Abstract
Fiscal deficits and the public debt has grown throughout much of the postwar period in most industrialized countries under the pressure of rising public expenditure, a trend that has begun to reverse after 1992. A number of studies argue that fiscal consolidation in association with expenditure restraint, particularly reductions in primary current expenditure, has proved more durable historically. All in all, the fiscal consolidation essential to qualify for European Monetary Union is a major achievement but also a difficult process in the four countries (France, Germany, Italy, and Spain).
II. Fiscal Rules: Experience of a Selected Group of Countries11
14. This chapter describes the experience with fiscal rules in Australia, Canada, Finland, the Netherlands, New Zealand, Sweden, Switzerland, the United Kingdom, and the United States. For each country, the context in which the rules were adopted, their objectives, their institutional basis, will be reviewed, and an evaluation of the performance of the rules will be attempted where possible. A broad definition of fiscal rules is adopted in order to cover both countries that established specific multiyear numerical targets as their objectives (as in the case of deficit, debt or expenditure rules) and countries that specify principles according to which the fiscal policy should be conducted.
Australia
Background
15. Poor fiscal performance for more than two decades, which led to a marked build up in public debt, prompted the Australian authorities to adopt a new fiscal policy framework in the mid-1990s. The Charter of Budget Honesty Act (BHA), broadly similar to New Zealand’s Fiscal Responsibility Act, was set out in 1996 and enacted by Parliament in 1998, and was aimed at enhancing fiscal discipline and raising public scrutiny of fiscal policy.
The Institutional Arrangement
16. Under the BHA, the Commonwealth (federal) government must lay out its short-term fiscal objectives and targets as well as its medium-term strategy in each annual budget. In doing so, the BHA establishes general principles for formulating fiscal policy on a sound basis and requires that governments be more explicit about their fiscal policy intentions and present comprehensive information on fiscal developments. Short-term fiscal targets are established in the budget law, but should be consistent with the principles determined by the BHA, particularly the principle of fiscal balance over the course of the economic cycle.
Objectives
17. The objective of the BHA is to improve fiscal policy outcomes by requiring the government’s fiscal strategy to be based on principles of sound fiscal management and by facilitating public scrutiny of fiscal policy and performance. Moreover, the BHA establishes that the government’s fiscal policy is to be directed at maintaining economic prosperity in a sustainable medium-term framework.12
Characteristics
18. Under the BHA, the government’s fiscal strategy is to be based on the following principles: first, financial risks must be managed prudently, including to maintain the general government debt at prudent levels; second, fiscal policy should help achieve adequate national saving and moderate cyclical fluctuations in economic activity, taking account the economic risks and the impact of those risks on the fiscal position; third, spending and taxing policies should be consistent with a reasonable degree of stability and predictability in the level of the tax burden; fourth, the integrity of the tax system should be maintained; and fifth, policy decisions should be fair from an intergenerational point of view. 13
19. The Act also contains provisions for the publication of several fiscal reports. The government is required to release a “Fiscal Strategy Statement (FSS)” at or before the time of the first budget. The FSS is intended to increase public awareness the fiscal strategy and to establish a benchmark for evaluating the conduct of the fiscal strategy. Additionally, the Act requires the government to release a “Budget Economic and Fiscal Outlook (BEFO)” report, a “Mid-year Economic and Fiscal Outlook (MYEFO)” report, and a Final Budget Outcome (FBO) report. The Treasurer is also to publicly release an intergenerational report every five years to assess the long-term sustainability of government policies for the next 40 years, including the financial implications of demographic change. To increase the transparency of the budget process in electoral times, the government must publish a “Pre-election Economic and Fiscal Outlook” report. In addition, the Prime Minister or the leader of the opposition can request that the administration provide cost estimates for their electoral plans.
20. The BHA does not specify any particular numerical target, but it requires the government to set its operational targets on a 3-year basis and publish them in the FSS. The 1999-2000 budget, which introduced accrual budgeting, contains the following short-term objectives: to maintain fiscal surpluses over the three-year projection period; to reduce the ratio of federal net debt to GDP to 10 percent in 2000–01; not to increase the tax burden; and to improve the federal net asset position over the medium and long term.
Evaluation
21. The new framework contributed to a significant turnaround in the federal fiscal position, which shifted from a deficit of about 4 percent of GDP (on a cash basis) in 1992–93 to a surplus of 2 percent of GDP in 1999–00.14 Spending has increased only slightly and tax burden has remained constant. Moreover, transparency has improved due to the new reporting requirements established in the BHA.
Canada
Background
22. In Canada, federal government debt fluctuated around 35-40 percent of GDP in the 1980s, but the decline in economic growth during the early 1990s led to dramatic increases in the deficit, which reached around 6 percent of GDP in 1993. By 1994 debt reached 70 percent of GDP. The authorities responded through legislated spending restraint beginning in 1992.
The Institutional Arrangement
23. The “Fiscal Spending Control Act (FSCA)” of 1992 established a nominal expenditure limit for the period 1992–96. In addition, since 1994 the government introduced several policy rules which were not formally legislated.
Objectives
24. The main objective of the FSCA was to control public expenditure growth, reduce fiscal imbalances, and stop the increase in public debt. The non-legislated policy rules aimed at minimizing the use of overly-optimistic economic assumptions for budgeting, reducing public debt to cope with population aging costs, increasing the planning horizon for public sector activities, and improving the transparency of public operations.
Characteristics
25. The FSCA set nominal limits on “Program Spending” (with the exception of self-financing programs) from 1991 to 1995.15 Program Spending included all public expenditures except those associated with the service of debts, payments of employment insurance, expenditures related with the “Farmer Protection Act,” and those arising from emergencies and payments in satisfaction of judgments of Courts against the government. The expenditure limits were legislated and therefore binding by law; therefore the government was not allowed to present a budget proposal inconsistent with the expenditure limits in the FSCA. Overspending in one year could be offset in the following two years, including the final year stipulated in the law. Additionally, spending could be increased in a given year if there were unexpected revenues, or if spending in the previous year had been under the limit.
