Colombia - Second Public Financial Management Project

Report No. PID8539 Project Name Colombia-Public Financial Management Project II Region Latin America and Caribbean Region Sector Public Financial Management; Institutional Development; Other Public Sector Management Project ID COPE40109 Borrower(s) GOV'T OF COLOMBIA Implementing Agency Address MINISTRY OF FINANCE Ministry of Finance and Public Credit Santafe de Bogota, Colombia Contact Person: Mr. Federico Renjifo, Vice Minister Tel: 571-350-1204/1205 Fax: 571 209 6242, 286-4156 Environment Category C Date PID Prepared February 8, 2001 Projected Appraisal Date October 20, 2000 Projected Board Date March 23, 2001 1. Country and Sector Background I. Macroeconomic IssuesMacro-Economic Performance: Following the sharpest recession in its history, the Colombian economy has recently begun to show signs of recuperation, with GDP growing at an estimated 3t (annualized) in 2000, a balanced current account, and a fiscal deficit that has been reduced by about one third, to 3.6 percent of GDP. Economic performance had deteriorated sharply in the late 1990s, affecting nearly all areas of the economy: (i) GDP fell by an unprecedented 4.3w in 1999; (ii) the fiscal accounts of the non-financial public sector, which were roughly balanced in the early 1990s, showed a deficit of 4.5 percent of GDP in 1998, which rose to 6.3w percent of GDP in 1999; and (iii) the current account of the balance of payments reached a deficit of 5.7 percent of GDP in 1998, although it fell to 1.1 percent of GDP in 1999 as a result of a sharp decline in imports and an increase in oil revenues. Economic decline has been accompanied by a steep rise in unemployment, which in urban areas now stands at about 20 percent. Restoring medium term fiscal sustainability is essential if Colombia's efforts at poverty reduction and more rapid and sustainable medium-term growth are to be realized. It is also crucial for nursing a fragile financial sector back to health.In addition to a deteriorating domestic economy, Colombia's external environment also worsened substantially throughout 1998 and into 1999. The country was hit by severe shocks: (i) a trade shock in 1998 due to the drop in oil and coffee prices, estimated at 1.5 percent of GDP; and (ii) events in international credit markets which increased the cost of borrowing and decreased the availability of external finance for both the public and private sectors. With the virtual closing of international credit markets to developing economies and the skyrocketing cost of external credit, Colombian authorities had to turn to the domestic market to finance a growing deficit, putting pressure on domestic interest rates  that resulted in a marked increase in the debt burden of the private sector. Repeated pressure against the peso trading band ensued, causing the Central Bank to initially react by further increasing interest rates, followed by a devaluation of the peso. Pressure on the currency continued, however, leading to the eventual abandonment of the trading band for the peso and the floating of the currency.Although general external conditions have improved, due to the heightened internal conflict in the country, the deep recession highlighting structural problems of the Colombian economy and the removal of Colombia's investment-grade status by three major credit rating companies, external financing has become increasingly limited and costly. Table land Table 2 provide the fiscal accounts of the Combined Public Sector and the Central Administration, respectively from 1996 to 2002.Government Strategy: The Government has made reducing the fiscal deficit one of its key macroeconomic objectives. During the first year of its administration, the present Government took several measures to enhance revenues and reduce expenditures, including instituting measures to fight tax evasion and smuggling, increasing gasoline surcharges, and widening the VAT base and improving tax collection. However, due to the outlays needed to rebuild the areas affected by a devastating earthquake that hit the country in January 1999, shore-up an ailing financial sector, and fund additional relief to mortgage holders, the deficit continued its increase in 1999 to 6.3w of GDP. In order to consolidate its stabilization program, the Government, towards the end of 1999, requested a three-year Extended Fund Facility from the IMF, aimed at supporting its efforts to restore growth, further reduce inflation and achieve a sustainable external position. The stabilization program calls for a sharp reduction of the Non-financial Public Sector deficit to 3.6w of GDP in 2000 and to 2.6w in 2001, and is underpinned by strong tax enforcement, better management of resources under the fiscal decentralization system and economic recovery. The restructuring of the financial sector is another of the Government's major objectives, and a number of measures have been taken to help re-capitalize viable private entities, restructure public banks and restore their solvency in preparation for their divestment, and to alleviate the debt burden of mortgage holders.The success of the fiscal policy initiatives mentioned above depends, to a considerable extent, on the ability of the public sector entities, engaged in revenue administration and public expenditure management at the national level, to translate the policy into results. These are the focus of this project.Table 1 : Combined Public Sector (t of GDP)1996199719981999(1)2000(2)2001(2)2002(2)Total Revenue27.027.426.527.628.828.527.4 Tax Revenue3l6.817.717.317.017.519.419.3 Non-tax RevenuelO.19.89.110.611.39.18.lTotal Expenditure & Net Lending29.731.031.133.632.331.128.9 Current Expenditure2O.821.623.024.624.823.522.9 Wages and Salaries6.66.77.07.87.67.46.5 Goods and Services3.53.73.43.73.53.12.9 Interest2.72.63.33.84.44.44.1 Transfers and Other8.08.69.39.49.38.69.3 Capital Expenditure8.99.58.18.87.57.66.0 Net LendingO.00.00.00.10.00.00.ONon-financial Public Sector Balance-2.9-3.5-4.5-6.3-3.6-2.6-1.5Table 2: Central Administration (t of GDP)1996199719981999(1)2000(2)2001(2)2002(2)Total Revenuell.812.611.812.113.214.513.8 Tax Revenue3lO.110.810.410.111.313.112.4 Tax on Income and Profits3.84.44.34.34.65.34.6 Taxes on Goods and -2 -  Services5.35.34.94.95.05.76.1 Value Added Tax4.74.84.54.44.65.25.3 Gasoline TaxO.60.50.50.50.50.50.9 Taxes on International TradeO.91.01.20.91.01.21.0 Financial Transactions TaxO.00.00.00.00.60.80.6 Stamp Duty and other Taxes0.00.10.00.00.10.00.0 Non-tax Revenue and Transfersl.71.81.42.01.91.41.5Total Expenditure & Net Lendingl6.715.917.819.619.118.817.9 Current Expenditurell.912.214.215.116.115.314.2 Wages and Salaries2.52.52.72.93.13.02.4 Goods and Servicesl.31.61.41.41.41.11.2 Interestl.11.21.92.12.73.12.8 Transfers and Other7.06.98.38.78.98.17.8 Capital Expenditure4.43.63.44.02.53.13.7 Net LendingO.40.20.20.60.50.40.0 Overall Balance-4.9-3.4-6.0-7.5-5.9-4.3-4.OSources: Ministry of Finance and Public Credit, Banco de la Repulica and IMF Staff estimates.1. Preliminary; 2. Projected; 3. Excludes proceeds of the financial transaction tax in 1999 from revenue and expenditure.Note: Some totals may not add up due to statistical discrepancies or rounding off.II. Revenue Administration IssuesRevenue administration is the responsibility the DIAN, which collects Income Tax, VAT, Customs Duty, Transactions Tax and Stamp Duty. It also monitors foreign exchange transactions. The total revenue collected in 1999 was 15,554 billion Pesos, which amounted to 10.1w of GDP. Trends in tax collection from 1996 to 1999 show that total tax revenues at the central level have fluctuated between 10.1w to 10.8w of GDP. Tax revenues as projected to increase to 12.4w by 2002. The DIAN manages about 1,040,000 taxpayers and processes approximately 3.85 million tax and customs declarations annually. It has eight Regional Directorates and forty three local offices. There are also four Special Administrations: Large Tax Payers Administration, Bogota, Legal Entities Administration, Bogota, Customs Directorate, Bogota, and Eldorado Airport, Bogota. The staff strength is about 6,800.Since 1994, with the assistance of the Bank's Public Financial Management Project (PFMP), the GTZ and the IDB, the DIAN has undertaken significant capacity building initiatives. These are summarized in Annex 2. Institutional and organizational deficiencies that still need to be addressed are discussed below.