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Israel: Selected Issues

Author(s):
International Monetary Fund. European Dept.
Published Date:
February 2014
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A Fiscal Council for Israel?1

1. Fiscal councils are non-partisan agencies aimed at promoting sound fiscal policies. Such institutions have been a long-standing feature of a handful of developed economies (US, Netherlands, Belgium, Sweden and Korea). In recent years a number of new councils have been set up in response to the fiscal crisis in Europe, while similar bodies have also been introduced in Australia, Canada, Kenya and South Africa.

2. An emerging literature suggests that well-designed councils can be effective in improving fiscal outcomes. A fiscal council does not have delegated responsibility for policy-making and so cannot guarantee sound fiscal policies. Its influence comes from its mandate to publish independent and authoritative fiscal analysis, which enhances transparency and increases the accountability of decisions taken by policy-makers. Specifically, IMF (2013) suggests fiscal councils can improve policymakers’ incentives to opt for sound fiscal policies in the following ways:

  • by providing transparent analysis of the fiscal implications of policy decisions over the political cycle, a fiscal council can improve democratic accountability and discourage opportunistic shifts in policy, e.g. pre-electoral giveaways;

  • through independent analysis, assessments, and forecasts, fiscal councils can raise public awareness about the consequences of certain policy paths. Hence a fiscal council can raise the reputational and electoral costs of unsound policies; and

  • by providing direct inputs to the budget process—for example forecasts or assessments of structural positions—fiscal councils can close technical loopholes that allow governments to circumvent numerical fiscal rules.

3. The remit and structures of fiscal councils vary widely, depending on country-specific circumstances such as the specific causes of excessive deficits and the nature of the political system. However, effective councils can be shown to share some key features: a well-defined institutional structure and a reputation for professionalism and political independence; a clear mandate focused on fiscal sustainability; a duty to be objective and transparent; a strong presence in the public debate; the provision or public assessment of budgetary forecasts; and an explicit role in monitoring fiscal policy rules.

4. This Annex examines the case for a fiscal council in Israel. It considers the role that a fiscal council could play in improving fiscal outcomes in Israel, compares this with the role that the Bank of Israel currently plays in fiscal policy, and considers the evidence on the design features of effective fiscal councils in the context of Israel’s institutional frameworks.

How could a fiscal council improve fiscal outcomes in Israel?

5. A fiscal council should be designed to address country-specific circumstances. Therefore it is important to identify areas of fiscal policy-making in Israel that could potentially benefit from a fiscal council. The previous paper sets out a number of areas where Israel’s fiscal framework could be improved:

  • fiscal policy lacks a clear medium- and long-term fiscal anchor, for example in the form of an explicit medium-term target for debt;

  • there is no medium-term budget framework in place to guide policy decisions, as a result expenditure and revenue policy commitments have often been made without full consideration for medium-term fiscal sustainability. This has led deficit targets to be missed and revised; and

  • there has been a lack of enforcement of the fiscal rules. Governments have frequently changed the fiscal rules and revised targets, often in response to political factors as well as economic circumstances. There is no regular and official analysis of the factors driving such changes and of the implications for the fiscal position.

6. A well-designed fiscal council could complement the proposed reforms set out in the previous paper, which are designed to address these weaknesses. In particular, there is a role for a fiscal council in enhancing enforcement of the fiscal rules and, if a medium-term framework is introduced, in ensuring medium-term forecasts and estimates of the costs of new policies are realistic and credible. Table 1 provides a summary of the potential roles of a fiscal council in Israel and the benefits this could bring.

Table 1:Summary of potential roles for a fiscal council in Israel
IssueRole for fiscal councilPotential benefits
No clear medium-term debt target to provide anchor for fiscal rules.Produce independent analysis of long-term fiscal sustainability in Israel.Increase transparency about long-term fiscal pressures. Provide evidence base for government’s choice of debt target.
Produce independent analysis of the consistency of the fiscal rules with fiscal sustainability.Increase transparency about implications of fiscal rules for fiscal sustainability. Increase the cost to the government of changing targets for short-term political benefit.
No medium-term budget framework.If a medium-term framework is introduced, assess the government’s medium-term economic and fiscal forecast or produce its own parallel forecast.Curb any tendency for the government to base its plans on unrealistic forecasts. Increase understanding of the risks around forecasts.
If a medium-term framework is introduced, assess the government’s medium-term policy costings.Curb any tendency for the government to base its plans on unrealistic policy costings. Increase understanding of the fiscal risks around new policy commitments.
Deficit targets are frequently missed and revised.Provide ex ante analysis of the likelihood of targets being achieved on basis of government’s budget plans.Increase transparency about the risks to the achievement of fiscal rules. Curb any tendency for the government to produce unrealistic budget plans.
Provide ex post analysis of factors driving outturn compared to the government’s budget plans.Increase transparency and understanding of factors driving deviations from plans. Prevent the use of technical loopholes to circumvent rules.

