I. Use of Fiscal Rules in Poland1
1. In 1999, Poland adopted both a more decentralized fiscal structure and an ambitious medium-term fiscal consolidation plan. Local government structures were reformed, and considerable additional spending responsibility was devolved to the sub-national governments; health care financing and delivery was restructured, with financing through independent government health funds; and the pension system was remodeled on a partially private, three pillar system. The government in June officially adopted the goal of balancing the general government budget over four years. This chapter discusses whether Poland’s existing “fiscal rules” should be modified in light of these developments. It suggests that improvements to current rules can be made, notably concerning the central government intra-year budget execution rule and in the rules pertaining to local government borrowing.
B. The Concept of Fiscal Rules
2. The term “fiscal rules” normally refers to the concept of legally binding, quantitative targets for various possible fiscal variables, including different measures of the actual or structural (“cyclically adjusted”) deficit or expenditures; the level of public debt; and/or limitations on government borrowing. The use of such rules has spread in the past two to three decades, originally in response to a general deterioration in the state of public finances in the OECD countries and increases in the level of public debt during the 1970s and 80s. Fiscal rules are intended as a means of helping to effect fiscal discipline. A regime operating under a fiscal rule or combination of rules is to be distinguished from one operating on the basis of discretion of the relevant policy makers from one budget cycle to the next. This chapter also addresses the use of less formal constraints on the actions of policy makers designed to achieve the same ends—for example, projections and plans for the fiscal situation which are heavily publicized and the importance of which is emphasized in policy announcements.
3. No fiscal rule can succeed without a true underlying commitment by society as a whole over time, as represented by successive governments. In its absence, formal rules will more likely generate non-transparent creative accounting techniques and one time, sub-optimal measures to achieve annual targets, without achieving their real purpose. In addition to such commitment to the goals represented by the rules, among the more important features of “good” fiscal rules are said to be clear definition of parameters and avoidance of ambiguity in the scope and level of target variables; transparency in operation; enforceability associated with sanctions; and flexibility to accommodate exogenous shocks. Particularly important for the case of Poland currently, any rule must be designed in terms of its type and level to be adequate to achieve the stated goal (e.g., reduction in the overall deficit), and in such a way as to be within the control of the authorities committing to the rule.
C. Existing Rules
4. Poland presently has several fiscal rules—an overall Constitutional limitation on the level of public debt to 60 percent of GDP2; a nominal overall deficit rule applying to the central government budget3; and two other rules designed to restrict the borrowing activities of the sub-national governments.4
5. The rule with respect to the central government budget provides that after enactment of the annual budget by the parliament, the nominal zloty cash deficit included in that budget cannot be exceeded without additional parliamentary approval, that is, without the enactment of an amended budget for the current year. This rule applies, ex post, whatever the reason for the deficit overrun. In previous years, the inflexibility created by this rule has been addressed by the use of cautious projections in the state budget on both the expenditure and revenue sides, and in some instances by expenditure arrears.5
6. Of particular importance at present, in light of the restructuring of the sub-national governments and increased devolution to them of expenditure authority, are restrictions on the spending and borrowing activities of these governments. Two types of rules apply to the local governments. First, debt service expenditures of each poviat and gmina-respectively the intermediate level (similar to counties in the U.S. system) and smallest, municipal, geographical units of sub-national administration—cannot exceed annually 15 percent of total planned revenues for the year6, and second, the stock of debt of each such government unit at the end of a fiscal year cannot exceed 60 percent of total revenues in that year.7 Local governments cannot borrow in foreign currency. For most local governments, these restrictions are not binding, as the poviats and voivodships—the latter being the largest, regional, geographical unit of sub-national administration—are new, and most gminas have not in the past incurred any significant debt. Operationally, local governments may borrow with the permission of the various legislative bodies that pass their budgets; in addition, “regional clearing chambers,” which are bodies partially responsible to the elected representative body of each voivodship (the highest level of the restructured sub-national governments) and partially to the central government give an opinion on the annual budgets of the local governments. These bodies verify that the proposed annual budgets of the gminas and poviats will not lead to a violation of the applicable fiscal rules, but they do not exercise control.