(i) Organization and Management: While major efforts have been made to strengthen the organization and management of the DIAN in the last ten years, many weaknesses remain. There is a history of instability at top management levels, with ripple effects down the line. Accountability systems do not fully match the high degree of autonomy enjoyed by the DIAN. Formal planning, budgeting, evaluation and monitoring systems exist, but there is a need to increase their credibility and effectiveness. Communication, coordination, control and supervision mechanisms need improvement. The remuneration structure has become non-competitive with the private sector, affecting DIAN's ability to recruit and retain staff with appropriate skills. This poses a particularly severe problem in the context of the introduction of sophisticated information systems that require higher level technical skills. The administrative career is too rigid and promotion avenues are limited, causing frustration amongst staff. Recently improvements have been made in the design of the administrative career to strengthen the link between promotion and professional qualifications. However, institutional arrangements for the transparent implementation of the new system are yet to be implemented. Business processes need to be streamlined to increase operational efficiency and reduce the risk of - 3 -  corruption. Internal control and anti-corruption systems are still weak. There is a need to develop a corporate information management strategy and improve the capacity of the central Informatics Unit, to manage, maintain, safeguard and continually update the information infrastructure. Also, management of notifications, correspondence and paper records requires improvement. Relationships with external actors, such as the legislature, the judiciary, the Prosecutor General, commercial banks collecting taxes, taxpayers, business, industry and professional associations, other government departments and foreign tax administrations, need to be strengthened to increase the DIAN's ability to enhance the positive effect of environmental influences on its performance and reduce their negative impact. Finally, considerable management training is required at different levels of the organization.(ii) Voluntary Compliance:The DIAN has made serious efforts to facilitate voluntary compliance. There is, however, a need to extend some of the recent initiatives and intensify efforts to create tax compliance culture. The system for electronic filing of tax returns, introduced in 1999, needs to be expanded to cover medium and small taxpayers. Also, the functionality of the system has to be enhanced to provide additional electronic services, such as payment of taxes and submission of claims for tax refunds. To further reduce compliance costs, integrated taxpayer assistance units, dealing with both tax and customs matters, need to be established. The Office of the Taxpayer Ombudsman, created recently needs to be made operational to provide quick redress to taxpayers' problems. The quality of taxpayer education materials and interactive tools requires to be enhanced. Complementing these efforts to raise compliance in the near term, a longer term initiative to build a stronger social consensus in favor of tax compliance needs to be undertaken, by reaching out to future taxpayers while they are still in schools and colleges. (iii) Routine Processing of Tax Declarations and Payments:While the DIAN now possesses a complete suite of systems to manage tax declarations and payment information, some of the older systems, namely the Unique Taxpayer Register and the system for accounting of tax and customs receipts need to be updated. Also, a second generation version of the system for control of refunds and credits needs to be developed to enhance its functionality. Finally, a system for assessing taxes payable by small and medium taxpayers, covered under a special tax regime, is required. (iv) Routine Processing of Cargo, Customs Declarations and Payments: The routine processing of cargo, customs declarations and payments has various deficiencies. Although a new system for processing customs declaration (COMEX) has been commissioned on a pilot basis, as yet, it covers only regular import transactions. Additional modules to deal with imports under special regimes, goods in transit and exports are yet to be developed. Thereafter, the system needs to be extended to other customs locations in the country. Due to a lack of a national level communication network for transfer of customs information, there are significant delays in transmission of data regarding customs operations between border posts and head quarters and amongst border posts. Further, most customs declaration processing stations are not linked electronically to ports, warehouses and banks. This creates discontinuities in information flows related to different stages of cargo processing, causing control weakness. The process of valuation and classification of the goods and assessment of customs duties needs significant improvements. The physical infrastructure at customs posts, including weigh-bridges and closed circuit TV systems, requires enhancement. Also, customs facilities need to be reconfigured to minimize - 4 -  the interaction between customs staff and clients, which increases the risk of corruption. Finally, the monitoring and control of private bonded warehouses is weak. (v) Enforcement: The external environment of the DIAN has become very difficult. The opening up of the economy has increased the complexity of business transactions that need to be dealt with, while creating additional avenues for tax evasion. Taxpayers and customs users have become more sophisticated. The narcotics trade has also contributed to the growth of the informal sector. Even though the performance of the DIAN in tackling tax evasion shows steady improvement in recent years, enforcement continues to be a relatively weak area. There are various reasons for this. The DIAN receives voluminous tax related information from third parties. However, there are major deficiencies in the classification, dissemination and effective use of this information. A system to improve management of external information relating to taxes is under development. This needs to be extended to cover information relating to customs and foreign exchange violations. The DIAN does not have adequate systems and