26. Parallel to the FSCA, the government introduced a set of non-legislated policy rules that complemented and enhanced the spending limit imposed by the law. The practice of basing budget planning on economic assumptions that are consistently more cautious than private sector forecasts was introduced in 1994. Furthermore, two-year rolling deficit targets were adopted with the goal of balancing the budget and, as part of a pre-budget consultation process, mid-year fiscal updates describing deficit targets and revised economic assumption began to be published. In 1995, an annual “Contingency Reserve” to finance forecasting errors and unpredictable events was created. If not needed, the reserve would be used to pay down the debt, as it was indeed the case. In 1998, the government committed to follow a debt repayment plan implying balanced budgets in the following two years (in the event, surpluses were achieved).
27. In 2000, the government announced a new element to its debt repayment plan. In addition to setting aside a contingency reserve, each fall it would announce whether more of that year’s surplus would be devoted to debt reduction than anticipated in the budget. In addition, in the future the effect of “prudent assumptions” on budget projections would be identified explicitly in order to facilitate the evaluation of the fiscal strategy. This implies that the public budget starts by establishing the amount of economic prudence required to cushion against potential pressures on government finances (such as higher-than-expected interest rates or lower-than-forecast growth), which helps to ensure that the government meet its commitment to balanced budgets.16 Finally, the government announced its intention to move toward full accrual accounting in the budget and, in 2001, announced that its final audited financial statements for 2001–02 will be presented on a full accrual basis.
Evaluation
28. The FSCA was successful; actual spending remained within the limits in all years, except 1993, when overspending compensated the under-spending in the preceding fiscal year. Furthermore, the deficit of 5 percent of GDP in 1995 became a surplus of more than 1 percent of GDP by 1999. Although part of this improvement is cyclically based, most of it reflects structural gains. Additionally, the ratio of net public net to GDP was reduced from around 70 percent in 1995 to 52 percent in 2000.
Finland
Background
29. As a consequence of a severe recession and a banking crisis in the early 1990s, Finland’s fiscal accounts deteriorated markedly. From levels of public expenditures of around 30 percent of GDP in the 1970s and of 45 percent of GDP in the middle 1980s, this ratio increased to around 60 percent in the early 1990s because of increases in welfare expenditures and of bank support programs. Tax receipts did not keep pace with spending increases, causing substantial deficits that peaked in 1993 with an imbalance of over 7 percent of GDP. The public debt ratio quadrupled in 1990-93, going from about 14 percent to about 56 percent of GDP. Forced by the evolution of the public accounts, a cabinet accord was reached to improve the public finances.
The Institutional Arrangement
30. The fiscal rule is a political understanding endorsed by the cabinet but not by Parliament. As a result, only the first year of the multiyear program is legally binding, as it is reflected in the yearly budget law. In 1995, the new government extended the practices established in 1991, but it changed the planning horizon from 3 to 4 years. In 1999, the government coalition that had ruled the country since 1995 was re-elected, and a new extension of the agreement was reached.
Objectives
31. The original agreement had as its main objective the reduction of the public deficit and the debt. The 1999 agreement extended the original objectives to include tax reduction. Other objectives stated in the budget laws are to increase the autonomy of spending departments, improve the transparency and simplicity of public sector operations, maintain deficits and public debt ratios consistent with the Maastricht Treaty and the SGP, and gradually prepare the public finances for population aging.17 The 1999 agreement established the objective to keep the expenditure of the central government fixed in real terms at its 1999 level.
Characteristics
32. The basic fiscal rule is a multiyear expenditure ceiling on total central government spending measured in constant prices of the budget year, with a rolling 4-year horizon. This rule is complemented with a balanced budget rule for autonomous local governments and by strong regulation of the privately managed social security funds. The real expenditure ceilings are set not only for total expenditure of the public sector but also for each ministry and are binding, although supplementary budgets have been used on occasion to dispose of privatization revenues resulting in minor deviations from the ceilings. Unemployment benefits, transfers to local governments and social security funds as well as interest on public debt are included in the expenditure aggregate.
33. There is no contingency reserve in case of differences between ex-ante projections and ex-post outcomes. The expenditure ceiling must be met ex post, but projections for the remaining years can be adjusted to reflect unexpected changes in the economic scenario. To facilitate expenditure management, the introduction of the rules was accompanied by a move from line-item budgeting to lump-sum appropriations. To avoid inefficient spending of appropriations not used at the end of the year, transfers to the following year are allowed. The expenditure ceilings are projected in real terms and then converted to nominal terms at the time of the budget using specific price and cost deflators. Finally, performance targets are developed between ministries and their agencies to improve service provision. Ex-post controls and auditing of spending budgets were also strengthened.
Evaluation
34. Since the introduction of the expenditure restraints in 1991, the central government has been able to keep its primary spending around its 1992 real levels, resulting in a decline in the ratio of public expenditures to GDP from almost 60 percent in 1993 to around 45 percent in 2000. The fiscal deficit decreased from its peak in 1993 to 1.6 percent in 1997 and turned to consistent surpluses beginning in 1998. The debt to GDP ratio was stabilized and began to decrease after 1994. It is estimated that approximately 70 percent of this improvement was due to structural rather than cyclical factors (IMF, 1999). Although the main expenditure reductions were in transfers to private sector and in public consumption, public investment suffered a more noticeable reduction in relative terms.
The Netherlands
Background
35. The Netherlands has a long history of carefully planned fiscal policy. As early as the 1960s, the Dutch government adopted a “Structural Fiscal Policy,” that related public expenditures and the budget balance to the size of potential GDP. Budgetary policy was mainly based on the principle that the budget deficit should be constant as proportion of trend GDP.18 The system performed well until the early 1970s, when unrealistic forecasts about trend GDP increased expenditures far beyond the level of actual revenues, resulting in a substantial increase in the fiscal deficit. By 1982, the general government deficit was around 7 percent of GDP. Forced by this situation, the government abandoned the previous fiscal policy and adopted one based on a multiyear deficit reduction target. The new policy however, was strongly pro-cyclical, and the deficit reduction path had to be revised often. In spite of these drawbacks, the fiscal deficit returned to more sustainable levels.
