributed fairly, and local governments have few ways of raising money and even less control over funds they do raise. Finally, local governments often have flawed financial management systems and lack of accountability.
27	SHIRAISHI, Kausuke, 2003	Budget Deficit and Fiscal Discipline: Budget Reform in US and Japan	With respect to the role of fiscal rules, there only exist few rules based on statutes which restrict the budget deficit and debt level. Japan establishes centralization in budget process. The institutional arrangements attain an equal level with other countries. However, the strategic examination of the entire budget, target setting, budget examinations are not conducted well in Japan. With respect to the transparency of budget, they do not show the medium-term fiscal projections and the fiscal impact of economic packages.

No	Authors	Titles	Finding
28	Tóth, Kriztina and Bernard Dafflon, 2006	Managing Local Public Debt in Transition Countries: an Issueof Self Control?	It argues that compliance with the legal norms and favorable ratings at the bank are necessary but not sufficient conditions for a municipality to incur debt. Success in the overall financial management requires a more proactive attitude in which local policymakers adjust their investment policy to the actual debt capacity of the local government, assessing the short, medium and long-term costs and benefits of each investment project.
29	Willoughby, Katherine, 2002	Performance Measurement Utility in Public Budgeting: Application in State and Local Governments	The results show that there is little distinction by level of government of budgeters’ perceptions of the importance of output or outcome measures to departmental budget cycle. However, larger proportions of local budgeters view this information as important to government wide budget processes, and these budgeters are significantly more likely than state budgeters to view performance measurement as important or very important to final appropriation determinations.
30	Gabriela Pérez Yarahuán, 2007	Social Development Policy, Expenditures and Electoral Incentives in Mexico	In the programs analyzed here I find that political variables have had limited influence on the distribution of resources of federal programs at the municipal level between the years 1999 and 2005 and that programs differences in this respect may depend on program characteristics, specifically rules of allocation.

2.13. Chapter Summary

1. Agency theory explain that it may occur agency problems in budgeting process in which agent will act in different way to what actually desired by the principal. These circumstances when occur in local government relationship especially for the public budget process, it could be some unexpected behavior could accour, such as:

a. In the local government side:

1. Proposed expenditure allocation did not reflect budget priorities
2. Expenditure allocation tends to reward individual benefit.
3. Excessive allocation on budget expenditure so that target is easier to achieve.
4. Budget allocated to difficult to measure programs.

b. Local Parliament side

1. Activities allocated should be agreed when it is related to attract voters.
2. Neglected mission accomplishment on current temporarily issues.
3. Refuse budget allocation which is not related to the interest of legislature.
4. To enforce effective and efficient budget for allocation to legislature programs.

In order to avoid such unexpected behavior in the area of local government’s public budget, institutional arrangement should be enforced through establishment of political institution, and budget institution.

2. Accountability

Accountability relation in government organizations can be seen as complex relationship. More specific since accountability fit to budget process, some authors (Santiso, 2006; Acosta, 2007) seem agree to use similar framework in which within this relationship there involved political institution, budget institution and public as voters.

3. Political institution

Political institution which is constitute of parliament and committee, plays formal roles to establish rule and regulation, to oversight government and to accountable to people. In local government climate, the biggest part of local parliament is related to budget process. In the previous fiscal year, local parliament has to ensure that local regulatory framework has been established adequately and properly; discussed with constituents about the local government development planning and policies to gathering people aspiration regard to the work of government; discussed, debate and approval the budget discipline that is budget rule, local priorities and budget ceiling for the agencies and local offices proposed by local government.

The next tasks of the local parliament is to scrutinize, discuss, debate and approve the draft budget, and to oversight the budget execution.

4. Budget institution

Budget institution is a part of political institution which is involved government institution and budget process. Government institution consists of local government prerogative, local offices and agencies, budget committee, rule and policies, and budget and accounting system.Budget process is a process that beginning with yearly work plan which is derived from medium term planning, considering national priority, fiscal capacity estimation, given the budget ceiling and priority, budget draft preparation, legitimating, execution, control and reporting (Law No 32, 2004).

5. Therefore, within the budget institution as a part of political institution there exist three dimensions that are political, managerial, and accountability dimension. Political dimension is involved the role of local parliament, local government and national government. This political dimension would be mediated by approval process toward budget performance. (Campos and Phradan, 1996; del Valle and Morron, 2001; Santiso, 2006, Acosta et al, 2007; Acosta and Renzio, 2007). Managerial dimension involved managing the local fiscal capacity, budget ceiling, local priority and considering national priority. This dimension would be mediated by budget discipline to perform the budget (Law No.32, 2004).

The third dimension is accountability. This dimension includes financial reporting system, internal audit, external audit, and parliament oversight. All these factors are embedded in the term accountability (Government Regulation No. 8, 2005). Accountability involved wide range of interest including public as voters so that this dimension is also can be considered as public interest dimensions.