Download Implications for Aggregate Fiscal Discipline [220K

Budget Institutions and Fiscal
Performance
Ernesto Stein
Research Department
Inter-American Development Bank
Why the interest in budgetary
institutions?
• Growth of deficits in the U.S.
– Changes in legislative procedures (1974)
– Supply side economics (Reagan)
– Gramm-Rudman-Hollings (1985)
• Great variety of fiscal experiences among relatively
homogeneous countries (or states)
• Difficulty of explaining those differences on the
basis of purely economic variables motivates several
authors to explore the role of political and
institutional variables
Budget institutions and fiscal
performance
• Several studies exploit the differences in the balance
budget rules across U.S. states to measure the impact of
budget institutions on fiscal performance
• Von Hagen (1992) and von Hagen and Harden (1995)
study the role of budget institutions in explaining fiscal
performance in the countries of the European Union
• Alesina, Hausmann, Hommes and Stein (1998) study the
same thing for 20 countries in Latin America.
• Jones, Sanguinetti y Tommasi (1998) do the same for
the case of Argentine provinces
Budget institutions and fiscal
performance
In general, this literature finds that budget
institutions contribute to explain an
important part of the differences in fiscal
performance across countries (or states)
Budget Institutions
• Definition: We define budget institutions as
the set of rules, procedures and practices
according to which budgets are drafted,
approved and implemented.
Why are BI important?
• If fiscal decisions were made by the social planner we
studied in textbooks, one would observe optimal fiscal
behavior
• In such a context, any rules that constrain the decisions of
the social planner have to be sub-optimal
• Of course, the social planner does not exist. The process
of fiscal decision-making is a collective one, in which a
variety of actors, each with its own preferences and
motivations, is involved.
• This generates a number of potential problems, which
good budget institutions may contribute to solve.
Problems to be solved
• The common pool problem (Weingast, Shepsle
and Johnsen 1981)
• Other potential externalities across government
units (Canzoneri and Diba 1990)
• The electoral cycle (Nordhaus 1975, Tufte 1978,
Rogoff 1990)
• Strategic use of debt (Alesina and Tabellini 1990)
Problems to be solved
• Principal/agent problems (private benefits of those
who participate in the budget process)
• Problems associated with the short time horizon of
politicians (Cuckierman and Meltzer 1989)
• Problems of dynamic inconsistency in fiscal
policy
The common pool problem
Two important characteristics of public programs:
1 While their benefits tend to be concentrated, they
tend to be financed from a common pool of
resources
2 The budget is the result of a collective decisionmaking process, involving a variety of agents:
– Legislators
– Spending ministers
– The finance minister
The common pool problem
• Legislators: they respond to the interests of their
respective jurisdictions; tend to favor programs that
benefit their districts, but are financed by the nation
as a whole
• Spending ministers: Favor programs that fall within
their control. Their power within the government is
associated with the size of the budget they manage.
• Finance minister: Is responsible for macro stability,
and therefore usually has incentives to promote fiscal
discipline
The common pool problem
• Since most of the agents involved in the
budget process represent geographical or
sectoral interests, the combination of these
two characteristics of government public
budgets can, under certain institutional
arrangements, result in an overutilization of
the common pool of resources, and in
excessive spending and deficit
The common pool problem
• Weingast, Shepsle y Johnsen 1981, find that
the common pool problem generates
excessive spending under the practices of
universalism and reciprocity common in the
US legislature.
• Velasco (1998) introduces dynamic
elements into the model, and obtains also
excessive debt and deficit
The tale of the chicken and the lobster
Why do BI matter??
• Budget institutions matter because they
affect the rules of the game under which the
different actors involved in the budget
process interact, either by placing
constraints to the whole process, or by
distributing the power, information and
responsibilities among the different agents,
and thus affecting fiscal outcomes.
Budgetary rules
• Following Alesina and Perotti (1995), we identify
three different types of budgetary rules:
– numerical rules
– procedural rules
– rules that affect the transparency of the budget
Numerical rules: examples
• Balanced budget rules, such as those of the
U.S. states
• Maastricht criteria (which impose limits on
deficit and debt)
• Gramm-Rudmann-Hollings (in the US),
which imposes a gradual reduction of
deficits, until their elimination
Numerical rules may differ...
• Regarding the indicator of performance they refer to
• regarding the legal rank of the norm that establishes
them
• regarding their coverage
• regarding the stage of the budget process in which
they apply
• regarding their “flexibility”
– They may be non-contingent or contingent, with clearly
specified escape clauses
– may be defined on the basis of an indicator of structural deficits
– as a general rule, the greater the flexibility, the greater the
complexity, the easier it becomes to elude them
Numerical rules: pros and cons
• Pros:
– If they are enforced, they may solve the majority of the
problems identified above
•
•
•
•
they limit the strategic used of debt
they limit the transfer from future to present generations
they limit the electoral cycle
they limit the common pool problem, etc.