36. In 1994, the administration of Prime Minister Kok returned to a type of structural fiscal policy, though with a number of important differences. This fiscal framework (also denominated “Trend Fiscal Policy”) established medium-term ceilings for government expenditures and rules for the disposition of revenue shortfalls or overruns.19 In 1998, the second Kok administration continued with the approach, but introduced some modifications.
The Institutional Arrangement
37. The “Trend Based Fiscal Policy” established in 1994 was the result of a political agreement among the three parties forming the first Kok coalition for the four years of the legislature. The coalition is committed to implement the rules as established. As in Finland, the only ceilings that are legally binding are those included in the current year budget.
Objectives
38. The fiscal framework adopted in 1994 and continued in 1998 aims at introducing transparent and orderly decision-making in the budgetary process, increasing efficiency in public sector activities and improve financial control of such activities, reducing the ratio of structural government spending to GDP, and permitting a more effective use of the public budget as a counter-cyclical tool in order to stabilize GDP around its potential. Finally, the fiscal framework is intended to strengthen the budgetary process.
Characteristics
39. The budgetary framework of 1994 established specific expenditure ceilings in constant prices for central government spending, social security, and healthcare on a 4-year basis based on cautious economic assumptions (i.e., a projection of real GDP growth of 2.25 percent, which is below trend growth during the last 15 years).20 The cautious assumptions implied that the probability of windfalls was greater than the probability of setbacks, which facilitated an orderly execution of the budget. In addition to the ceilings, the agreement established that expenditure overruns had to be redressed within the spending category in which the excess occurred. In the case of lower than planned expenditures, the difference had to be used to reduce the public deficit and/or taxes. Non-recurrent revenues, such as those generated by privatization, were excluded. Revenue windfalls or setbacks could be absorbed by the deficit, thus allowing for the operation of automatic stabilizers, or used for tax cuts.
40. The 1998 coalition agreement introduced the following new provisions. On the expenditure side, it allowed expenditure undershoots in one category to be used to cover overruns elsewhere, but only after a cabinet vote. A small expenditure reserve (of 0.25 percent of budgeted expenditure) was created to cover public sector wage bill overruns as well as to carry over spending across periods (i.e., spending can be advanced from or postponed to the following year in an amount equal to that percentage). In addition, another small reserve was established to face unforeseen expenditures. On the revenue side, if the budget deficit was less than 0.75 percent of GDP, half of the revenue overshoot had to be used to reduce the deficit and half to cut taxes, while if the budget deficit exceeded 0.75 percent of GDP, 75 percent of the excess had to be used to reduce deficit and the rest to cut taxes. In the case of revenues undershoots and if the budget deficit was larger than 2.25 percent of GDP, half of the undershoot would go to the deficit and the other half would be covered with higher taxes. Finally, if the budget deficit was lower than 2.25 percent of GDP, the percentages would be changed to 75 percent and 25 percent respectively.
41. As an implementation issue, when a new budget is drawn-up the estimated revenue is compared with the forecasts made at the time of the coalition agreement. This comparison indicates, for a given year, the extent of overshoots or setbacks. The situation is not reviewed during the course of the year. If there are differences with ex-ante estimations, such differences go entirely to the fiscal result. The provisions on the revenue side make clear one of the central aspects of the Dutch budgetary framework, i.e., the strict separation of expenditure and revenue planning and therefore the intended impossibility for revenue windfalls or setbacks to generate changes in expenditures.21 Since the expenditure ceilings are expressed in constant prices, the projected GDP deflator is used to convert them into nominal amounts. There is a mid-year Supplementary Budget that allows for a last adjustment in the projected GDP deflator. After that, changes in the GDP deflator are not reflected in nominal spending ceilings.
Evaluation
42. Under the budget framework established by the two Kok administrations Dutch public accounts improved substantially, and both public spending and the tax burden were reduced. The fiscal deficit of 4.2 percent of GDP in 1995 became a surplus of 1.5 percent of GDP in 2000, while the gross public debt to GDP ratio was reduced to 56.1 percent in 2000 from more than 75 percent in 1995. As in the other countries, however, a favorable position in the business cycle also contributed to these outcomes.
43. The use of a cautious economic scenario and the unexpectedly strong economic growth produced large revenue windfalls during the second Kok administration, which should have resulted in large tax cuts according to the rules. In order not to further stimulate the economy, tax cuts will remain below what would be implied by the rules for the distribution of the revenues windfalls. The spending rules, on the other hand, have remained binding.
New Zealand
Background
44. By and large, fiscal management was orderly in New Zealand during the 1960s and early 1970s. Government expenditure was around 30 percent of GDP and the public budget was close to balance. However, during most of the 1970s and 1980s tax revenues lagged spending growth, with the latter being led by increasing transfers, higher debt service caused by persistent fiscal deficits, and higher interest rates following financial liberalization. By the early 1990s, government spending had reached 40 percent of GDP. Debt peaked at 74.5 percent of GDP in 1987, from levels of around 40 percent of GDP in the mid 1970s. As a consequence of the poor fiscal performance, the New Zealand’s debt rating was downgraded in the early 1990s, increasing the cost of financing the continuing fiscal imbalances.
45. In this context, the authorities began a process of institutional reform. First, the government enacted laws that changed the way the public sector was managed from a microeconomic perspective, with the objective of increasing the efficiency in the provision of public services. Second, the autonomy of the Central Bank was guaranteed by law and its main objective, i.e., price stability, was made explicit. Finally, Parliament enacted a law that modified the way public policy was managed from a macroeconomic perspective. The government also established principles, procedures and goals for budget administration.
The Institutional Arrangement
46. The fiscal rules are contained in the “Fiscal Responsibility Act” (FRA) which became effective in July 1994 and was preceded by earlier reforms; these reforms intended to increase the efficiency of the public sector as a provider of services and were contained in the “State-Owned Enterprises Act” of 1986 and the “State Sector Act” of 1988. Both laws adopted private sector procedures for the management and evaluation of public sector services. Additionally, the “Public Finance Act” of 1989 reformed the budgetary appropriation and reporting process, granting officials chief executive powers and responsibilities in relation to fiscal management and imposing reporting requirements for departments and the government as a whole; it also changed the basis for appropriation from inputs to services (outputs) and from a cash-basis to an accrual basis. It is worth emphasizing that the FRA reflected a process that began well before 1994. The principles contained in the FRA constitute the current guidelines for budget policy in New Zealand.
