27-30 January 2003 Santiago de Chile XV Seminario Regional de Pol

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27-30 January 2003 Santiago de ChileXV
Seminario Regional de Política Fiscal Fabrizio
Balassone, Daniele Franco, Stefania Zotteri
Fiscal Rules for Sub-National GovernmentsSoundne
ss, Stabilisation and Decentralisation
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EMU NEW HISTORICAL DEVELOPMENT

• EU fiscal rules have extensive implications
• Stabilisation
• Allocation and distribution
• Long-term sustainability intergenerational
  redistribution
• Relationships between levels of governments

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MOTIVATIONAND STRUCTURE

• Motivation
• Evaluate implications of EMU fiscal rules for
  relationships between levels of government
• Structure
• EU fiscal rules
• Critical issues for decentralisation
• What solutions can be considered?
• What solutions have been adopted?
• Are current solutions sustainable?

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EU FISCAL RULESA DESCRIPTION

• ? Deficit should not exceed 3 of GDP unless
• Exceptional events
• Excess temporary
• Excess limited
• ? Close to balance or in surplus
• ? Multilateral surveillance
• ? Excessive deficit procedure (sanctions related
  to excess)

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INTERPRETING THE RULES DISCIPLINE AND FLEXIBILITY

• Fiscal targets
• Soundness (monetary-financial stability)
• - limits to deficit and debt ratios
• Flexibility (stabilisation policy)
• - medium-term position of close-
  to-balance or in surplus
• ? Deficit fluctuates over cycle (automatic
  stabilisers can operate)

SURPLUS
0
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DEFICIT

BAD TIMES GOOD TIMES


LENGTH OF CYCLE
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National rules for sub-national governments
? Co-ordination between different government
tiers at national level needed independently of
EMU ? Standard solutions - central
government control - formalised co-operation
- rules (e.g., deficit limits) -
exceptions allowed (e.g., capital
outlays) - ex ante validity only
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A COMPARISON WITH RULES AT NATIONAL LEVEL
EU approach is stricter ? Rules defined as
predetermined numerical parameters ? Ex-ante
and also ex-post compliance required ?
Flexibility margins defined ex-ante for
exceptional factors ? No provision for
investment ? Non-compliance triggers predefined
monetary sanctions
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EU RULES LOCAL GOVERNMENTS THREE CRITICAL
AREAS
? Asymmetry of constraints and incentives
local vs. central governments
? Public investment how can we carry out
adequate investment at local level without
deficit-finance?
? Economic cycle how can we avoid the need for
pro-cyclical policies?
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ASYMMETRY OF CONSTRAINTS
Compliance with EU rules evaluated with respect
to the general government budget (central local)

• But in EU rules
• no role for sub-national government
• central gov. primarily responsible
• central gov. carries burden in terms of
  credibility, sanctions, etc.

Risk distortions in allocation (sub-national
government free-riding)
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PUBLIC INVESTMENT (I)
Balanced budget ? tax-finance for public
investment Risk reduction of public capital
accumulation Common wisdom easier to cut
investment than current expenditure Political
economy policy makers with finite horizons (if
we cannot smooth the burden, we cut projects with
deferred benefits) Empirical evidence fiscal
consolidation often implies lower investment
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PUBLIC INVESTMENT (II)

• Compression effect potentially stronger for local
  governments
• peaks in expenditure
• mobility of citizens/taxpayers

? risk under-supply of public capital at local
level
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EFFECTS OF THE CYCLE
EU rules reconcile stability and flexibility
via reference to structural budget balance
If this approach cannot be applied to
sub-national governments, a risk of either
pro-cyclical policies at local level or
central government compensating
slippages (distortions in allocation)
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SOLUTIONS IN THEORY (I)

• Adapting existing rules
• Replicating the Stability and Growth Pact (SGP)
• A market for deficit permits

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SOLUTIONS IN THEORY (II)
Solution 1 Adapting existing regulations

• Asymmetry of incentives
• give equal responsibility to all gov. tiers
  sanctions (implementation ?)

• Local investment
• allow debt-finance with a ceiling
  (compensated golden rule) rules to allocate
  outlays (allocation ?)

• Effects of the cycle
• ex-post nominal limits (pro-cyclical ?)
• rainy-day funds (ESA95 ?)
• tax-base selection (responsibility ?)

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SOLUTIONS IN THEORY (III)
Solution 2 National replicas of the SGP

• Asymmetry of incentives implementation problems
  for local governments (CABB?)

• Local investment problem remains (no
  debt-financing, peaks)

• Cycle implementation problems for local
  governments (CABB?)

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SOLUTIONS IN THEORY (IV)
Solution 3 A market for deficit permits

• Asymmetry of incentives
• a predetermined ceiling
• to overall deficit market-based allocation to
  avoid free-riding

• Local investment total amount related to
  investments needs (initial allocation of permits?)

• Cycle total amount related to cyclical position
  (forecasts?)