organizational arrangements to collect covert intelligence about tax evasion and smuggling. While the new system for selection of cases for tax audit (SICAT), developed under the PFMP, has shown encouraging results, its functionality and risk analysis capacity needs to be enhanced. Similar improvements are needed in the system for selection of customs cases for audit (SIFARO). The monitoring and evaluation of audit performance are weak. There is inadequate follow up of cases in the post-audit stages, such as objections, appeals and payment of additional tax liabilities. As a result, a high proportion of cases (40.2w in 1997) are decided against the DIAN leading to a major reduction in assessed tax liabilities (53.29 or 149,330 million pesos in 1997) Source: Colombia: Medidas para Aumentar las Eficacia de la Administraci6n de Impuestos, Marzol998, IMF. There is inadequate coordination between the audit (Fiscalizaci6n), assessment (Liquidaci6n) and legal (Juridicas) branches of the DIAN. Second order improvements in the functionality of the tax recovery system (SIPAC) and the system for monitoring filing of returns and payment of taxes need to be done. Lastly, as the final outcome of enforcement actions depends on decisions at the appellate stage, the DIAN's capacity to effectively represent cases before appellate authorities needs to be strengthened.(vi) Policy and Legal Framework of Revenue AdministrationSince 1990 there have been five Tax Reforms (Law 49 of 1990, Law 6 of 1992, Law 223 of 1995, Law 383 of 1997 and Law 488 of 1998). In addition, in 1995, through Law 218 of 1995 a series of income tax exemptions were granted to attract investment to a region affected by natural disaster. A new Customs Statute was decreed in 1999 and became effective in July 2000. A new tax reform package was passed by Congress in 2000. These tax reforms have mainly focused on increasing tax collections through widening of the tax base, levying temporary surcharges and encouraging the declaration of concealed transactions and income. They have also sought to modify the powers of the DIAN as well as administrative procedures, to facilitate compliance and enforcement. The frequent amendments to the tax laws have, however, increased their complexity. Also, the concessions granted to encourage disclosure of past tax evasion have had the unintended effect of discouraging voluntary compliance by building expectations of more such concessions in the future. In addition, weaknesses continue to exist in certain procedural and enforcement provisions of the tax and customs statutes. There is, thus, a need to carry out a systematic review of the tax structure and tax laws with a view to optimizing the tax burden, - 5 -  reducing distortions, lowering compliance costs by simplifying procedures, and strengthening enforcement. The costs and benefits of measures to induce declaration of evaded taxes also need to be properly evaluated.Government Strategy: The government is seeking to support the modernization of the DIAN through a multi-pronged strategy. On the legislative side, Law 488 of 1998 was passed to increase revenue collections and make major organizational changes in the DIAN. In 1998, the government agreed with the IDB on the implementation of an Action Plan to reform tax and customs administration, in the context of structural adjustment loan: Programa Inter-Americano de Reforma de las Finanzas Publicas (Loan No. 1166-OC-CO). Budgetary allocations amounting to a total of about US$12 million, spread over 4 years, are being made to the DIAN for the purpose of implementation of the Action Plan. Meanwhile, the government has continued to support modernization of the DIAN through the PFMP. It is relying on the PFMP-II to carry the process further. III. Public Expenditure Management IssuesDuring the last decade, various steps have been taken strengthen public expenditure management. Extensive assistance to improve the institutional capacity of the Ministry of Finance and Public Credit (Ministerio de Hacienda and CrSdito Publico - MHCP); the National Planning Department (Departamento Nacional de Planeaci6n - DNP); the Office of the National Accountant General (Contador General de la Naci6n) and the Comptroller General of the Republic (ContralorUa General de la Republica - CGR) in this areas was also provided by PFMP as discussed in Annex 2. As in the case of revenue administration, however, the process of institutional strengthening in public expenditure management also needs to be continued, so as to complete some of the reforms initiated by the PFMP and to deal with other weaknesses that were not covered by that project. The main areas requiring attention are the following:(i) Macro-programming, Formulation and Monitoring of the Budget:The following deficiencies continue to reduce the effectiveness of the processes of macro-programming and budget formulation: There is a lack of clarity about the role of national, regional and local governments. In many cases, ministries and agencies at the central level continue to perform, and budget for, functions that have been devolved to local and state authorities. There is also a need to clarify the roles and responsibilities of entities at the central government level that participate in different stages of expenditure management, i.e. the MHCP, DNP, CGR, CGN and the sector ministries. For instance, the DNP spends a considerable amount of its time on technical and financial evaluation of programs and projects proposed by sector ministries because the ministries do not provide it with the results of such evaluations. Also, agencies monitoring public spending impose multiple reporting requirements on line agencies, often calling for the same information. Besides increasing the compliance overload of the agencies, this leads to proliferation of mutually inconsistent information that affects the quality of programming and budgeting decisions. In recent years, there has been constant pressure to increase public expenditures. Many factors have contributed to this trend, including decentralization, the need to improve income distribution, efforts to enhance the credibility and legitimacy of the state, increased involvement of citizens in public decision making and an aversion amongst politicians to saying no. Thus, in the last decade, fiscal results of the central government have changed from a surplus of 0.5t of GDP in 1990, to an estimated deficit of 6.3w of GDP in 1999. Total gross public expenditure for all programs increased from 24t of GDP in 1990 to 31t in 1998. Partly - 6 -  due to political incentives and partly due to deficiencies in tools to accurately forecast economic trends, revenues and expenditures, there is a tendency to overestimate revenues and underestimate costs. The consequent relaxation of the budget constraint allows low priority programs and projects to be included in the budget. The situation is worsened by the inadequacy of systems to evaluate programs and projects and by deficiencies in the capacity of the sector ministries to carry out such evaluations effectively. The MHCP and DNP also suffer from lack of reliable information about per unit cost of inputs and outputs of different sectors. This affects their ability to properly evaluate budget requests. As a result of unrealistic budget estimates as well as macro-economic shocks, the government has been unable to execute a significant portion of budgeted