7. A primary role could be to monitor and report on compliance with the fiscal rules. This could include ex ante analysis of the likelihood that the fiscal rules will be met on the basis of the government’s plans and projections, which could be provided alongside the government’s budget or shortly afterwards. In addition, a council could provide ex post analysis of performance against the rules, explaining the reasons for any deviations from targets or any changes to targets. These activities would bring greater transparency to fiscal policy, increase understanding of the risks to achieving the fiscal rules, and raise public awareness of the fiscal implications of government decisions. This should help to counter any temptation to change targets for short-term political benefit.

8. This function would be enhanced if the fiscal council also produced an independent analysis of the longer-term outlook for fiscal sustainability in Israel. A number of fiscal councils around the world produce this type of analysis. It typically consists of long-term public finance projections which focus on the prospects for government expenditure and revenue, given long-run trends such as demographic change and natural resource depletion. It can also include an analysis of the government’s exposure to specific fiscal risks, including implicit and explicit contingent liabilities. Such analysis helps to raise public awareness about the long-term fiscal consequences of government policy, and increases the pressure on decision-makers to consider such issues when setting policy.

9. A supplementary role could be to evaluate the Ministry of Finance’s economic and fiscal forecasts. This would be particularly important if Israel moves to a full medium-term forecasting and budgeting framework. Over such time periods forecasting becomes inherently more difficult and there is an increased temptation to produce optimistic forecasts in order to flatter the fiscal outlook and create space to fund policy objectives. By rigorously assessing the government’s forecast, or producing parallel forecasts for comparison, fiscal councils can act to curb such tendencies. Indeed, evidence suggests that countries with effective fiscal councils tend to have more accurate and less optimistic forecasts than others. For example, IMF (2013) found that countries with fiscal councils that were given the task of assessing or producing forecasts had on average lower forecast errors and less optimism bias than countries without such an institution.

10. An additional role within a medium-term framework could be to assess the costings of new government tax and expenditure policies, with the aim of ensuring they are realistic and unbiased. For a council to produce policy costings internally typically requires significantly more resources and staff expertise than is needed for monitoring fiscal policy and assessing forecasts. However, there are examples of councils which scrutinize and publically endorse or reject costings produced by government officials, and this can be done with significantly fewer resources. This would be a particularly important role in Israel where a lack of rigorous estimates of the costs of medium-term policy commitments has often led to expenditure over-runs and a resulting failure to meet the fiscal rules. Such a role can also improve the policy decision-making process by introducing an independent arbiter to help resolve disagreements over the costs of new policies between the Ministry of Finance, spending ministries and the legislature.

11. International experience suggests that in most cases a fiscal council should provide its analysis on an objective basis and not provide normative assessments of the merits or otherwise of the government’s policies. In some countries, councils have been given the right to provide normative assessments of the government’s fiscal policy decisions. For example, the Swedish fiscal council is tasked with assessing the merits of the government’s fiscal policy objectives and fiscal stance. However, in most cases councils are restricted from doing this in order to reduce the chance that they are drawn into political debates, which could place their independence at risk.