7. While not in the nature of binding rules, several other factors do impose some constraint on the formulation and execution of fiscal policy in Poland. These include Article 87 of the Public Finance Law, which requires that the formal justification for each annual central government budget must include on a rolling basis the macroeconomic assumptions (including revenue and expenditure projections) for the current and two subsequent years. As a matter of practice, though not law, the projections for the overall general government balance under those assumptions are also included. In addition, the authorities announced the government’s formal, though not legally binding, long term fiscal projections and plans in a paper formally adopted by the Council of Ministers in mid-1999, “Strategy for Public Finances and Economic Development, 2000-10.” This was intended to serve as a means of generating consensus and thus constraining informally the behavior of those involved in public sector planning, as well as providing a credible basis for decision making by the private sector.
D. Fiscal Challenges in Poland-Implications for Fiscal Rules
8. The authorities have targeted further deficit reduction, to balance in the general government in the medium term. This goal is appropriate from the standpoint of the present need to increase domestic savings. Poland will also likely have to conform to stage three of the Maastricht fiscal rules in order ultimately to join the European Monetary Union (EMU).8 The authorities’ medium term fiscal strategy framework would bring Poland into conformity with the deficit requirements of Maastricht, and that requirement may serve to bolster the credibility of the authorities’ framework. Further, as part of its effort to more efficiently and effectively stimulate investment and labor effort, the government has introduced substantial reform of direct taxes as from 2000, reducing significantly over the medium term the rates applicable both in the corporate and personal income taxes.9
9. These fiscal challenges raise the issue of whether formal rules are needed in the interim to facilitate implementation of the authorities’ medium term framework and the Maastricht targets and whether the existing complex of Polish rules will serve to do so.
10. The task of medium term deficit reduction is complicated by three factors with which any proposed fiscal rules must contend:
First, the public sector faces demands arising from prospective EU accession-anticipated for the early- to mid-part of the decade-and significant costs arising from prospective coal, steel, defense, railways and agricultural restructuring. Public expenditure requirements under all these headings are unclear. Of particular relevance from the EU standpoint is environmental clean-up and introduction of standards, which, though beneficial in the long term, will be expensive. In all of these areas, there is considerable uncertainty regarding the costs involved and what part of such costs will be borne by the public sector; the real cost is also dependent upon the pace at which the transformations, will have to occur, which is equally uncertain.
The second source of complexity in the deficit reduction process stems from the recent significant decentralization of expenditure authority. This occurred in part through the creation of two new levels of government—the 300-plus intermediate level poviats, and the 16 regional voivodships—between the central government and the local gminas; and, importantly, involved the devolution of responsibility for spending on the health sector. Health care, which had been operated and financed in the main by the central government, became the province of new public health insurance funds, which are to negotiate for the provision of care for all citizens with private providers and the publicly-owned hospitals and clinics. “Ownership” of the latter was largely transferred from the central government to the local governments as part of this reform, including in part to the new poviats.
Third, the pay-as-you-go system of public pensions was transformed (with grandfathering of existing pensioners and those over age 49) into a three pillar defined contribution system under which there is a substantial funded component managed through new private pension funds. The state pension funds apart from KRUS, the farmer’s pension fund—have always been a separate part of general government operated through a pension agency (“ZUS”), which has been subject to the indirect control of the central government, and this ultimately remains the case. However, implementation of this reform brings out two points in connection with deficit control—(i) there have always been problems in ZUS with regard to implementation of tax collection and control over benefit abuse, and such problems became markedly worse this year, as an artifact of the transformation of the system; and (ii) the government’s ultimate practical responsibility and consequent actions (as opposed to its formal legal liability) in the event that one or more private pension funds fail to deliver benefits in the future remains to be seen.