expenditures due to non-availability of resources. Until recently, unexecuted spending commitments and unpaid bills were rolled over to the following year and were financed out of that year's revenues. Such rollovers have the effect of reducing the government's ability to properly match public expenditures to strategic priorities of a particular year. The problem is particularly felt at the time of change of government. For a significant part of its term an incoming government continues to spend money based on the priorities of the previous one. Fiscal arrears have more than doubled from 1.0% of GDP in 1990 to 2.6 % in 1998 and are a major concern of the current government. To begin to tackle this problem, the budget law of 2000 provides that commitments carried over to the next year be subtracted from the budget appropriations of the concerned entity for that year.Constitutionally mandated transfers to territorial entities have increased from 29% of total revenues in 1990 to 42.9% in 1998. These are targeted to increase to 46.5% in 2000. Mineral royalties are also earmarked. These entitlements, when combined with mandatory expenditures on salaries and debt service, cover close to 90% of the national budget. As a result, the degrees of freedom available to the Central government to implement its policy priorities through changes in expenditure patterns are extremely limited.The DNP is in charge of formulation of the National Development Plan and the budget for capital expenditures. The MHCP is responsible for the preparing the recurrent budget. This division of responsibilities has led to problems in integration of investment and recurrent expenditures, although, recently, efforts have been made to improve coordination between these two entities as well as with the CGR, through an inter-institutional agreement.The norms for formulation and execution of the budget need to be consolidated and streamlined. (ii) Budget Execution, Treasury, Public Credit and Accounting:Current deficiencies in the field of budget execution, treasury, public credit and accounting are the following:As mentioned above, when actual revenue collections do not come up to expectations, the government has to frequently resort to cash-flow driven cuts in expenditure. In effecting these cuts, it suffers from the same information deficiencies that affect decisions at the planning and budget formulation stage. As such, budget cuts are often made in an arbitrary manner without full knowledge of their economic costs. The Integrated Financial Management Information System (SIIF) developed with the assistance of the PFMP needs to be extended to the regional offices of central government entities. The functionality of the system needs to be enhanced based on user feedback. Also, to increase the coverage of the budget by the system, a modified version of the system needs to be developed for implementation in decentralized entities that receive funds from the national budget. Further, in order to eliminate - 7-  the proliferation of accounting systems used by different projects funded by external donors and increase control over funds executed by these projects, a new module of the SIIF needs to be developed that would allow both the execution of project funds through the system as also compliance with reporting requirements of donors. The Treasury manages various investment portfolios. However, its current portfolio management system is inadequate and needs to enhanced to improve control of investment transactions and optimize returns on investment. The debt management system of the Directorate of Public Credit (DPC) also needs to be replaced. While the system has adequate information about external debt, it suffers from various deficiencies, including the inability to connect with the SIIF and the lack of the functionality to allow debt service and cash flow projections.In the area of accounting, there is a need to improve the quality of accounting information generated by public entities, especially those not covered by the SIIF; strengthen the information systems of the Office of the CGN to improve its capacity to consolidate accounting information pertaining to the national, decentralized, and territorial levels; and provide additional training to public officials in the evolving accounting norms and practices.(iii) Evaluation of Results of Public Expenditure:Colombia has pioneered a comprehensive National System for Evaluation of Results of Public Sector Performance (SINERGIA) to institutionalize systematic evaluation of government policies, programs, projects and entities. While considerable progress has been made, given the major paradigm shift being pursued, not surprisingly, progress has been slow. The uncertainty of budgeted funds remains a major impediment in enforcing compliance with agreed performance targets. Further, performance is still not linked to specific incentives or penalties. The current version of the information system supporting SINERGIA also needs to be improved. At present it monitors performance only with respect to investment expenditures. It needs to be extended to cover recurrent expenditures as well. Further, the system needs to be extended to public enterprises and territorial entities. There is also a need to systematically analyze incentives faced by public sector managers in executing the budget, so as to develop insights that would help modify the incentive system in a manner that would promote achievement of organizational objectives. In addition, it is important to improve the dissemination of the objectives, performance evaluation and budgetary results of public entities to civil society and the public, to improve transparency and accountability.(iv) Government Procurement and Contracting: One of the areas that was not included in the PFMP, but has a major impact on the results of public expenditure is government procurement and contracting. A draft Country Procurement Assessment Report (CPAR) dated September 2000 highlights the strengths and weaknesses of the Colombian legal and administrative public procurement framework and makes specific comments to improve it. There is a wide consensus that procurement and contracting activities need to be made more transparent and efficient. The legal framework, consisting of Law 80 of 1993 and around 80 regulatory decrees and other laws, over-regulates public procurement and has introduced opportunities for corruption. Over-regulation and the high concern with corruption has in turn led to an environment of mutual distrust between the government and those doing business with it. There is a lack of institutional leadership in the area that makes it difficult to develop and improve the public procurement framework on an ongoing basis. Also, there is no system to monitor and evaluate procurement practices. Finally, the government is yet to develop - 8 -  a capacity for disseminating procurement opportunities, bidding documents and contract awards to the public via the internet, or to carry out procurement transactions on-line. Before the CPAR was completed the Government submit to Congress a bill amending Law 80. The proposed bill would, however, benefit from further improvements, which the Government is inclined to make. The DNP is promoting a series of meetings with the parties concerned to review the bill and propose changes.Government Strategy: The government is taking various steps, in addition