Objectives
47. The FRA aims at improving fiscal policy by specifying principles of responsible fiscal management and strengthening reporting requirements to achieve more transparent, decision-making by the government. The law also intends to increase accountability by promoting a more informed public debate about fiscal policy, and facilitate the independent assessment of fiscal policies.
Characteristics
48. The FRA’s provisions can be grouped in two areas. The first area establishes five principles of responsible fiscal management: to reduce public debt to prudent levels by achieving operating surpluses every year until prudent levels of debt are reached; to maintain public debt at prudent levels by ensuring that, on average, over a reasonable period of time, total operating expenses do not exceed total operating revenues; to achieve levels of public sector net worth that can provide a buffer against adverse future shocks; to prudently manage the risks facing the public sector (i.e., recognize risk and where possible, take steps to manage it); and to pursue policies that are consistent with a reasonable degree of predictability about the level and stability of tax rates for future years; i.e., to avoid surprises about future tax rates.
49. In addition to these principles the FRA requires that two new publications be issued stating the intentions and objectives for fiscal policy: a Budget Policy Statement to be published by the end of March, and a Fiscal Strategy Report to be published at the time of the budget, i.e., around May. The Budget Policy Statement must include the government’s broad strategic priorities for the upcoming budget, their fiscal intentions for the next three years and their long-term fiscal policy objectives. The government must also make clear the consistency of its plans and objectives with the principles of responsible fiscal management set out in the FRA. In turn, the Fiscal Strategy Report analyzes the consistency between the economic and fiscal projections included in the budget and the government’s short-term fiscal plans set out in the most recently published Budget Policy Statement. Where those plans have changed, the government has to provide an explanation.
50. In addition to the reports on policy intentions (Budget Policy Statement and Fiscal Strategy Report), the FRA requires the publication of a substantial array of fiscal information throughout the year, including an economic and fiscal update for the next three years to be published on budget night; a half-year economic and fiscal update for the next three years to be published in December; a pre-election economic and fiscal update for the next three years to be published, depending on circumstances, between 42 and 14 days before the date of any general election; and a current-year fiscal update to be published with the Supplementary Estimates, towards the end of each financial year. The reports are to be made using Generally Accepted Accounting Practice principles and on an accrual basis. In the case of differences between ex-ante and ex-post outcomes, the FRA establishes no formal sanctions. The government can depart from the principles but the reasons for the departure and when and how it expects to return to them have to be stated explicitly.
51. In addition to the FRA, non-legislated fiscal practices concerning expenditure management have been introduced. These involve giving spending departments fixed nominal baselines, which can be adjusted for demographic or demand-driven changes. Any new initiatives, or changes to existing initiatives, within the parliamentary cycle (three years) must be met from a fund called Fiscal Provision. Thus, in practice the size of this fund limits new discretionary spending. In the last budget, the government set a three-year Fiscal Provision.
Evaluation
52. New Zealand’s fiscal position improved substantially during the 1990s, but the direct contribution of the present fiscal framework has to be weighed against the cyclical improvements. Nevertheless, most estimates indicate a clear shift towards lower structural public deficits during the second half of the 1990s. Furthermore, by requiring all levels of government to be explicit about their short-term intentions and long-term objectives, the FRA has established a more transparent framework for annual budget decisions.
Sweden
Background
53. Fiscal adjustment and the implementation of fiscal rules come in Sweden after a period of high fiscal deficits and a substantial increase in the public debt to GDP ratio in the early 1990s. This fiscal deterioration was partly caused by the severe recession and banking crisis of the early 1990s. The government elected in September 1994 faced a fiscal deficit of 10.5 percent of GDP and a ratio of public expenditures to GDP approximately equal to 70 percent. Gross public debt as a proportion of GDP almost doubled in 1990-1994, increasing to over 75 percent of GDP. The government reacted by issuing a “Consolidation Program” during the winter of 1994–95. The program included measures equivalent to 7.5 percent of GDP to be implemented over the period 1995–1998. In 1996, the Consolidation Program was augmented in order to allow room for an additional saving of around 0.5 percent of GDP.
The Institutional Arrangement
54. To consolidate the achievements of 1994–1996, the government introduced a fiscal rule, which was approved by Parliament in 1996 and implemented beginning in 1997. This resolution complemented and augmented previous Parliament resolutions and government guidelines. In 1993, the government strengthened financial control over its agencies. In 1994, Parliament resolved that the public budget should be planned on a 4-year basis, while in 1995 Parliament ruled that the budget should be prepared based on an expenditure ceiling for the public sector.
Objectives
55. The rules aim at achieving the long-term government’s goal of a budget surplus of 2 percent of GDP over the cycle to prepare the public finances for population aging. This goal is intended to be met with no further tax increases. The consolidation measures were in part guided by the Maastricht criteria for convergence to EMU.22
Characteristics
56. Work on the public sector budget begins more than a year before the start of the relevant fiscal year.23 In December, the Ministry of Finance reports to the government on the forecast of economic trends, which is done on a realistic (rather than prudent) basis. This is used as input for the “Spring Fiscal Policy Bill” (SPF) that the government presents to Parliament no later than April 15. Budgetary planning is made on a rolling 3-year basis based on economic forecasts that are reviewed by both the Parliament and the government. The basic fiscal targets are a binding nominal ceiling for central government expenditure and the general government net borrowing. The SPF contains the government’s forecast for revenues and expenditures, and the allocation of expenditures among 27 expenditure areas. The document also contains a “Supplementary Budget” with proposed changes in appropriations for the current year.24 The expenditure areas covered exclude pension costs and interest payments; the latter are excluded since they are considered beyond public sector control.25 As a result, the expenditure ceiling covers approximately two-thirds of total expenditure.