11. Prior to the devolution and public sector restructuring of 1999, local governments were legally permitted to borrow, but did not do so to any great extent, in part because their discretion was so limited that there was little cause for them to borrow. Now, there could be greater pressure on the sub-national governments to borrow, as a result both of the possibility that the central government will need to reduce transfers as part of its consolidation efforts, and, particularly, of the greater amount of spending at their discretion. In the latter regard, non-interest general government expenditure directly controlled by the central government represented on average approximately 36 percent of total government spending for the years 1995-98, with approximately 18 percent of total spending controlled by the local governments (the remainder constituting interest costs and transfers through the pension and other funds). In 1999, the comparable figure for central government controlled direct non-interest expenditures is only about 22 percent of total general government expenditure, with the share of local government rising to 24 percent, and expenditures through the health funds representing about 8 percent. Thus, while non-interest, non-fund-transfer spending remains at about the same proportion of total general government spending, this share has been significantly rebalanced away from central government.
E. What Changes May Be Appropriate?
12. Poland’s fiscal rules should facilitate the government’s plan for medium-term deficit reduction as outlined in the long term fiscal strategy paper of 1999. Within that, a case can be made that the rules should accommodate short-term fiscal stabilizers to operate. The rules also have to reflect the new relationship between the central government and other levels of general government established following the reforms of 1999. The rules should also anticipate the Maastricht criteria, even though the requirement that accessant countries meet these criteria has not yet been formally established.
The central government intra-year deficit rule
13. There is a strong case to soften or abolish the central government annual zloty target deficit rule. While this rule served to effect fiscal discipline during transition, it has several drawbacks: it impedes the operation of fiscal stabilizers at the level of central government; it provides only a loose anchor for the deficit of general government; and it may readily be circumvented in ways that are nontransparent and which distort the fiscal accounts.
14. These drawbacks were all apparent in 1999. Then, in the context of negative exogenous shocks on growth, automatic stabilizers could not operate at the level of central government to moderate the impact of the shocks on output. Instead, the revenue losses emanating from the weakness in output required offsetting cuts in central government expenditures and increases in excise taxes in order to satisfy the rule. Evasion of the rule was also apparent in 1999, notably when additional central government support for the health funds was recorded as a “loan” rather than as a transfer to the health funds. This treatment of the additional support meant that it had no effect on the measured state budget deficit, but the consequent nontransparency of this treatment was one factor undermining market confidence in the fiscal stance. And while the state budget deficit outturn was within the budget target, there was a substantial slippage on the deficit of the general government, only part of which was related to the operation of automatic stabilizers outside of central government. All of these developments serve to underscore the case for a reconsideration of the rule on the deficit of central government as the key operational rule for fiscal policy in Poland.
15. In light of these concerns, public attention should be focussed on the conduct of fiscal policy as indicated by the general government accounts, rather than those of the central government. Within that, the operation of automatic stabilizers should be concentrated at the central government level, by for example allowing the central government deficit target to be exceeded by an amount based upon tax revenue shortfalls attributable to deviations of macroeconomic variables relative to the projected levels underlying the budget forecast.
Operation of fiscal rules in light of the decentralized fiscal structure
16. A key aim of the devolution—through the health fund structure, the reformed sub-national governments, and the privatized pension system—is to afford greater fiscal discipline by hardening budget constraints and by tying costs more closely to recipients of benefits. This has to be balanced, however, with the need to maintain central control over the general government deficit and with effective incentives at lower levels of government to rationalize their operations.10 (See Box 1 for alternative approaches to control sub-national borrowing).
Box 1.Alternative Approaches to Control Subnational Borrowing
Approaches to control subnational borrowing can be grouped in three main categories: (i) primary reliance on market forces; (ii) administrative controls; (iii) rules-based controls.
Sole reliance on market discipline fosters accountability at the local level but is unlikely to be appropriate in many circumstances. To be effective, it requires a financial market free of ownership (or other regulatory) links to the local governments, and a credible commitment by the central government not to bail out insolvent subnational borrowers. There are only very few countries that rely solely on market discipline to control local borrowing, as the risks of widespread default are perceived as too large.