• Cons:
– They may generate incentives for “creative accounting”
– They limit the possibility of engaging in tax-smoothing
(a la Barro) (at least in the case of balanced budget
rules)
– They tend to be too inflexible (in particular in the case
of highly volatile regions such as Latin America)
Numerical rules and inflexibility: 3 caveats
• Volatility itself may be induced by the absence of
fiscal discipline. Thus, if the rule is effective, the
need to respond to the cycle may be decline
• Even in the absence of numerical rules, Latin
America has been characterized by having a
procyclical fiscal policy.
• It is possible to combine numerical rules with
other mechanisms which allow a response to the
cycle (such as stabilization funds)
What makes a rule more credible?
• It must be simple, and easy to monitor
• has to be defined on the basis of fiscal indicators
which cannot be easily manipulated
• must be defined on the basis of fiscal indicators
which are to a reasonable extent under the control
of the fiscal authorities
• must be defined in such a way that the cost of
complying with the rules should not be excessive
under a reasonable set of likely circumstances
Procedural rules
• They affect the rules of the game in the interaction
among the different agents that participate in the
budget process
• May be more “hierarchical” or more “collegial”
• Hierarchical rules concentrate the power on the
finance minister vis a vis the spending ministers,
and on the executive vis a vis the legislature
• Collegial rules tend to allocate power more
equally among all the actors involved
Examples of hierarchical and collegial rules
• During the drafting of the budget:
– Hierarchical: At the beginning of the drafting of the budget,
spending ministers receive spending caps which they must
observe.
– Collegial: each spending minister drafts its own budget, and
these are then negotiated within the cabinet.
• During the approval of the budget:
– Hierarchical : Congress can modify the composition of
expenditures, but cannot increase total expenditure or deficits
– Collegial: Congress may propose any changes, without
restrictions
Examples of hierarchical and collegial rules
• During the implementation of the budget:
– Hierarchical : The government may cut expenditures
unilaterally if revenues are lower than projected
– Collegial: Congress has the initiative to propose
increases in the budget, even after it has been approved
Procedural rules: pros and cons
• Pros:
– They may generate fiscal discipline by concentrating power
on those who are responsible for macro stability.
– May solve the common pool problem
– They are more flexible than numerical rules, and allow a
response to the cycle
• Cons:
– They do not solve the electoral cycle problem
– They do not solve the problems associated to the short time
horizon of politicians.
– They do not solve the problem of the strategic use of debt
– By allowing a greater degree of discretion, they may have a
slower effect on the credibility of fiscal policy
Rules that affect the transparency of the
budget
• Off-budget items
• strategic use of macroeconomic forecasts used for
the drafting of the budget
• Treatment of contingent liabilities
• Creative accounting
Numerical rules, procedural rules and
transparency: complements or substitutes?
• Numerical rules and procedural rules:
– alternative ways of introducing fiscal discipline
– But they solve different problems
• Numerical rules and transparency:
– They are complements: without transparency, numerical
rules will not be effective
– However, the more restrictive the rule, the larger the
incentives for creative accounting
– Thus, if numerical rules are introduced, it is important
to improve transparency at the same time
Fiscal rules at the subnational level
Several reasons why they may be more
appropriate at the subnational level
• Possibility to balance budgets during recessions
with anti-cyclical transfers from the central
government
• Automatic stabilizers of the central government
may provide stabilization services
• Bailout problem (Eichengreen and von Hagen
1997)
• Macro stability as a public good
• Need to coordinate restrictions
Budget institutions and fiscal performance:
International experience
Numerical rules
• Gramm-Rudman-Hollings
• Maastricht
• The experience of the US states
Gramm-Rudman-Hollings
•
•
•
•
•
Gradual reduction of the deficit to achieve balance
Limited results
Increase in creative accounting
Part of the reduction was covered by asset sales
But GRH did have some effect on deficits
Maastricht:
•
•
•
•
Criteria for access to common currency
deficit/GDP<3%
debt/GDP<60%
Credibility of the rule is in this case imposed by a
group of countries (with some flexibility), not by
the individual countries alone.
• Have been effective in helping achieve
convergence, but part of the adjustment was
achieved through creative accounting, as well as a
reduction in the quality of expenditures (Easterly
1998)
The experience of the US states
• 49 out of 50 states have balanced budget rules.
The only exception is Vermont.
• But they differ in several dimensions:
– legal rank of the rule (statutory or constitutional)
– Coverage of the rule
– Stage of the budgetary process in which they apply:
drafting, approval or implementation.
• In 1987, ACIR put together an index that measures
how restrictive the different balanced budget rules
are
The experience of the US states
• States with more restrictive rules (see Poterba, 1995)...
– Tend to have lower deficits (Eichengreen 1992, Bohn and
Inman 1995) and lower debt (von Hagen 1991)
– tend to face lower interest rates, even after controlling for the
size of deficits (Goldstein and Woglom 1992, Eichengreen
1992, Lowry and Alt 1995, Poterba and Reuben, 1998)
– adjust more in response to past deficits (Alt and Lowry 1994)
– react by adjusting more during the fiscal year in response to
adverse shocks (Poterba 1994)
– have a less counter-cyclical fiscal policy (Bayoumi and
Eichengreen 1996), but...