57. Since the ceiling is set in nominal terms and on a 3-year rolling basis, the government’s SPF includes updates of expected price movements, as well as projected expenditure ceiling for the new third year. In order to create room for forecast errors, the ceiling is set up at a slightly higher level than the sum of the expenditure items included. This “Budget Margin” serves to accommodate differences between ex-ante projections and ex-post outcomes without having to change the expenditure ceiling. In the Budget Bill of 1997, when the expenditure ceilings were first set, the budgetary margins for the period 1997–99 were established at 1.5, 2.0, and 2.5 percent of total expenditures respectively. In practice, the margins have been used to finance discretionary increases in public expenditures.
58. The SPF constitutes the basis for the Budget Bill that is submitted to Parliament by September 20. When Parliament receives the Bill, it decides in two stages. In the first stage, it approves the global expenditure ceiling, the expenditure ceiling for the expenditure areas, and changes in taxes. After this decision has been made, no further changes in the ceilings are allowed. In the second stage, the various parliamentary committees decide how the expenditure in each area is to be allocated to the individual appropriations. The final Budget Bill has to be approved by mid December.
59. After approval, ministries monitor the development of expenditures on a monthly basis. In August, there is an interim report on the first half of the year, and an assessment on the use of appropriations for the rest of the year. The government has to inform Parliament of substantial deviations from the expenditure ceilings and of the reasons for such deviations. As mentioned above, if necessary, the government can propose an amendment to the current budget by means of a Supplementary Budget to be presented with the SPF. Any overruns have to be financed by reductions in other areas of spending, though for the differences between ex-ante and ex-post outcomes there are no formal sanctions. In the case of limited expenditure overruns, a borrowing possibility is allowed, but the amount borrowed is automatically deducted from the budget appropriation of the following year.
60. Finally, the National Audit Office (RRV) carries out annual audits and efficiency audits. The annual audit examines whether an agency’s annual report gives a true picture of its financial situation and performance, while the efficiency audit concentrates on how government activity is carried out. The RRV presents its observations by April 1.
Evaluation
61. Even though the rules have been in place only for the last four years, it is clear that the first results are positive, although favorable economic growth has also contributed to the outcome. Government expenditure as a percentage of GDP has decreased to about 55 percent of GDP in 2000 form around 70 percent in 1997, and the Budget Bill for 2001 projects a further decrease to levels around 53 percent. At the same time, the fiscal balance has shown steady surpluses since 1998. Accordingly, the gross public debt to GDP ratio is forecast to decrease to below 55 percent of GDP in 2001 from a level of 75 percent of GDP in 1997.
Switzerland
Background
62. During the 1980s, the Swiss authorities were able to manage the fiscal accounts prudently, which resulted in public debt to GDP ratios substantially below those of other European countries. In the first half of the 1990s the Swiss economy experienced a protracted recession which reduced the annual average growth rate of GDP from 1.8 percent in 1970-1990 to zero in 1990–1996. As a result, spending growth, fueled by raising pensions and health care costs, outstripped revenue growth and deficits appeared. The situation worsened as unemployment rose from below 1 percent of the labor force to over 5 percent. The public debt as percentage of GDP increased from 31 percent in 1990 to 54 percent in 1998, especially because of an increase in the debt of the federal government.
The Institutional Arrangement
63. In 1998, a constitutional amendment established the obligation to balance the federal budget by 2001.26 In order to achieve this goal, the authorities cut military spending and the railroad budget, and increased social security payments by the cantons. The recovery of the economy in 1999–2000 allowed the Swiss government to balance the budget one year earlier than planned. In 2000, the government proposed another constitutional amendment, subject to a public referendum in 2001, that introduces rules to control the fiscal accounts of the federal government in all stages of the business cycle.
Objectives
64. The Swiss fiscal rule aims at preventing structural deficits in the federal budget and allowing scope for counter-cyclical fiscal policy.
Characteristics
65. The fiscal rule proposed in the constitutional amendment imposes a ceiling on federal government expenditure (including capital expenditure but excluding net lending to the unemployment insurance fund) according to the following formula:
where
where YTt+1 denotes one-year ahead trend real GDP and Yt+1 is the one-year ahead real GDP; thus, Ct+1 > 1 if the economy is below trend and Ct+1 < 1 if the economy is in a period of expansion. Equation (1) implies a level of expenditures that depends on projected fiscal revenues and on the position of the economy in the cycle. Thus, if the economy is expected to be below trend, expenditures are allowed to exceed revenues and vice versa, allowing for the fiscal position to move counter-cyclically. As a consequence of this mechanics, the federal budget is expected to be in equilibrium over the cycle. Thus the fiscal rule is approximately a rule on the cyclically adjusted balance.27
66. The Swiss fiscal rule is intended to hold also ex post, i.e., at the execution stage. However, equation (1) relies on projections which sometimes may be inaccurate. To address this problem, the proposed fiscal rule creates a fictional account,
67. Supplementary budgets can be introduced in mid-year, but if they violate the fiscal rule they have to be approved by a qualified majority in both chambers of Parliament.29 This provision attempts to give some flexibility to the rules in the event of exceptional circumstances, although the proposed law does not specify what these circumstances may be.
Evaluation
68. An evaluation of the workings of the proposed rule is still not possible due to its prospective nature.
United Kingdom
Background
69. The United Kingdom’s fiscal policy was highly volatile during the 1970s, with deficits averaging around 3.3 percent of GDP in 1979–1996, and reaching over 4 percent of GDP in 1997. When the authorities attempted to control the fiscal accounts, fiscal policy turned pro-cyclical with the main burden of the adjustments falling on public investment. This bias against capital investment resulted in under-investment in public assets and in levels of capital formation below those of other G-7 countries. In this context, in 1977 the authorities introduced a new framework for conducting fiscal policy with the objective of making it more effective. The introduction of this framework was complemented by a clear separation between monetary and fiscal policy.
The Institutional Arrangement
70. The fiscal framework introduced in 1997, the “Code for Fiscal Stability” (CFS), is a set of principles and guidelines for effective fiscal policy that received statutory backing through the “Finance Act” of 1998. Thus, the CFS binds also future governments.
