Ending Off-Budget Military Funding: Lessons From Chile – Analysis

By Dr Diego Lopes da Silva and Dr Nan Tian*

In September 2019, Chile enacted legislation to abolish its off-budget funding mechanism of arms acquisitions for its armed forces and replace it with a more transparent and accountable funding system.

Off-budget funding for the military is not unique to Chile: Indonesia, Myanmar, Peru, Turkey and Venezuela also systematically rely on off-budget revenue to partially fund their armed forces. Other countries, such as Mozambique, Nigeria and South Sudan, use ad hoc off-budget transactions. Chile now stands out though, because it has reformed its funding system to end off-budget allocations to the military. The process that led to Chile’s reform thus offers important lessons to those countries that plan to introduce or remove off-budget mechanisms.  

Chile’s 60-year-old off-budget system

Chile’s 1958 Restricted Law on Copper (Ley Reservada del Cobre) required the state-owned National Copper Corporation (Corporation Nacional del Cobre, or Codelco) to transfer a certain share (10 per cent since 1973) of revenues from its copper exports to pay for arms acquisitions and equipment maintenance for the armed forces.

These transfers were significant, corresponding to roughly one-quarter of Chile’s military expenditure. The Copper Law was restricted in the sense that its full text was secret. Moreover, transactions under this law were conducted outside the state budget, lacking congressional approval and scrutiny from oversight institutions. Given the opacity of Chile’s military procurement as well as the lack of civilian control over the budgeting process, the Organisation for Economic Co-operation and Development (OECD) deemed the Copper Law ‘highly inappropriate from a budgetary point of view’. 

In September 2019 Chile partially replaced the Copper Law with new legislation. The new funding system for arms acquisitions and other military investment is composed of a Multi-year Fund for Strategic Defence Capacities and a Strategic Contingency Fund. In the future, the Chilean National Congress must approve allocations for arms acquisition and military investment, thus officially ending the use of off-budget funds. Likewise, the oversight powers of the Comptroller General—the government audit office—have been expanded to encompass all financial activities involving these funds.

The derogation of the Copper Law, that is, its partial repeal by the enactment of the new funding system, involves a transition plan. Funds from the copper tax will be gradually phased out over 12 years: the 10 per cent tax on copper exports will remain until 2028 and will then decrease by 2.5 per cent each year until it disappears in 2032. During this period however, copper revenues will no longer be transferred directly to funds for arms acquisitions controlled by the armed forces; instead, they will be made available to all sectors of government through the regular state budget. 

Off-budget military transactions

Off-budget military transactions encompass all revenue, expenditure and funding that is not included in the state budget. Their inherent opacity appeals to some armed forces given the culture of secrecy that often surrounds the military sector. 

Off-budget military funding mechanisms contravene several principles of public expenditure management. They privilege the armed forces in resource distribution, disregard financial discipline, lack legitimacy and harm transparency. Such off-budget transactions prevent an accurate assessment of the opportunity costs involved in military funding as no information on actual expenditure is given. While these transactions are often justified on the grounds that military funding requires stability, governments have instead used them to secure the political support of the armed forces.

Although off-budget transactions can take many forms, the reliance on revenue from exports of natural resources is frequent. Institutionalized off-budget mechanisms, such as the Copper Law, levy taxes on exports or extract royalties. These transactions can have harmful effects on the economy. For a country’s budget, it decreases the funds that could be used to support macroeconomic stability during economic downturns. Additionally, when off-budget revenues stem from taxing a specific company, it limits that company’s investment capabilities, severely hindering its competitiveness and economic performance.  

Repealing the Copper Law: Why now?

While the inadequacy of the Copper Law has been discussed since Chile’s return to democracy in 1990, it was only in 2011 that the Congress introduced a bill to create a new funding system for the armed forces. The bill argued that Congress should not be excluded from relevant decisions such as arms acquisitions. Civil–military relations and institutional oversight had improved considerably since the return of democracy. The exclusion of the Congress and the absence of a wider debate regarding the military budget was thus out of line with Chile’s democratic maturity.