Administrative controls (e.g., through absolute borrowing limits on subnational debt, or central approval of individual loans) require strict monitoring and are often subject to political bargaining which introduces rent-seeking and uncertainty.
Rules-based controls, such as the golden rule (which limits all borrowing to investment purposes), may not be sufficiently restrictive or even desirable-as expenditure on education and health, for example, may have higher rates of return than many capital projects—and can be circumvented through “relabeling”. Alternative rules, with debt limits set on criteria that mimic market discipline (such as the current and projected levels of debt service in relation to revenues) appear superior, and may be combined with additional features that reduce incentives for borrowing.
In general, responsibility of local governments for containing the public debt level can be strengthened by increased cooperation and their enhanced involvement in formulating and implementing medium-term fiscal programs.
17. The current debt and interest spending rules for the devolved system may need to be strengthened in order to achieve these aims.11 The existing rules-based approach seems adequate to contain sub-national borrowing without unduly constraining both effective decision-making at the lower level and the operation of automatic stabilizers. However, the specific limits set are fairly high in the current situation (where poviats and voivodships have only just been established) and would accommodate significant deficit spending by local governments before becoming binding.12 Preliminary first half data for 1999, and anecdotal evidence to date provide a modicum of comfort on this score as they indicate that the new local government bodies have not yet begun to exploit the scope for additional borrowing. But this may change, particularly as their access to credit develops and as pressures for additional spending mount.
18. International experience suggests a number of approaches to limiting local government borrowing in countries with decentralized structures. There are two basic approaches in federal systems—the “autonomous approach,” as in Canada and the United States, in which sub-national governments adopt their own approaches to fiscal restraint and control; and the “coordinated approach,” in which sub-national governments are subject to rules under the authority of the central government. The former is more common where there is no tradition or belief that the central government will bear responsibility for or bail-out any fiscal failures on the part of the subnational governments. The latter approach, given the degree of coercion involved, is more likely to generate creative methods of avoidance and lack of transparency. But it may well be necessary where the subnational units view themselves, or are viewed by potential creditors as ultimately reliant upon the central government. This is likely true, at least now, in Poland.13
19. The centralized approach requires some enforcement mechanism in order to afford the central government a sufficient degree of control over fiscal execution to make the rule meaningful on an ex post basis. It may also entail corrective measures designed to offset violations of the rules that do occur. There are many options that might be considered in this context:
Loans from the central government budget to other sectors could be prohibited, or such loans could be treated as transfers from the point of view of the current annual budget rule. However, such overruns in the sub-national budgets that were met with loans or transfers from the central government could then be subject to the requirement that corrective steps must be taken in the sub-national budget in question in the following year.
Similar disciplinary measures could also be enforced through the rules governing direct central government transfers and allocations of direct tax revenues to local governments. There may be a case for temporarily imposing tighter current borrowing limits, and combining them with additional incentive-based measures to limit debt accumulation such as “automatic” reductions in state transfers in case of excessive borrowing, and higher capital requirements applied to bank lending to local (as opposed to central) government units.
There may even be a case for explicitly allocating the total general government deficit between the central and sub-national governments, and among the latter, on a short-term basis (akin to the German proposal for dealing with the Maastricht limitations). Alternatively, an overall framework similar to that proposed for Brazil (see Appendix) would provide a possible model, including through the use of binding expenditure ceilings for problematic sectors such as the public sector wage bill accompanied by ex post sanctions for non-compliance. These enforcement and corrective mechanisms are a notable feature of the proposed fiscal rules for Brazil, and are likely the sort of approach that could be effective with respect to short-term sub-national deficits in Poland.
Other extensions to Poland’s fiscal rules
20. Going beyond these proposals—to shift the focus of the main rule from the state budget to the general government, and to tighten central control on local government borrowing—raises complex and as yet largely unresolved issues. As a result, the case to go further is not yet persuasive.
Fiscal rules for Poland cannot yet be designed around a concept of structural fiscal balance because it is not yet possible to make robust calculations of the output gap or trend real growth.
