Download Daniele Franco

EMU: NEW HISTORICAL
DEVELOPMENT
EU fiscal rules have extensive
implications:
• Stabilisation
• Allocation and distribution
• Long-term sustainability &
intergenerational redistribution
• Relationships between levels of
governments
MOTIVATION
AND 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?
EU FISCAL RULES:
A 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)
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 ‘closeto-balance or in surplus’
 Deficit fluctuates over cycle
(automatic stabilisers can operate)
SURPLUS
0
3%
DEFICIT
BAD TIMES
GOOD TIMES
LENGTH OF CYCLE
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
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
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 procyclical policies?
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)
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
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
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)
SOLUTIONS IN THEORY (I)
• Adapting existing rules
• Replicating the Stability and Growth
Pact (SGP)
• A market for deficit permits
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 ?)
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?)
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?)
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
SOLUTIONS IN PRACTICE (I)
• Sample: Austria, Belgium, Germany,
Italy, Spain (countries differ widely in
size/institutions)
Nominal GDP per capita PPP
GDP (thousands
of Euros)
2
Population
Km
(trillions of
(millions) (thousands)
Euros)
Austria
Belgium
Germany
Italy
Spain
8.1
10.2
82.1
57.6
39.4
83.8
30.5
356.2
301.3
504.8
206.0
246.0
2,025.5
1,165.7
606.3
Min.
Number of
Number regional
municipalities of regions GDP per
(1)
capita
Austria
Belgium
Germany
Italy
Spain
(1)
Euros.
2,400
600
15,000
8,100
8,100
9
3
16
20
17
14,227
17,203
14,369
13,186
10,566
23.3
23.4
22.5
21.8
17.1
Max.
regional
GDP per
capita
(1)
33,398
48,298
38,671
28,756
23,197
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
Domestic rules
Explicit
Implicit
Imposed
Agreed
Italy
Austria,
Belgium, Spain
Germany
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
Flexibility for investment
Explicit
flexibility for
the cycle
No
Yes
No
Yes
Austria,
Belgium
Germany, Italy,
Spain
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
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
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 (bailingout is constitutionally set)
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)
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
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 
(1+0.8 of GDP growth rate)) in
proportion to (S - K - I)
Sanctions:
only if Italy sanctioned at EU level
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
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)
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
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
SUSTAINABLE SOLUTIONS? (II)
• A rules+sanction 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
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)
SOME DATA (I)
Local gov. taxes as a share of
general gov. revenues
19
19
17
17
15
15
13
13
11
11
9
9
7
7
5
5
3
3
1990
1991
1992
1993
1994
1995
1996
1997
Austria (regions)
Austria (sub-regional gov.)
Belgium (sub-regional gov.)
Italy (overall local gov.)
Spain (regions)
Germany (regions)
1998
1999
Germany (sub-regional gov.)
SOME DATA (II)
Local gov. expenditure as a share
of general gov. expenditure
30
30
27
27
24
24
21
21
18
18
15
15
12
12
9
9
1990
1991
1992
1993
1994
1995
1996
1997
Austria (regions)
Austria (sub-regional gov.)
Germany (regions)
Italy (overall local gov.)
Spain (regions)
Belgium (sub-regional gov.)
1998
1999
Germany (sub-regional gov.)
SOME DATA (III)
Local gov. taxes as a share of local
gov. overall revenues
80
80
70
70
60
60
50
50
40
40
30
30
20
20
10
10
1990
1991
1992
1993
1994
1995
1996
1997
Austria (regions)
Austria (sub-regional gov.)
Belgium (sub-regional gov.)
Germany (sub-regional gov.)
Italy (overall local gov.)
Spain (regions)
1998
1999
Germany (regions)