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SOLUTIONS IN THEORY (V)
Solution 4 An eclectic solution

• Incentive cycle replicate SGP for larger
  government tiers proper choice of tax bases
  budget rules in nominal terms (ex-post) for
  smaller government tiers
• Investment compensated golden rule and
  co-operation

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SOLUTIONS IN PRACTICE (I)

• Sample Austria, Belgium, Germany, Italy, Spain
  (countries differ widely in size/institutions)

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SOLUTIONS IN PRACTICE (II)

• Most countries have adopted new explicit
  rules/procedures
• No SGP replica (technical problems?)
• Most countries rely on co-operation between tiers
  of government

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SOLUTIONS IN PRACTICE (III)

• Countries do not use CABB
• Insulation from cyclical effects via non
  cycle-sensitive tax bases and predetermined
  transfers (sometimes also for larger regional
  governments) ?Limited autonomous revenues
• Different solutions for investments

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AUSTRIA

• Federal State since 1920
• Three government tiers
• Crucial role of co-operation and co-ordination
  between gov. tiers
• No explicit flexibility for investment and for
  the cycle
• Explicit Domestic Stability Pact
• targets
• sanctions
• ESA 95

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BELGIUM

• 1980s-1990s federalisation
• 3 economic regions 3 linguistic communities
  provinces communes
• Federal gov. responsible for most revenues.
  Regions insulated from cycle
• No predefined rules no investment allowance
• Consensual approach Conseil Superieur des
  Finances sets guidelines and targets
• Successfully combines decentralisation and fiscal
  consolidation

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GERMANY

• Federal State (new Constitution after WW2)
• Three government tiers
• Crucial role of co-operation between government
  tiers
• Golden rule (not very strictly defined) ?
  flexibility for investment
• No explicit flexibility for the cycle
• No explicit Domestic Stability Pact, but an
  implicit rule exists (bailing-out is
  constitutionally set)

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SPAIN

• From centralised to decentralised (advances in
  1990s)
• Three government tiers
• Commitment by central government not to bail-out
• Mixture of explicit and implicit rules, largely
  based on consensus
• Golden rule for local governments ? flexibility
  for investment
• No explicit flexibility for the cycle (but
  borrowing limits can apply only ex-ante)

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ITALY

• From centralised to decentralised (advances in
  1990s)
• Three government tiers
• Domestic Stability Pact (1999)
• imposed by central government
• not comprehensive (excludes investment health)
• not binding
• Increasing revenue responsibility of regions
• Debt financing only for investment
• 2001 change in Constitution ? move to consensual
  approach

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ITALY DOMESTIC PACT - 1999
Budget balance (cash terms, exclude financial
transactions) (R - T) - (S - K - I) R
total revenue T central government transfers S
total expenditure K capital account outlays
I interest payments Target improve trend
balance (t-1 deficit ? (10.8 of GDP growth
rate)) in proportion to (S - K -
I) Sanctions only if Italy sanctioned at EU
level
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ITALY DOMESTIC PACT - 2000
Budget balance (R - T - XR - HR) - (S - K
- I - XS - HS) XR exceptional revenues (asset
sales) HR health revenues XS exceptional
expenditure HS health spending Target as
1999 but must compensate for 1999 slippages
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ITALY DOMESTIC PACT - 2001/02
2001 Target deficit cannot exceed 103 of 1999
deficit 2002 Target deficit cannot exceed
102.5 of 2000 deficit 2002 additional limit
on expenditure growth sanctions for local govs
(reduction of transfers)
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ITALY DOMESTIC PACT - PROBLEMS

• Many changes
• Targets proportional to expenditure or past
  deficit, not to gap with respect to budget
  balance
• Balance ? EU relevant balance
• Double golden rule?
• No debt target
• Weak sanctions till Italy is sanctioned
  (credible?)
• Expenditure ceiling compatible with
  decentralisation?
• Asymmetry problem not solved
• Cycle problem not addressed
• Investment problem odd solution

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SUSTAINABLE SOLUTIONS? (I)

• Robustness to economic shocks
• lengthy negotiations adjustments

• Robustness to further decentralisation
• larger autonomy requires more revenue power ?
  more effects of cycle

• Effects on allocation
• local government insulated from cycle ?
  distortions

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SUSTAINABLE SOLUTIONS? (II)

• A rulessanction based eclectic framework
• (regions domestic-SGP
• others nominal budget balance
• revenue structure
• all compensated golden rule)
• may
• shorten reaction time to shocks
• be robust to institutional changes
• improve allocative efficiency through
• increased transparency and control
• of policy implementation

• Pre-requisite common accounting standards for
  all government tiers

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IN OTHER WORDS ...

• The extent to which the liberty of experiments
  in taxation should be conceded to the
  subordinates bodies must, we believe, be
  carefully limited.
• For the smaller units the taxes should be
  absolutely laid down and also the maximum to be
  raised, but the opportunity of economy should not
  be denied on the condition that they duly
  discharge their necessary function.
• The larger circumscriptions are fairly entitled
  to great latitude. A higher standard of
  intelligence may be expected from their
  representatives, and their economic resources are
  more varied. But even with them the need for
  supervision cannot be said to be absent.
• Pigou (1927)

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SOME DATA (I)
Local gov. taxes as a share of general gov.
revenues
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SOME DATA (II)
Local gov. expenditure as a share of general gov.
expenditure
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SOME DATA (III)
Local gov. taxes as a share of local gov. overall
revenues