Firm targets for the fiscal deficit going beyond even just two or three years run into difficulties given the considerable uncertainty about prospects for private savings in Poland. These complicate efforts to identify the appropriate fiscal deficit targets at which to aim, an issue of immediate relevance given the high current account deficit.
Identification of appropriate targets for the fiscal balance over the medium term is impeded by uncertainty about the scale and timing of spending needed to accomplish structural transformation and EU accession. Both could require some flexibility in the deficit targets adopted.14
And appropriate targets should be set in reference to the macroeconomic balance rather than fiscal sustainability given that public debt ratios are relatively low and will fall substantially with prospective privatization. Thus, any rule that is focussed on the level of public debt is unlikely to be sufficient in the short to medium term.
21. Any fiscal rules for Poland at this stage must reflect many significant and sometimes competing concerns, making their design quite difficult. These include:
the need to signal investors regarding the path of fiscal policy;
the uncertainty of the extent and timing of spending that will be needed to complete the task of structural transformation and EU accession;
the difficulty of determining the appropriate general government fiscal balance given the uncertain behavior of private savings and investment;
the fact of devolution to sub-national governments and of the health system;
lack of knowledge of the economic cycle and consequent inability to define a rule in terms of that cycle; and
the need to permit the operation of automatic stabilizers.
22. These considerations warrant careful consideration of two sets of reforms. First, the centerpiece of any set of fiscal rules in Poland should focus on the general government, and should allow scope for the transparent operation of automatic stabilizers at the level of central government. Second, the degree of effective central control over the deficit of general government needs to be enhanced by strengthening control over local government borrowing. The fact that such borrowing has hitherto been modest provides no more than a modicum of comfort, because the scope and pressure for local governments to borrow was also hitherto more limited. The ceilings on sub-national government borrowing should be tightened to bind in the short term, and this should be done before local government borrowing becomes problematic. And as discussed in Chapter III on public expenditure, it is critical to get as good a grip as possible on the potentially necessary levels of public spending on structural adjustment and EU related spending commitments over the medium and longer term.
23. In other respects, the fiscal rules operating in Poland provide an appropriate framework for policy in light of the constraints under which policy must be formed. Uncertainty about the prospects for the savings and investment balance impede formal deficit targeting beyond the short- to medium-term, so the current practice of making general government projections in conjunction with the annual budget submission is appropriate. However, there may be a case for hardening the official commitment to those numbers.
APPENDIX I: Some Examplesof Fiscal Rulesin Decentralized Systems
1. Germany has “golden rule” provisions at both central and state levels, restricting budgeted borrowing to projected investment spending.1 However, these rules are subject to great flexibility, in that there is an exception allowed for “disturbances of general economic equilibrium,” and in that the rules apply only on an ex ante (budget formulation) basis, not on an ex post basis. In fact, between 1970 and 1997, the borrowing rule was breached ten times at the central government level (though it was more than met in every year by the general government deficit, reflecting procyclical behavior of the sub-national governments). Recent proposals in connection with the Maastricht requirements (the National Stability Pact, or NSP) would have set separate ceilings of 1.5 percent of GDP on the actual deficits at the central government and state levels, respectively, and allocated the variable portion of the Maastricht financial penalties among the central government and various states depending upon relative contributions to the overall deficit overrun. As part of this system, there would be an ex ante allocation of the sub-national 1.5 percent deficit allowance, by means of pre-established rules. This plan has not, however, been adopted.