The bill reached the Senate in 2012, where it remained without any progress until 2018. Meanwhile, however, parallel efforts made important headway. In 2015, the Defence Commission introduced a motion to make the content of the Copper Law publicly available. After a positive outcome, the Senate approved the motion unanimously. In December 2016, the complete content of Chile’s Copper Law and its amendments since 1958 became publicly available.

The debate over the Copper Law gained momentum in the wake of several corruption cases involving high-ranking military officials. Between 2010 and 2014 it is estimated that around $11 million was misappropriated through irregular arms acquisitions. In 2018, army officers were charged with fraud in the so-called Milicogate case. This was taken as evidence of the growing strength of the civil authorities in relation to the armed forces. A congressional investigative commission on this corruption recommended the development and strengthening of control systems, the repeal of the Copper Law and the creation of alternative forms of funding of the armed forces. 

Corruption also amplified economic arguments against the legislation. The obligation imposed on Codelco represented a heavy burden. The fall in copper prices from mid-2017 substantially strained the company’s finances. Moreover, the automatic transfer of revenues to the armed forces hindered Chile’s counter-cyclical financial policies: the Copper Law limited the funds transferred to the Economic and Social Stabilization Fund (ESSF), the country’s main instrument to cope with economic downturns.

The conjunction of corruption charges with lower copper prices fuelled Chile’s efforts to repeal the Copper Law. In 2019 the Senate Defence Commission finally approved the 2011 bill, establishing a new funding mechanism for the armed forces. It is noteworthy that, at that time, centre-left parties held the majority of seats in both the Senate and the Chamber of Deputies, but the presidency was held by Sebastián Piñera, elected on a centre-right platform. Piñera continued the efforts of his predecessor—Michele Bachelet of the centre-left—to end the legislation. The agreement of both sides of the political spectrum on the need to finally revise Chile’s arms acquisition funding is a testimony to the harmful impact of the Copper Law.  

Chile’s new funding system for strategic national defence capacities: Is it better?

The goal that drove the enactment of a new funding system for arms acquisitions and other military investments was reconciliation of the need for financial stability with transparency and democratic participation. As President Piñera put it, the new system is ‘an additional step towards the normalization of relations between civil society and the armed forces’. From 2020 onwards, the new Multi-year Fund for Strategic Defence Capacities will cover investments in military equipment and infrastructure. A second instrument, the Strategic Contingency Fund, will provide funds to address unforeseen circumstances related to national security.

Chile’s new funding system introduces important mechanisms of democratic control. The Congress must approve the annual allocations to the Multi-year Fund, levied through regular taxation. This officially ends off-budget funding as resources will now be integrated into Chile’s national budget. The minister of national defence must present to the Congress an investment plan aligned to Chile’s Defence Policy as a basis for the vote on the budget, thus redressing the historical mismatch between strategic planning and arms acquisitions in Chile. Likewise, the minister must report back to the Congress on the development of investment plans, granting the Congress further supervision over the process. To address the lack of transparency that led to the Milicogate case, all financial activities will be audited by the Comptroller General, a substantial improvement in oversight.

A special council presided over by the undersecretary of defence with representatives from the Ministry of National Defence, the Ministry of Finance and the Presidency, will manage the Multi-year Fund. While the involvement of different parts of government creates a power-sharing structure less prone to corruption, the authorization of funds will be made via a joint secret decree exclusively by the Ministry of National Defence and the Ministry of Finance.

The Multi-year Fund will be financed by congressionally approved allocations, in addition to a one-off contribution of 55 per cent of all surpluses that have arisen from the Copper Law. Such allocations must meet a historical six-year average baseline. Thus, while the Congress will approve annual allocations to the Multi-year Fund, the historical baseline rule will restrict its decision-making power since the allocations cannot fall short of that baseline.

Despite introducing significant improvements, the new funding system still falls short of best practices of public expenditure management. The baseline requirement privileges the armed forces in resource distribution. Likewise, it hinders financial discipline as the baseline must be met regardless of current resource constraints. The secrecy of the decrees to authorize the funds is also harmful to transparency; whereas allocations to the Multi-year Fund are included in the national budget, actual expenditure figures will remain unknown.   