The institutional structure and features of effective fiscal councils

12. The institutional structure of fiscal councils varies widely reflecting local legal frameworks, political structures, and resource and capacity constraints. However, recent IMF (2013) and OECD (2013) publications set out a number of shared principles that are important to effective fiscal councils. In summary these include:

  • political and operational independence is a key prerequisite for the success of a fiscal council. There are a number of aspects to this including: a legal basis for independence; an appointment process which ensures leadership and staff are selected on the basis of merit and technical competence and not political affiliation; and a budget which is not subject to discretionary adjustment. Some countries have recently established councils under existing bodies such as the national audit office. This approach may provide an initial boost to credibility and provide a stable source of financing. However, it also risks creating a conflict of interest with the institution’s primary remit and clouding perceptions of the operational independence of the fiscal council. Therefore, on balance credibility is likely to be best enhanced if the council is established as a stand-alone institution. This is a relevant issue in Israel given the current role of the Bank of Israel in producing fiscal policy analysis and advice, which is discussed further in Box 1;

  • a clearly defined mandate set out in law and in supporting publications which describes the core tasks required and the role of the council in relation to partner institutions. Good practice is to also allow the council flexibility to undertake wider analysis of its own choice in support of its core remit. A clear mandate focused on fiscal sustainability, and the requirement that the government respond to its analysis, provides the institution with the legitimacy and credibility it needs to play an active and influential role in fiscal policy;

  • a duty to be transparent and accountable. Fiscal councils should promote the adoption of best practice in transparency as this is the key to their effectiveness in raising awareness of fiscal policy issues. This includes making all analysis available to the public and the media. As an independent public body it is also important for legitimacy that a council is clearly accountable to both the legislature and the executive, for example through a duty to present reports and explain its analysis at public hearings of the legislature;

  • a right of access to government information is vital if the council’s analysis is to add value over that produced by external analysts. This should include access to the data, assumptions and modeling underpinning the government’s fiscal forecasts and plans. Safeguards are often required to protect confidential budget and taxpayer information; and

  • sufficient resources should be made available commensurate to the remit of the council. Typically councils that focus on monitoring compliance with fiscal rules and assessing government forecasts, as suggested for Israel, are able to operate with relatively few resources, with up to 10 full-time professional staff members in addition to a small leadership committee. The leaders and staff members must be appointed on the basis of their competence and expertise in fiscal policy and the public finances.

Box 1.The Role of the Bank of Israel in Fiscal Policy

The Bank of Israel currently undertakes some of the functions that might be performed by a fiscal council. The Governor of the Bank has a duty under law to act as “an economic adviser to the government”. Under this duty, the Bank has produced analysis of fiscal policy and the fiscal outlook, and provided commentary on the government’s fiscal decisions. This arrangement has functioned effectively in the past and the Bank produces high-quality fiscal analysis. While establishing a fiscal council in an existing institution can help establish credibility and provide resources, on balance the expanded functions suggested in this paper would be more effectively delivered by a stand-alone fiscal council:

  • expanding the Bank’s role on fiscal policy could lead to a potential conflict of interest with its primary concern for monetary policy and financial stability. For example, in a situation where inflation was above target the Bank might be perceived to have a preference for fiscal tightening which could influence the analysis it produced. Moreover, a reputation for political independence is important to the success of a central bank’s monetary policy operations, and maintaining this would be more difficult if the Bank were to increase its involvement in what are often highly political fiscal policy issues. International experience suggests that a fiscal council should be an independent stand-alone institution with a clear remit focused on fiscal sustainability, while a central bank’s remit is clearly focused on monetary policy and financial stability.

  • the Bank’s role on fiscal policy is currently not clearly defined, and its activity in this area is at the discretion of the Governor. Reflecting this, over the past its publically-available analysis while of high quality has not always been produced to a regular timetable and the volume of material produced has varied over time. Moreover, the Bank has not produced the full range of detailed outputs that would be expected of a fiscal council, as set out above. Good practice is that the fiscal council’s remit is clearly defined and it produces regular, detailed and transparent analysis at set points in the budget timetable.

  • there is currently no formal procedure specified for holding the Bank accountable for its fiscal policy advice. For example, there are no specific procedures by which the Knesset scrutinizes the Bank’s fiscal policy advice. Moreover there is no obligation for the Government to publically respond to the Bank’s advice. Good practice is that the fiscal council is held accountable through dedicated scrutiny and hearings by the legislature and through a duty on the government to respond publically to its advice. Such accountability would increase the demands on the Bank’s senior management who are appointed primarily for their expertise on monetary policy and financial stability, rather than fiscal policy. Analysis of the public finances is a highly-specialized field and senior leaders in fiscal councils around the world typically have significant expertise focused in this area.