2. Switzerland, like Germany, has experienced weak operation of automatic stabilizers and even procyclical discretionary fiscal policy over a long period of time. There has been very low variability of the general government balance, even though the variability of output has been quite high over the period from the mid–1970s to the mid–1990s. Use of fiscal policy as a stabilizer has been impeded by the highly decentralized system, in which approximately two-thirds of spending powers reside with the sub-national governments. The system, like that of Canada and the U.S., would be described as autonomous at the sub-national level, and the tendency, though not the formal rule, at the sub-national level has been to target balanced budgets. Thus, the problem in Switzerland has been perceived largely as one of ineffectiveness of macroeconomic policy through lack of cyclical adjustment, rather than a potential lack of deficit discipline. A constitutional amendment has recently been proposed which would combine a structural balanced budget rule and a countercyclical budget rule at the Confederation (federal government) level only. The fiscal policy rule proposed would impose a strict balanced budget on the federal government when GDP growth fell within the range 0.5 percent to 1.8 percent. Below that range, the combined deficit effects of automatic stabilizers and discretionary policy could equal the change in the real output gap below 0.5 percent. With real GDP growth above 1.8 percent, the rule would require a surplus of one half of the change in the output gap.
3. There are several problems with these rules. First, there has been a rather stark failure in Switzerland to accurately forecast GDP growth, and hence the output gap. Actual growth has fluctuated widely; forecast growth has always hovered in the range of 1 to 2 percent. The proposed rule requires use of projected real growth in budget formulation; this is an ex ante rule that would not effectively counter large cyclical variations that occurred after the budget’s approval (over a year in advance). Second, the rule’s sanction mechanism requires the legislature to order budget cuts effective two years after the year in which the target is missed, because of the budget cycle. Finally, the rule includes no mechanism to control or restrict the behavior of the sub-national governments, but places all cyclical fiscal policy adjustment at the federal level. As noted, behavior at the sub-national level is quite procyclical, All of these problems may be instructive for Poland, indicating that a nuanced rule designed explicitly to enhance the operation of stabilizers in the overall government is not very practicable even in a country like Switzerland.
4. Brazil has a highly decentralized fiscal system, but one in which deficit discipline and control is currently the primary source of concern, rather than short-term cyclical stabilization. The government introduced in April, 1999, a bill into Parliament embodying a new set of fiscal rules, the Fiscal Responsibility Law (FRL).2 The FRL embodies several types of rules, including limits on the consolidated net debt of each level of government (to be established as a proportion of its net tax revenues by the Senate on the recommendation of the President); limits on borrowing operations, generally governed by a golden rule (i.e., limited to capital expenditures), prohibition of central bank financing to any level of government, and restriction of short-term cash flow financing; and a number of different rules regarding expenditure limitations for all government entities (most important, any long-term—greater than three year—increase in expenditure must be fully offset by a reduction in other expenses or a revenue increase; there are specific limitations on personnel expenditures; and there are restrictions on unspent commitments carrying over from one year to the next). The FRL requires the multi-year development plan to define rolling three year fiscal objectives and targets, which, if not met at any level of government, result in automatic cuts in expenditure until the attainment of the targets is assured. If states and municipalities fail to execute these cuts, the federal government will withhold transfers to them. All of these rules are to be enforced by ex post sanctions—in the case of the debt limitation, adjustment to the ceiling must occur within two quarters, and failure to do so would result in the suspension of all voluntary transfers from the next higher level of government. During the time that the limit is exceeded, all borrowing other than refinancing is suspended by operation of law, and all available cash balances are transferred to a special central bank account where drawings are permitted only for essential expenditures. In general, the granting of new intergovernmental credits is strictly prohibited. Finally, managers who fail to observe the provisions of the FRL can be subject to criminal penalties, including imprisonment.
BlejerM. and A.Cheasty1991“Measuring the Fiscal Deficit: Overview of the Issues” in How to Measure the Fiscal Deficited.by Blejer and Cheasty (IMF).
BuiterW.1997“Notes on `A Code for Fiscal Stability’” unpublished mimeo.
KellM.1999“An Assessment of the United Kingdom’s Fiscal Rules,”Unpublished Working Paper.
KopitsG. and S.Symansky1998“Fiscal Policy Rules” Occasional Paper No. 162 (IMF).
MackenzieG. A.1991“Are All Summary Indicators of the Stance of Fiscal Policy Misleading?” in How to Measure the Fiscal Deficited. by Blejer and Cheasty (IMF).