Objectives
71. The new fiscal framework intends to achieve multiple objectives. In addition to meeting the government’s microeconomic objectives, i.e., those related to the efficiency and effectiveness of taxation and spending, it intends to achieve macroeconomic goals over the short and long-term horizon. The short-term objective is to support monetary policy—where possible—by allowing the automatic stabilizers to smooth fluctuations in aggregate demand and, where prudent and sensible, provide further support to monetary policy through discretional changes in the public accounts. Over the long-term, the fiscal framework intends to ensure sound public finances and a fair allocation of taxation both within and across generations, and to avoid unsustainable increases in public debt by balancing, over the cycle, current expenditures with current revenues. In this way, the new fiscal framework aims at removing the bias against capital spending.
Characteristics
72. The GFS is based on three pillars: a set of fiscal policy principles, two fiscal rules, and specific reporting and auditing requirements.
73. Under the CFS fiscal policy should respect five principles: transparency, in the setting of fiscal policy objectives, the implementation of fiscal policy and in the publication of public accounts; stability, in the fiscal policy-making process and in the way fiscal policy impacts on the economy; responsibility, in the management of public finances; fairness, including a fair treatment among different generations; and efficiency, in the design and implementation of fiscal policy and in managing both sides of the public sector balance sheet.
74. In addition, fiscal policy should respect two general rules that are in accord with these principles. The first one, the golden rule, specifies that over the economic cycle, the government will borrow only to invest, while the second one, the sustainable investment rule, establishes that the public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level.30
75. These fiscal rules provide benchmarks against which the performance of fiscal policy can be judged. In this sense, the U.K. fiscal framework is similar to that of New Zealand, since the determination of specific targets are left to the current authorities.31 Accordingly, the government can change, permanently or temporarily, its objectives and rules of operation, provided that the new objectives and rules are in accord with the principles stated in the CFS and that the government specifies the reasons for departing from the previous goals. In the case of temporary changes, the government has to state when it intends to return to the previous objectives and rules.32
76. The CFS also specifies reporting and auditing requirements, and mandates the publication of a “Pre-Budget Report” to encourage debate on the proposals under consideration for the budget, a “Financial Statement and Budget Report” to disclose the key budget decisions and the short-term and fiscal outlook, an “Economic and Fiscal Strategy Report” outlining the government’s long-term goals, its strategies for the future and how it is progressing in meeting its fiscal objectives, and a “Debt Management Report,” outlining the government’s debt management plans. Furthermore, the government has to publish its economic and fiscal projections, including estimates of the cyclically-adjusted fiscal position and long-term projections, assess the sustainability of policies and disclose and quantify, where possible, all decisions and circumstances which may have a material impact on the economic and fiscal outlook.
77. All reports have to be drawn up using best practice accounting methods and have to be referred to the Treasury Committee of Parliament, ensuring that the general public will have full access to them. The National Audit Office is in charge to audit changes in key assumptions and conventions on which fiscal projections are based. The CFS does not include provisions for formal sanctions; thus, enforcement is based on reputational considerations, supported by the rigorous reporting requirements.
78. To support the fiscal framework, the government has implemented a new regime for planning and controlling spending.33 This regime establishes that all spending departments will have “Departmental Expenditure Limits (DEL),” which will be set in nominal terms for three years on a two-year rolling basis. The DELs are only adjusted if inflation forecasts differ significantly from the original projections. Unspent DEL funds can be carried over to the next year, but overruns are not allowed. DELs cover most non-cyclical primary expenditure, i.e., around 50 percent of total expenditures, and include central government transfers to local governments.
79. Expenditures that are not subject to multi-year limits are subject to annual scrutiny as part of the budget process and are referred to as “Annually Managed Expenditure” (AME). Current and capital expenditures are treated separately in order to be consistent with the golden rule established in the CFS. The ceiling on AME is only binding for the current budget year and it includes a contingency reserve in order to deal with changing circumstances.
Evaluation
80. Since the beginning of the fiscal framework, fiscal accounts have improved markedly, with consistent decreases in the public debt-to-GDP ratio, which is projected to reach 30.3 percent in 2001/02. At the same time, the general government balance switched from a deficit of 3.8 percent of GDP in 1996 to an estimated surplus of 3.6 percent of GDP in 2000. The structural balance improved from a deficit of 3.0 percent to a surplus of 1.9 percent over the same period. Thus, a significant part of the fiscal improvement is not attributable to the positive position of the U.K. economy in the business cycle.
United States
Background
81. During 1950-1975, the public debt to GDP ratio declined continuously, while the budget deficit remained low.34 In 1975, however, public expenditures began to increase rapidly mainly due to expanding entitlement programs. Initially, the deficits were partly covered by growing tax revenues, as high inflation moved individuals into higher income tax brackets. However, the introduction of inflation indexing in the tax code, tax relief introduced through the “Economic Recovery Tax” of 1981, increases in defense spending, and an adverse cyclical position resulted in a substantial increase in the public deficit, which reached more than 6 percent of GDP in 1983. After the mid 1980s the deficit was reduced thanks to stronger economic activity and to several legislative initiatives, but the mild recession of the early 1990s resulted in a new increase in the budget deficit. All in all, the public debt to GDP ratio rose from approximately 25 percent in the early 1970s to just under 45 percent in the early 1990s.
The Institutional Arrangement
82. The U.S. experience with fiscal rules is a long one.35 Recent rules were introduced in a series of laws enacted since the mid 1980s. The “Balanced Budget and Emergency Deficit Control Act” of 1985, also known as Gramm-Rudman-Hollings I (GRH I), established specific deficit targets for each year through 1991. This law was followed in 1987 by the “Balanced Budget and Emergency Deficit Control Reaffirmation Act,” also known as Gramm-Rudman-Hollings II (GRH II), which revised the deficit targets established in 1985 and extended them through 1993. In 1990, as part of a major deficit reduction package, Congress approved the “Budget Enforcement Act (BEA 1990),” which replaced the deficit targets with expenditures ceilings or “caps” and established a “pay-as-you-go” system (PAYGO) for the period 1990–1995. The Act also established guidelines concerning how baseline budget projections were to be made. In 1993, the “Omnibus Budget Reconciliation Act,” extended the provisions of the 1990 law until 1998.36 Finally, the “Budget Enforcement Act” (BEA) of 1997 extended again the provisions of the 1990 law until 2002. Due to the success in controlling the deficit, the budget for 2002 proposes the extension of the spending caps and the PAYGO system until 2006.