13. Two fiscal councils established in the past decade–in Korea and the UK–illustrate the range of structures that councils can take, as described in Box 2. The UK fiscal council is a relatively small independent office of the executive with a remit focused on fiscal forecasting and analysis. The Korean council is an office of Parliament with a much larger staff of around 125 and a wider remit which includes project and policy evaluation. However, both institutions share common features such as a clearly-defined remit, a reputation for professionalism, and duty to be transparent and accountable.

Box 2.Case Study: Recently Established Fiscal Councils in the UK and Korea

The UK established the Office for Budget Responsibility (OBR) in 2010 with a mandate primarily designed to address the perceived optimism bias in the fiscal forecasts produced under previous UK administrations. It is an independent branch of the executive comprised of a senior committee of three and a staff of eighteen. It is tasked with producing forecasts, assessing the achievement of fiscal targets, analyzing long-term fiscal sustainability, and scrutinizing the government’s policy costings. Unlike most other fiscal councils, the OBR produces the official forecasts which the government uses when setting fiscal policy and budgets. To do this it has a right of access to relevant government information, analysis, and revenue and expenditure forecasts. Officials must provide these forecasts using the OBR’s preferred assumptions, judgments and modeling approaches.

A clear benefit of the introduction of the OBR has been greater forecast transparency. The OBR provides greater detail than previous official UK forecasts, including on the economic drivers of revenue and expenditure forecasts and the impact of new policies. It also provides extensive risk analysis including sensitivity analysis, alternative macroeconomic and fiscal scenarios, and forecast fan charts. This transparency increases wider public understanding of the fiscal position and should bolster the credibility of the forecasts. The OBR’s analysis of forecast accuracy also shows that to date its fiscal forecasts have on average been more accurate than those produced by the UK Government over the previous twenty years (OBR, 2013).

In 2003, the Korean National Assembly Budget Office (NABO) was formally established as an office to provide fiscal policy advice to Parliament. The creation of the NABO was driven by political factors–it was established during the first period of divided government in Korea. It was designed to provide the legislature with information and expertise on fiscal and budgetary issues to match that of the executive, and to provide it with the capacity to scrutinize the President‘s draft budgets.

The NABO is one of the largest fiscal councils with 125 members of staff in 2011 and was broadly modeled on the United States’ Congressional Budget Office. It performs all the typical functions of a fiscal council including monitoring and reviewing the government’s fiscal policy, developing alternative forecasts, and costing proposals and programs. It also now conducts analyses of long-term structural issues and has begun to develop long term projections. A unique element of its mandate is the evaluation and review of a range of government projects, programs and policy initiatives. It has also started to make normative recommendations on appropriate policy objectives and fiscal stance.

The NABO is seen to provide valuable reports and analysis which increase the transparency of the government‘s budgetary data. The council now plays a role in public discussions on fiscal policy. It has raised alarms when government policy may not be in line with sound policy settings—even going so far as to recommend an alternative course of action in 2010.

Conclusion: the case for a fiscal council in Israel

14. There is a strong case for Israel introducing a fully-fledged medium-term fiscal and budget framework, and then establishing a fiscal council. Such a council should have a mandate to assess the long-term sustainability of the public finances and monitor and report on the Government’s ex post and ex ante compliance with the fiscal rules. This would increase transparency and raise awareness of the fiscal implications of the government’s policy choices. It could also prevent any temptation to use technical loopholes to circumvent rules. Within a medium-term budget framework the council could also assess the government’s fiscal plans, forecasts and policy costings, which would help curb any tendency to base plans on unrealistic projections and policy estimates. To avoid being drawn into political debates, the council’s analysis should be objective and it should not make normative recommendations on fiscal policy.

15. A fiscal council in Israel would be most effectively structured as an independent and stand-alone institution with a clearly-defined mandate focused on fiscal analysis. While the Bank of Israel has provided high quality analysis on fiscal issues in the past, an expanded role on fiscal policy would require it to produce much more extensive and detailed fiscal analysis which would potentially conflict with its core monetary policy remit. A new institution with the remit suggested above could be of a relatively small size with a leadership committee and up to ten well-qualified staff. The international evidence suggests that it would be vital for the institution to establish a reputation for operational and political independence, and to be fully transparent with a strong media presence.

References

Prepared by Tom Josephs.

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