to those mentioned above to improve public expenditure management. A number of major reforms have been undertaken including a Fiscal Responsibility Law to reduce the level recurrent expenditures at the local and departmental level, a bill to amend the constitution to freeze, in real per capita terms, future transfers to local governments, and a law authorizing lottery and gaming activities to contribute resources to pension and health insurance funds. In addition, the Government plans to submit to Congress legislation which aims to complete the reform of social security, including the elimination of several special regimes and an increase in the retirement age. With regard to public procurement, as mentioned before, the government has presented proposals for amendment of Law 80 to improve procurement and is considering other actions to improve it. At the operational level, the government proposes to use the resources provided by this project, to continue improvements in national public expenditure management and deal with the capacity deficiencies discussed above. For strengthening financial management capacity at the territorial level, the government is being assisted by the IDB. 2. Objectives a. Strengthen the institutional capacity of the Direcci6n de Impuestos y Aduanas Nacionales (Directorate of National Taxes and Customs- DIAN) to foster voluntary compliance; collect revenues efficiently, effectively and equitably; and combat tax evasion and smuggling so as to enable it to mobilize adequate tax revenues to finance public expenditures. b. Strengthen public expenditure management at the central government level, to facilitate achievement of fiscal and national development objectives, improve cost effectiveness of public services, and increase transparency and accountability. 3. Rationale for Bank's Involvement The Bank has been actively involved in supporting public financial management reforms in Colombia for the last six years. In the process it has acquired considerable country specific knowledge of the issues that need to be dealt with. This, coupled with the its international and regional experience in similar projects, would help the Bank provide high quality assistance to the Borrower, enabling it to consolidate the reforms initiated by the PFMP and dealing with deficiencies that remain to be addressed. Also, as has been the experience with the PFMP, as a disinterested party focused on achieving the development objectives of the project, the Bank would be able to help overcome inter-institutional boundaries and catalyze cooperation between different counterpart agencies in areas that require concerted action. 4. Description The project would provide consulting services, training and goods to support activities under three components: Revenue Administration, Public Expenditure Management and Project Managementa. Revenue Administration: - 9-  US$36.02 millionSub-component 1: Strengthening Organization and Management of the DIAN: $13.64 million: This sub-component would support a range of activities aimed at strengthening critical areas of the organization and management of the DIAN, including strategic planning and management, personnel management and professional development, prevention and control of corruption, information management, management of notifications, official correspondence and archives, and change management.Sub-component 2: Facilitating Voluntary Compliance: $6.50 million: This sub-component would help promote voluntary compliance by supporting the setting up of Integrated Taxpayers Education and Assistance Centers; training external stakeholders in tax and customs policy and procedures; expanding the reach and scope of electronic interaction between the DIAN and its clients; making the Office of the Taxpayer Ombudsman fully operational; and fostering a tax compliance cultureSub-component 3: Improving the Effectiveness of the DIAN in Managing Routine Processing of Tax Declarations and Payments: $ 1.23 million: This sub-component would assist in increasing the efficiency and productivity of routine tax administration operations by supporting the updating and enhancement of systems for registration of taxpayers, accounting of revenue collections and control of refunds and credits. It would also help develop and implement a system for assessment of small and medium enterprises covered under a special tax regime.Sub-component 4: Improving the Effectiveness of the DIAN in Managing Routine Processing of Cargo, Customs Declarations and Payments: $9.61 million: This sub-component would support the improvement of routine customs operations, such as cargo processing, processing of customs declarations and payments, release of merchandise, monitoring and control of warehouses and sale of confiscated goods. It would also assist in enhancing the taxpayer current account to include customs transactions.Sub-component 5: Strengthening the Capacity of the DIAN in Enforcement Operations: $ 4.57 million. This sub-component would support the building up of the enforcement capacity of the DIAN by strengthening economic studies, management of external information, intelligence operations, risk analysis, audits, investigation and inspections, monitoring of filing of declarations and payments, control of VAT invoices, recovery of tax arrears and legal and appellate functions.Sub-component 6: Improving Policy and Legal Framework of Revenue Administration: $0.45 million: This sub-component would support the review and revision of tax and customs policy, laws and regulations, and strengthen the ability of the DIAN to participate in international tax and customs treaty negotiations.b. Public Expenditure Management : US$ 18.51 million Sub-component 1: Improving Macro-programming and Formulation and Monitoring of the Budget: $6.09 million: This sub-component would (a) assist in clarifying and adjusting the roles and responsibilities of different entities that participate in the programming, budgeting, execution and evaluation of public expenditures; (b) develop, enhance and implement models and information for (i) medium term and long term macro-economic projections and simulations, (ii) evaluation of expenditure and revenue policies to assist in decisions regarding reforms in the fiscal structure, (iii) generation of consolidated economic, fiscal and budgetary accounts of the public sector, (iv) classification of budget execution information contained in the SIIF according to economic categories, and (v) monitoring of public sector finances, to improve macro-programming; (c) develop, improve and implement methodologies and systems for (i) analysis of budget programming, (ii) quantification of expenditures earmarked by different laws and development - 10 -  of options for reforms aimed at reducing earmarking, (ii) projection of revenues, with interfaces with information systems of the DIAN, (iv) calculation of unit costs of inputs and outputs, initially for the Transport Sector and the Judicial Branch and, subsequently, for the Education and Health Sectors, (v) formulation and monitoring of the investment budget of the central government (vi) analysis of public policies, programs and projects, (vii) projection of cash flows of the non-financial public sector, and (vii) financial monitoring of the budget; (d) improve interfaces between the information systems of the Budget Directorate of the MHCP and those of the sector ministries, to