Objectives
83. The goal of GRH I and GRH II was to increase fiscal discipline by reducing the public deficit and control the increase in the public debt. The BEA 1990 and 1997 shared with its legal predecessors the objective to control the fiscal deficit and the public debt, but changed the fiscal framework used to achieve the goals.
Characteristics
84. GRH I specified declining nominal targets for the budget deficit, ending with budgetary equilibrium in 1991. The targets were to be enforced by uniform percentage reductions in selected mandatory and most discretionary spending programs. However, this was ruled unconstitutional because its implementation violated the separation of powers. In 1990, because of unexpected expenditures arising from the war with Iraq and a major flood, and faced with the prospect of substantial expenditure cuts (over 30 percent in some programs, including defense), the President and Congress agreed to postpone balancing the budget until 1993 (GRH II). This triggered a change in the fiscal framework, and the BEA 1990 reflects such a change.
85. The BEA 1990 changed the main control variable from the budget deficit to expenditure.37 The BEA defined categories of discretionary spending and established nominal caps for them for the period 1990–95. Discretionary outlays were defined as those controlled by the annual appropriation process. Currently, discretionary expenditure represents about one third of total public outlays. The caps could accommodate emergencies and other circumstances. When initially enacted, there were three separate caps, covering defense spending, international spending, and non-defense domestic spending. The 1993 amendment introduced a single cap for 1994–96. Under the BEA of 1997, two separate caps were established for defense spending and non-defense discretionary spending for the period 1997–99, while a new cap for the years 1997–2000 was established for a new category of outlays called Violent Crime Reduction. In the 2001 Budget Bill there is again only one cap for all discretionary spending.
86. In addition to the nominal caps, the BEA of 1990 introduced the “PAYGO” system for revenues and direct spending. Direct spending included entitlement programs established through legislation; for these programs, outlays were determined not by annual appropriations but by the eligibility criteria and benefit formulas specific to each of them. Under the PAYGO system all changes in taxes and in direct spending had to be deficit neutral over one and five year horizons. The PAYGO did not require congressional action if revenues fell or outlays grew due to changing economic conditions or changing technical assumptions. Additionally, it was enforced one year at a time, implying that no “carry-over” was allowed.
87. Both the nominal caps on discretionary spending and the PAYGO system were enforced by the threat of sequestration. The required sequestrations were to be identified by the Congressional Budget Office (CBO) and the Office of Management and Budget (OMB), and to be enforced by the President based on the OMB estimates.38 The sequestration process was characterized by three stages which resulted in three different reports, a preview report, and update report and a final report, which had to be based on consistent economic and technical assumptions. Sequestration could be suspended in the event of a Declaration of War or a passage of a joint resolution of Congress triggered by a CBO report indicating that economic growth was likely to slow below a defined threshold rate. In practice, however, appropriations have been deemed to be “emergencies” to skirt PAYGO provisions. The law also introduced new budget-related reporting, such as the “President’s Budget Review.”
Evaluation
88. The GRH laws did not produce the targeted decline in deficits because of mistakes in estimating the potential rate of growth of GDP and of flaws in the determination of the targets. As a result, the sequestrations required to achieve the goals were so large that they were unworkable. In contrast, the BEA 1990 and its subsequent modifications (1993, 1997) established more realistic targets, and fiscal restraint was more easily maintained. Nonetheless, an important part of the improvement in fiscal accounts during the 1990s was due to the favorable position of the U.S. economy in the business cycle (about 40 percent according to the CBO).
89. Finally, some have argued that the BEA may not be enforced at the current juncture since the law indicates it was developed to address deficits and the U.S. budget is now in surplus. Also, the PAYGO rules have been interpreted to allow spending in future years to be financed from unexpected revenues in the previous years.
References
General
Hemming R. and M. Kell, (2001), “Promoting Fiscal Responsibility. Transparency, Rules and Independent Fiscal Authorities,” Fiscal Affairs Department, IMF, May.
Kopits, G., and S. Symansky (1998), “Fiscal Policy Rules,” IMF Occasional Paper 162.
IMF, (2001), “World Economic Outlook,” Chapter 3, May.
Australia
Department of Finance and Administration, (1998), “Charter of Budget Honesty Act.”
IMF, (2001), “Australia: Staff Report for the 2000 Article IV Consultation,” March.
Canada
Department of Finance, “The Economic and Fiscal Update.” Several issues.
Department of Finance, “The Budget Plan.” Several issues.
HM Parliament, (1992), “Spending Control Act,” June.
IMF, (2000), “Canada: Selected Issues,” March.
IMF, (2000), “Canada: Staff Report for the 2000 Article IV Consultation,” February.
Kennedy, S. J. Roberts and F. Delorme, (2001), “The Role of Fiscal Rules in Determining Fiscal Performance,” Department of Finance, Canada, January.
Finland
IMF, (1999), “Finland: Selected Issues,” October.
IMF, (2000), “Finland: Staff Report for the 2000 Article IV Consultation,” August.
Ministry of Finance, (2000), “Government Report to Parliament of Budgetary Appropriation Guidelines,” March.
Ministry of Finance, (1999), “Stability Program for Finland,” September.
OECD, (2000), “Country Surveys: Finland.”
The Netherlands
Berndsen R., (2001), “Postwar Fiscal Rules in The Netherlands: What Can We Learn?,” Banca d’ltalia, Third Workshop on Public Finance, Perugia, February.
IMF, “Kingdom of the Netherlands-Netherlands: Staff Report for the Article IV Consultation,” Several Issues.
Ministry of Finance, (1999), “Netherlands: 1999-2002 Stability Program. 1999 Update,” November
OECD, (2000), “Country Surveys: The Netherlands.”
Reininga T., (2001), “Coalition governments and Fiscal Policy in The Netherlands,” Banca d’ltalia, Third Workshop on Public Finance, Perugia, February.