Milesi-FerrettiG.“Fiscal Rules and the Budget Process,”56 Giornale degli Economistie Annali di Economia pp. 5–40.
Ter-MinassianT. and J.Craig1997“Control of Subnational Government Borrowing” in Fiscal Federalism in Theory and Practice (IMF).
Prepared by Victoria Summers (FAD).
Budget Law, Article 1.3 (setting the state budget deficit at a certain number of zlotys); Law on Public Finances, Article 61.2 (requiring the annual budget to be in the form of a law).
In addition, the primary (non-agricultural) social security fund (FUS) can enter into commercial borrowing arrangements, as it did in 1999, but its borrowing is restricted by the requirement for specific approval in each instance by the Ministry of Finance.
Such techniques are formally adopted in some countries to address deviations in macroeconomic variables during the budget period. For example, in Canada, projections are to be based upon the consensus growth forecast less 1 percent, and a slightly higher interest rate forecast must be adopted than the consensus forecast.
Law on Public Finances, Article 113.1. This rule can be shown to be essentially equivalent to a debt limitation rule under specified assumptions.
Law on Public Finances, Article 114. In addition, as total general government debt crosses thresholds at 50, 55 and 60 percent of GDP, the reporting and approval procedures for local government borrowing become more restrictive.
Stage three of the Maastricht treaty requires that member states bring the level of general government gross debt to a ceiling of 60 percent (excluding guarantees of liabilities of the rest of the public sector or the private sector, accrued pension liabilities, and unfunded contingent liabilities from the calculation of gross debt). With government debt of approximately 40 percent of GDP, Poland currently overperforms this target. The treaty also has a dual deficit target, requiring both an annual overall general government deficit not exceeding 3 percent of GDP, and a medium-term term structural budget position “close to balance or a surplus,” under the Stability and Growth Pact. Taken together, these two rules are supposed to permit the operation of automatic stabilizers in the short run. There are financial penalties for failure to meet the 3 percent deficit ceiling, in the form of a lump sum sanction of 0.2 percent of GDP and a variable portion equal to 10 percent of the excess of the deficit above the Maastricht 3 percent limit, though time for correction of the problem is also granted.
Amendments to the CIT were passed in November, 1999, effective as of January 1, 2000; the PIT amendments were vetoed by the President, on procedural grounds, but will be reintroduced in early 2000 with the hope of enactment effective as of 2001.
For a comprehensive discussion of this topic, see T. Ter-Minassian and J. Craig, “Control of Subnational Government Borrowing” in Fiscal Federalism in Theory and Practice (IMF 1997)
The best designed systems of fiscal rules combine stock and flow rules; however, the interest rule here is virtually equivalent to a debt stock rule, rather than a true flow (deficit or expenditure) rule.
Illustrative calculations (assuming a constant revenue-to-GDP ratio, an average interest rate of 13 percent, and five-year average maturity on contracted debt) indicate that for debt and debt-service rules to become binding by 2005, new jurisdictions could raise annual expenditures by some 7½ percent, in real terms. For the local government sector, as a whole, this would be consistent with a deficit of about 3 percent of GDP in 2005. By way of context, the total general government deficit projected for 2000 is 2.7 percent of GDP; of that, 0.4 percent comes from the sub-national governments.
Certainly the subnational governments remain highly dependent upon the central government for the bulk of their revenues, with approximately 2/3 coming from direct transfers and shares of the national income taxes. Changing this reliance is one of the government’s purposes in the next phase of amendments to the fiscal reform.
One theoretical possibility would be to craft a rule which would effectively implement rigidly binding ceilings on “non-transformation related” expenditures, while treating “transformation expenditures” (for example, severance payments to coal miners) as if they were investments, under the more traditional “golden rule” approach (limiting only the current budget to balance-permitting borrowing only for investment). However, such an approach would suffer probably fatally from definitional problems, and an accompanying lack of transparency and ease of avoidance.
And borrowing by the communes is subject to control by the states.
The government now anticipates that this law will now be passed by mid-2000 at the earliest; it could, however, take even longer to do so.