improve budget formulation and monitoring; and (e) implement existing inter-institutional agreements between the MHCP, DNP and CGR to reduce the costs of monitoring of budgetary expenditures, by identifying shared information needs, eliminating duplicate reports, establishing primary sources of information and developing systems to provide access to these sources.Sub-component 2: Strengthening of Budget Execution, Treasury, Public Credit and Accounting: $9.70 million: This sub-component would provide assistance to (a) extend and enhance the Integrated Financial Management System (Sistema Integrada de Informaci6n Financiera - SIIF) by (i) implementing it in 145 regional offices of central government entities; (ii) developing a modified version of the system for decentralized entities partially funded by the central budget and implementing the system in 11 major entities that spend about 12% of the national budget; (iii) enhancing the functionality of the system in accordance with user feedback and increasing its capacity to include additional users; and (iv) developing a module of the system to allow execution and accounting of externally funded projects through the system; (b) develop and implement a system to improve the capacity of the Treasury to better manage its investment portfolios; (c) develop and implement a new system for management of the public debt portfolio; and (d) improve the quality of accounting information in public entities by (i) enhancing mechanisms for the registration and reconciliation of accounting records covering income, debt transactions, expenditures and physical assets; (ii) supporting dissemination, advisory services and training to improve accounting practices; and (iii) strengthening the information systems of the Office of the Accountant General of the Nation, to capture and integrate accounting information at the national, decentralized, and territorial levels. Sub-component 3: Improving the Evaluation of Results of Public Expenditure: $ 0.73 million: This sub-component would (a) support the enhancement the National System for Evaluation of Results of Public Sector Performance (SINERGIA) by (i) expanding the project evaluation module to include recurrent expenditures in the evaluation process, (ii) developing new modules for strategic evaluations of different sectors and evaluation of performance of territorial and decentralized entities; (iii) developing a table of incentives linked to evaluation of results and implementing the incentives in two pilot sectors, namely Transport and Mines and Energy; and (iv) developing a methodology for identification of inputs and outputs of different sectors to establish efficiency standards for each sector; and (b) design and implement dissemination strategies to provide information to the public on performance targets for different policies, programs, projects and public sector entities, evaluation of the actual results achieved and the amount of money spent in the process, with a view to increase the transparency of public sector operations.Sub-component 4 : Strengthening Public Procurement and Contracting: $ 1.99 million:This sub-component would - 11 -  provide assistance to (a) develop legislation and regulations to support modifications to the Procurement and Contracting Law (Law 80) with a view to improve the legal framework for public procurement; (b) design and implement institutional arrangements, including the possibility of establishing a national body, for developing and regulating public procurement and contracting policy; standardizing and disseminating procedures, bidding documents and contracts; and assisting central and territorial entities in procurement and contracting matters on an ongoing basis; (c) develop and implement a system for monitoring and evaluation of procurement and contracting practices in the public sector, piloting the system in two central level entities, one decentralized entity and two territorial entities; (d) design and implement an internet based public procurement information system aimed at disseminating all information regarding procurement notices, bidding documents and contract awards to interested parties and the public, thereby setting the basis for online public procurement; and (e) carrying out a survey to determine procurement training needs and developing a pedagogical system aimed at providing public sector personnel with learning tools relating to the conceptual, technical, legal and procedural aspects of public procurement and contracting.c. Project Management: $ 4.57millionThis component will finance consulting services, equipment and training for the staff of the two Project Management Units, one at the MHCP and the other at the DNP; communication of project objectives and activities to stakeholder; and surveys to collect data on key performance indicators and obtain stakeholder feedback. A. Revenue Administration Public Expenditure Management Project Management 5. Financing Total ( US$m) Total Project Cost 58.88 6. Implementation A. Project Management: The project management arrangements will broadly follow the arrangements that have been successfully employed for the ongoing Public Financial Management Project (PFMP). Project activities will be divided into two clusters. Cluster 1, covering activities related to the MHCP, DIAN and CGN will be managed by Project Management Unit - MHCP (PMU-MHP) and cluster 2, covering activities related to the DNP, will be managed by Project Management Unit - DNP (PMU-DNP). A Coordinator General will oversee the activities of both the PMUs and ensure that the overall objectives of the project are met, inter-dependent activities are properly coordinated across organizational boundaries and fiduciary safeguards are adhered to. PMU-MHCP will consist of the following staff: n Technical Coordinator- DIAN, responsible for executing activities related to revenue administration, in close coordination with the management and staff of the DIAN.fn Technical Coordinator - Public Expenditure Management, responsible for executing activities pertaining to expenditure management in collaboration with the management and staff of the MHCP and CGN.fn Technical Coordinator - SIIF, responsible for the enhancement and expansion of the SIIF. He will work closely with the Technical Coordinator - Public Expenditure Management.n Project Administrator, responsible for developing the Annual Operational Program (Programa Operativo Anual - POA); managing procurement, accounting, - 12 -  financial reporting, disbursements, audits and project reporting.n Procurement Team consisting of a Procurement Officer and an Informatics Specialist, responsible for carrying out the selection and recruitment of consultants and the procurement of goods and other services required for the project in accordance with the relevant Bank Guidelines. The team will work closely with the procurement specialists at the UNDP who would, inter alia, ensure adherence to Bank Guidelines, invite bids, finalize contracts, clear goods through customs and make payments to suppliers and consultants.n Financial Management Specialist/Accountant, responsible for accounting, disbursements, financial reporting, auditing and adherence to Bank guidelines for project financial management. The Financial Management Specialist will also assist the PMU-DNP as needed and will be responsible for consolidating the accounts of both the PMUs into comprehensive