Van Ewijk C. and T. Reininga, (1999), “Budgetary Rules and Stabilization,” CPB Report 4.
New Zealand
Bollard A., S. Mac Pherson and A. Vandermolen, (2000), “The government’s Fiscal Position and its impact on the Public Sector,” Public Sector Finance Forum, August.
Janssen J. (2001), “New Zealand’s Fiscal Policy Framework, Experience and Evolution,” Third Workshop on Public Finance, Perugia, February.
The Treasury, (1995), “Fiscal Responsibility Act 1994: An Explanation,” September.
Sweden
Heeringa W. and Y. Lindh, (2001), “Dutch versus Swedish Budgetary Rules: Comparison and Stabilizing Properties,” Banca d’ltalia, Workshop on Fiscal Rules, Perugia, January.
IMF, “Sweden: Selected Issues,” Several issues.
IMF, (2000), “Sweden: Staff Report for the 2000 Article IV Consultation, August.
Ministry of Finance, (1999), “The State Budget Procedure,” June.
OECD, (1998), “Public Management developments in Sweden. Update 1998.”
Switzerland
IMF, “Staff Report for the Article IV Consultation.” Several Issues.
IMF, (2001), “Switzerland: Selected Issues,” May.
United Kingdom
HM Treasury, (2000), “Analyzing U.K. Fiscal Policy.”
HM Treasury, (1999), “Fiscal Policy: Public Finances and the Cycle.”
IMF, (1999), “United Kingdom: Selected Issues,” May.
IMF, (2001), “United Kingdom: Staff Report for the 2000 Article IV Consultation,” February.
Kilpatrick A., (2001), “Transparent Frameworks, Fiscal Rules and Policy-Making under Uncertainty,” Banca d’ltalia, Third Workshop on Public Finance, Perugia, February.
United States
IMF, “United States: Selected States.” Several Issues.
IMF, (2000), “United States: Staff Report for the 2000 Article IV Consultation,” July.
Peach R., (2001), “The Evolution of the Federal Budget and Fiscal Rules,” Banca d’ltalia, Third Workshop on Public Finance, Perugia, February.
This chapter was prepared by Enrica Detragiache and Gabriel Di Bella.
The Australian population is relatively young and therefore population aging is not a important concern compared to other OECD countries.
The financial risks identified by the Charter include those arising from excessive net debt, commercial risks arising from ownership of public trading enterprises and public financial enterprises, risks arising from erosion of the tax base and from the management of assets and liabilities.
The fiscal year runs from July 1 to June 30.
The FSCA in its article 10 established that by 1994 Parliament should consider extending the law. As legislation was not deemed necessary to further control spending, the act was not extended beyond 1995.
For the 2000, budget prudence has been set at $1 billion in 2000–01 and $2 billion in 2001-02, as in the 1999 Economic and Fiscal Update.
Short-term economic stabilization is not a specific objective, although the government has established that tax reductions have to be implemented taking into consideration the position of the economy in the business cycle.
In the context of this discussion potential and trend GDP are considered equivalent concepts.
In introducing this budgetary policy, the minister of finance followed the advice of the “Study Group of Budgetary Margin,” which is composed by the highest-rank civil servants of the financial and economic ministries, an executive director of the Central Bank and the director of the Netherlands Bureau For Economic Policy Analysis. This group also devised the fiscal policy followed by The Netherlands during the 1960s and 1970s.
Central government spending includes interest on public debt and excludes local government spending and a fund for infrastructure investment. In addition, it is net of non-tax and non-premium revenues.
This is known in The Netherlands as the “Zalm rule,” after the Finance Minister of the two Kok governments.
However, according to the Rome Agreement of 1992 Sweden is an observer member of the European Union and does not participate in EMU.
The public sector in Sweden includes the central, local, and regional governments and fiscal agencies.
The new budgetary process gives the Ministry of Finance more powers in drawing up the budget compared to the earlier process.
There is an indicative ceiling for general government expenditures, which includes estimated local government expenditure. It is only indicative because local governments have the right to decide on their own levels of expenditure. However, local government expenditure is primarily affected by central government grants and tax revenues, so the indicative ceiling is actually quite binding. Additionally, as of 2000, the Parliament decided that municipalities and county councils should present budgets with ex-ante surpluses.
Budget “balance” was defined as at most a deficit of 2 percent of total revenues.
The procedure to compute the output gap ensures that this objective is met. In this regard, the authorities have proposed the use of the Hodrick-Prescott filter, but this is not legislated and the government is open to using other methods.
In the formula for Ft, τ denotes the first period of application of the fiscal rule and t denotes the current period.
The fiscal rule is considered to be complied with if modified expenditures exceed the ceiling by at most 0.5 percent of the ceiling.
In order to avoid loopholes, the definition of public investment follows that included in the System of National Accounts.
As examples, the current authorities have stated that a sustainable level of net public debt to GDP ratio in 40 percent.
The rules of operation are related with government practice and are not specified in the CFS. For more on this, see below in the section.
It should be noted that the supporting expenditure framework is not established in the CFS.
The discussion that follows refers to the federal government only.
According to Peach (2001), the first law that incorporates a provision that can be interpreted as a fiscal rule is from 1917. This law, the “Liberty Bond Act,” established a statutory limit on the gross indebtedness of the Federal government. This law intended to provide a simplifying procedure to the issuing of bonds, since before the law, every individual bond issue had to be approved by the Congress. In the 1980s and 1990s, the need to raise the federal debt ceiling motivated the enactment of deficit reduction legislation. Additionally, the “Congressional Budget and Impoundment Control Act” of 1974, established the current congressional budget process, with the creation of the House and Senate Budget Committees and the Congressional Budget Office (CBO).
In 1996, Congress approved the “Line Item Veto Act,” which granted the President the authority to cancel selected categories of spending and tax provisions over the period 1997-2004. However this act was declared unconstitutional by the Supreme Court and therefore abolished.
It additionally placed the sequester “trigger” in the hands of the Office of Management and Budget (OMB) Director.
According to Peach (2001), there was only one sequestration since the enactment of the law, and of a very modest magnitude.