Lessons that can be learned

Off-budget military transactions are relatively common. For example, Venezuela transfers money from oil revenues to the armed forces through its National Development Fund (FONDEN). The Presidency is the sole manager of the fund, with no oversight by the National Assembly. SIPRI estimates that between 2005 and 2015 off-budget transactions increased Venezuela’s annual military spending levels by 26 per cent above the officially approved level. Peru has a similar funding system whereby natural gas revenues are transferred to the Fund for the Armed Forces and National Police. There are also cases where off-budget instruments are not institutionalized, but ad hoc transactions are made. Nigeria, for example, has occasionally used surpluses from the state-owned Nigerian National Petroleum Corporation to fund arms purchases outside the approved budget and without legislative approval.

The Chilean case presents features that can be generalized to other countries with off-budget military funding mechanisms. 

First, the lack of transparency and oversight of military transactions based on the Copper Law created a corruption-prone environment that enabled misconduct by army officials. Arms procurement processes are particularly susceptible to bribery and fraud due to the secrecy that surrounds them. The military sector, however, is only seldom covered by anti-corruption policies. As the Chilean case and other examples of military corruption exemplify, the military should not be exempt in this way.

Second, linking public expenditure to a company’s performance, or to commodity prices in general, renders the state accounts vulnerable to market fluctuations. Paradoxically, the opposite effect was originally intended by the Copper Law. Earmarked transfers to the armed forces have proven to be harmful to a country’s economy. Codelco’s commitment to transfer 10 per cent of its export revenues to the military led to a deficit. Moreover, such transactions not only contravene sound macroeconomic policy but also exacerbate the opportunity costs of military spending by absorbing funds that could have been used in other ways—in the ESSF or in other public sectors. Thus, off-budget military transactions can also hinder efforts to address poverty and inequality. 

A third, significant lesson that can be learned from the Chilean experience concerns civil–military relations. The armed forces oversaw Chile’s transition to democracy, and so were able to secure institutional enclaves. The maintenance of the Copper Law in the aftermath of the transition to democracy was a sign of the budgetary autonomy that the armed forces were able to maintain. By the early 2010s, the civilian authorities were strong enough to start reducing the remaining military privileges. In that sense, the prosecution of army officials for corruption was a milestone in Chile’s democratic history, attesting to the growing strength of civil authority in relation to the armed forces. Thus, reforms in military funding systems require solid institutions and the prevalence of civil authority over the armed forces.

The Copper Law lasted for over 60 years and its phasing out will take 12 more years. The inertia of the Copper Law is a cautionary tale for countries that are considering instituting off-budget mechanisms: once in place, they are remarkably resilient. Chile’s new funding system has inherited vices from its predecessor: the baseline contribution and the secrecy surrounding expenditure. This suggests that once privileges are institutionalized, reform will be slow and difficult to achieve. Nevertheless, although arduous, reforming opaque funding systems has worthwhile benefits.  

Chile’s efforts to promote transparency are not yet complete

The repeal of the Copper Law cannot be attributed to a single factor. Rather, it was the outcome of an auspicious alignment of interests—both economic and political—driven by the misuse of copper funds for self-enrichment. While the Chilean process had unique characteristics, the repeal of the Copper Law is full of useful insights for other countries that aim to abolish off-budget systems. The economic burden of off-budget allocations to the armed forces constrained Codelco’s performance, while also shifting valuable resources from economic stabilization policies such as the ESSF. Furthermore, the secrecy surrounding the Copper Law enabled corruption by army officers. 

Strengthening civilian control over the armed forces was a key step for Chile to reduce military privileges, prosecute corrupt officers and, ultimately, repeal the Copper Law. The new system introduces long-overdue improvements: greater oversight and the inclusion of allocations in the state’s budget. However, deficiencies in transparency remain. Figures on actual expenditure on arms procurement will remain secret. Likewise, allocations must meet a baseline contribution, harming the contestability of the state budget. Hence, Chile’s efforts to promote transparency and accountability are not yet complete.

About the authors:

• Dr Diego Lopes da Silva is a Researcher with the SIPRI Arms and Military Expenditure Programme.
• Dr Nan Tian is a Researcher with the SIPRI Arms Transfers and Military Expenditure Programme.

Source: This article was published by SIPRI