project accounts. He/she will also coordinate disbursement and accounting activities with the UNDP.n Two Secretaries.PMU- DNP will consist of the following staff:n Technical Coordinator/ Project Administrator, responsible for coordinating public expenditure management activities within the DNP and developing the Annual Program of Operations (Programa Operativo Anual - POA); managing procurement, accounting, financial reporting, disbursements, audits and project reporting. n Project Officer, to assist the Technical Coordinator/ Project Administrator in the discharge of her functions.n Technical Coordinator, Public Procurement Reform, responsible for the implementation of the Public Procurement component.n Accountant.n Secretary.Since project activities relate to multiple, autonomous organizations, it would be very important to ensure effective coordination. For this purpose a high level Project Coordination Committee (Comite de Coodinaci6n - COCOR) consisting of the Vice Minister, MHCP as Chairman; the Sub-Director, DNP; the Director General, DIAN; the National Accountant General; the Vice-Comptroller General of the Republic and the Coordinator General will be set up to provide leadership and oversight to the project. The Coordinator General will act as the Secretary of the COCOR. The COCOR will review the progress of the project, resolve implementation problems and bottlenecks, approve the POAs and project budgets and reallocate funds between components and activities as needed. The COCOR will meet at least once every three months.To ensure coordination at the technical level, two Technical Coordination Committees (TCCs) would be established. The Technical Coordination Committee - DIAN will be headed by the Director General, DIAN and will have the Director of Taxes, the Director of Customs, the Secretary General, DIAN, Secretary General - Institutional Development, the Head of the Office of Information Systems, the Coordinator General and the Technical Coordinator - DIAN (Member-Secretary). This Committee will deal with technical issues related to the implementation of project activities in the DIAN. The Technical Coordination Committee - Public Expenditure Management will consist of the Directors of Macro-programming, Budget, Treasury and Public Credit, MHCP; Heads of the Macro-programming, Budgeting, Public Investment and Finance, Territorial Transfers, Evaluation and Social Development Units of the DNP; representatives of the Fiscal Council (Consejo Fiscal- CONFIS), the Office of the National Accountant General and the Office of the Comptroller General of the Republic; the Coordinator General, the Technical Coordinator/ Project Administrator - DNP, the Technical Coordinator - SIIF and the Technical Coordinator - PEM, MHCP (Member- Secretary).As with the ongoing PFMP, in order to ensure smooth flow of project funds and timely and efficient execution of procurement - 13 -  contracts, GOC will engage UNDP under a Management Service Agreement. Since UNDP cannot enter into a competitive selection process as required by IBRD guidelines, the administrative fees paid to it would be financed out of counterpart funds. B. Financial Management Arrangements:a. Accounting and Financial Reporting : While the PMUs in charge of the project have gained experience in project accounting through the execution of the ongoing Public Financial Management Project since 1994, the current financial management system needs to be reinforced and expanded in line with the new financial management requirements of the Bank. In compliance with the conditions outlined in the Bank's Project Financial Management Manual (February 1999), a Financial Management Specialist carried out the required project financial management assessment to determine the capacity of the PMUs to observe present Bank financial management standards during project implementation (see Annex 6). An Action Plan to deal with observed deficiencies was agreed with project management. A follow up visit by a Financial Management Specialist and the progress made by the PMUs in meeting the requirements of the Action Plan indicate that the project meets the Bank's minimum financial management standards. A revised Action Plan has been prepared to further strengthen project financial management capacity. An Action Plan to enable the PMUs to produce Project Management Reports will be implemented within six months of effectiveness. Within the GOC counterpart contribution, there is an amount of US$8.5 million which will be shown in the national budget as the investment budget of the DIAN and not of the project. This amount will finance some of the activities included in the Revenue Administration component of the project, which will be directly executed by the DIAN, in line with the Action Plan agreed with the IDB. Since the funds will be spent in accordance with the National Budgetary and Procurement laws, special arrangements for monitoring of these funds have been agreed. These are: (i) the monitoring of the activities and the expenditures incurred will be carried out ex-post by the PMU and Bank supervision missions; (ii) the DIAN will submit quarterly reports showing the scope of activities carried out, categories of expenditure, physical progress achieved and the impact of such activities; and (iii) on that basis, the PMU financial specialist will consolidate the information and prepare all the required reports for the IBRD, national authorities and audit.b. Procurement: The PMU-MHCP will have a procurement team consisting of a Procurement Officer and an Informatics Specialist, who would look after procurement and contracting activities related to the project. In the PMU-DNP this function will be performed by the Technical Coordinator/ Project Administrator and the Project Officer. UNDP will be hired through counterpart funds to provide procurement management support and will work closely with the PMUs. Procurement of goods under the proposed project will be carried out in accordance with the latest version of Bank's "Guidelines for Procurement under IBRD Loans and IDA Credits". Consultants will be recruited in accordance with the latest version of "Guidelines: Use of Consultants by World Bank Borrowers and the World Bank as Executing Agency". A procurement capacity assessment has been carried out, with procurement risk being rated as "average". Procurement methods and thresholds for prior review have been agreed. Please see Annex 6 for more details.c. Monitoring and Evaluation Arrangements: The project would be implemented on the basis of an annual work program called "Programa Operativo Anual"(POA). The POA is being used by the ongoing project. The POA for each calendar year would be submitted to the Bank by the preceding October 31 for approval. The POA would contain details of activities to - 14 -  be executed during the year and the resources required, source of financing, time table, performance indicators and institutional responsibility for each activity. Further, in keeping with Bank financial management guidelines, (OP/BP) 10.2., project management reports (PMRs) would be submitted. The PMRs would comprise of financial reports, progress reports, and procurement reports. The format of these reports will closely follow the guidelines in the Project Financial Management Manual (IBRD, February 1999). The reports will reflect all project financing and expenditures, including those expenditures that are financed outside of the PMU. It was agreed, that the PMUs will prepare quarterly PMRs, to be consolidated by the PMU - MHCP for review by the COCOR and the Bank. The project would be supervised by the Bank on an ongoing basis, with at least two field supervision missions each year. A mid-term review of the project would be carried out in the third year of project implementation. d. Auditing Arrangements: The Comptroller General of the Republic (CGR) by law conducts the audits of public sector programs, including IBRD projects. Accordingly, this project would also be audited by the CGR. Audits of accounts and the financial statements of the project, including a separate opinion on Statements of Expenditures, would follow accounting and auditing procedures satisfactory to the Bank. All supporting records would be maintained at least one year after the completion of the project. A consolidated audit report would be submitted to the Bank no later than four months after the end of each fiscal year. The audit would cover project expenditures until such time as the loan has been closed. To ensure timely submission of the audit reports to the Bank, the CGR will be asked to submit within six months after loan effectiveness its report on the review of Project Internal Controls. Arrangements will also be made with the CGR to ensure its involvement in project audit early in the fiscal year, thus, enabling it to complete the audit process in a timely manner. The use of Bank guidelines on project audits and the terms of reference of Auditors will be agreed before negotiations.e. Disbursement Arrangements: GOC would sign a Management Service Agreement (MSA) with UNDP, similar to the MSAs currently in place under the on-going project, to manage both loan and counterpart funds. The MSA agreement would have the advantages of allowing the project a more predictable access to funds due to budgetary regulations governing this type of agreement. UNDP also has ample experience in international procurement and has tax exemption status. Under the MSA arrangement, IBRD will make disbursement directly to the General Account of the UNDP in New York. Payments will be made out of this account by UNDP in dollars or in local currency. The PMUs would still have full responsibility for the financial management, monitoring and reporting of the project and for preparing all aspects of the processes related to the procurement. UNDP will act as an internal auditor by guaranteeing that all procurement rules and guidelines are followed. It will also review all contracts executed under the project from the legal point view. UNDP will sign all contracts and pay the beneficiaries of the contracts. It will transfer all goods purchased to the executing agencies. 7. Sustainability The critical factors on which the sustainability of project benefits would depend include: continuing public demand for improvements in quality of public services, particularly, in revenue administration, public expenditure management and public procurement and contracting; sustained commitment of the government at the political, managerial and technical - 15 -  levels to whole-heartedly implement project activities and support the updating and maintenance of project outputs after the project closes; the willingness of the government to base critical revenue enforcement and resource allocation decisions on the objective information generated by different tools and systems provided by the project, rather than on purely political considerations; and the effectiveness with which change management strategies are implemented. 8. Lessons learned from past operations in the country/sector A number of lessons learned in the course of implementation of the PFMP and similar projects have been incorporated in the project design. These include:A project dealing with fundamental reforms in revenue administration (RA) and Public Expenditure Management (PEM) can succeed only if it has strong borrower commitment. In order to achieve this, it has been ensured that the project addresses real Borrower needs in both the areas and is in line with the Borrower's strategic priorities. Also, different agencies of the Borrower have been closely involved in preparation of the project, so as to build ownership of the proposed reforms. While computerization is necessary to improve efficiency and effectiveness in RA and PEM, it is not sufficient. It is imperative to address underlying institutional weaknesses in order to achieve lasting results. Therefore, a well-rounded institutional development approach has been adopted. While supporting extensive information technology investments, the project would also deal with issues relating to the normative framework, incentives, human resources, organizational arrangements, management systems, business processes and training. In addressing institutional weaknesses, it is not enough to focus on formal rules of the game. The informal rules must be taken into account. Consequently, informal rules have been specifically examined while diagnosing both RA and PEM, and to the extent possible project interventions have been designed to address problems related to both formal and informal rules. In reforming organizations, it is important to take into account the environment in which they operate. Accordingly, environmental factors of both the RA and PEM have been examined in detail at the diagnostic stage and an attempt has been design project activities that would strengthen the positive effects of the environment and reduce its negative influences on the targeted organizations.Institutional development is an iterative multi-year process. For this reason, the project has been designed to support second generation reforms, building on the progress made under the PFMP.Competent leadership of the project is essential. The project leader should have adequate authority to overcome inter-organizational hurdles and push reforms. For this purpose, the project will be headed by the Vice Minister, MHCP. It would also have a Coordinator General of sufficient stature to lead day to day implementation activities.Due to their regular responsibilities, it is very difficult for line managers and staff to devote adequate attention to longer term modernization activities. Yet their inputs are crucial to project success. Therefore, it is essential to create a dedicated group of individuals who are devoted full time to implementation of project activities, but work closely with line staff. To address this need, Project Management Units, consisting of consultants and regular employees, have been designed to coordinate project activities with line agencies and facilitate implementation. Also two Technical Coordination Committees and a high level Coordination Committee have been created to ensure smooth inter-institutional cooperation and an synchronized approach in activities - 16 -  involving more than one organization. 9. Program of Targeted Intervention (PTI) N 10. Environment Aspects (including any public consultation) Issues The project is classified as Category C and has been cleared by LCSES on October 6, 2000. 11. Contact Point: Task Manager Jit Bahadur S. Gill The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: (202) 473-6771 Fax: (202) 522-3133/34 12. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final project. This PID was processed by the InfoShop during the week ending February 9, 2001. - 17 -