– This is not translated into increased output volatility (Alesina
and Bayoumi 1997)
Procedural rules
• Budget Enforcement Act (US)
• The experience of the European Union
• The experience of Latin America
The experience of the European Union
• Studied by von Hagen (1992) and von Hagen and
Harden (1995)
• build index of BI based on
–
–
–
–
–
relative power of finance minister within the cabinet
structure of negotiations within the cabinet
relative power of executive vis a vis legislative
Degree of expenditure control by the finance minister
degree of transparency of the budget
• They find that more hierarchical (centralized)
institutions tend to reduce deficits and debt, without
affecting the capacity of govt. to stabilize output.
The experience of Latin America
• Studied by Alesina Hausmann Hommes and Stein
(1996) and by Stein Talvi and Grisanti (1998)
• AHHS build an index of budgetary institutions, based
on a questionnaire that was responded by budget
directors in 20 Latin American countries, for the period
1990-1993
• Includes the stages of drafting, approval, and
implementation of the budget
Questionnaire
1 Are there any constitutional or legal constraints on fiscal
deficits?
2 Is there a requirement that the budget be consistent with
fiscal targets previously specified in a macro program?
3 What kind of borrowing constraints are there on the
government?
4 Is the authority of the Finance Minister greater than that of
spending ministers on budgetary issues?
5 What kind of restrictions does Congress have to amend the
budget proposed by the government?
Questionnaire
6 What happens if Congress rejects the budget, or does not
approve it within the constitutionally set time frame?
7 Can the budget be modified after approval? On whose
initiative?
8 Can the government legally empowered to cut spending
after the budget has been approved? Under what
circumstances?
9 Does the government typically assume debt originally
contracted by other public agencies? Under what
circumstances?
10 Can subnational governments and public enterprises
borrow autonomously?
Effect of budget institutions
• We find that more hierarchical and restrictive budget institutions
lead to smaller primary deficits
• A difference of 20 points in the index (which ranges from 0 to
100) is associated with a difference of three percentage points
of GDP in the primary deficit
• This result is very robust to changes in the way the index is
built, in changes in the methodology of estimation, as well as to
the inclusion of other variables that control for the effects of:
–
–
–
–
–
external shocks
the economic cycle
age structure of the population
initial level of debt
wars and natural disasters
Effect of budget institutions
• Stein Talvi and Grisanti recalculate the index for the
period 1990-95
• They obtain the following ranking of countries,
according to the index of budget institutions:
Budget institutions in Latin America,
1990-95
Index of budget institutions
COL
JAM
CHL
MEX
PAN
URY
TTO
BHS
GTM
ARG
CRI
ECU
PRY
VEN
PER
HND
BRA
SLV
BOL
DOM
0.1
0.76
0.75
0.73
0.72
0.66
0.62
0.58
0.57
0.57
0.57
0.56
0.56
0.55
0.55
0.54
0.52
0.50
0.50
0.47
0.45
0.2
0.3
0.4
0.5
0.6
0.7
0.8
More hierarchical institutions lead to
smaller deficits
Fiscal deficits:1990-95
(% of GDP)
0.04
JAM
CHL
PRY
0.02
TTO
BRA
0
DOM
SLV
-0.02
MEX
COL
PAN
GTM
CRI
ECU
PER BHS
ARG
URY
BOL
-0.04
HND
VEN
-0.06
-0.08
0.4
0.45
0.5
0.55
0.6
0.65
0.7
Index of budget institutions
0.75
0.8
... And lower debt
Public debt: 1990-95
(as a share of revenues)
6.0
PER
5.0
HND
4.0
DOM
BOL
PAN
ECU
CRI
3.0
JAM
SLV
VENGTM
ARG
2.0
BRA
PRY TTO
URY
MEX
CHL
1.0
COL
BHS
0.0
0.4
0.45
0.5
0.55
0.6
0.65
Index of budget institutions
0.7
0.75
0.8
Budget institutions:
Some recent reforms
New Zealand: Fiscal Responsibility Act (1994)
• Does not include numerical rules. It is based
on procedural rules, and places a lot of
emphasis on disclosure and transparency
• Requires the government to follow a set of
principles of responsible fiscal management
• The government may depart from the
principles, but must explain publicly why it
does so, and indicate how and when it will
conform with the principles again
New Zealand: Principles of responsible fiscal
management
• Reduce debt to prudent levels, so as to provide a
buffer against future adverse events, by achieving
operating surpluses every year until prudent levels
of debt have been achieved
– This suggests that debt reduction cannot be achieved by
selling assets
• Maintaining debt at prudent levels by ensuring
that, on average, over a reasonable period of time,
total operating expenses do not exceed total
operating revenues
– This allows for departures from budget balance during
recessions
New Zealand: Principles of responsible fiscal
management
• Achieving levels of net worth that provide a buffer
against future adverse events
– Recognizes that financial strength depends on overall
balance sheet, not just debt
• Managing fiscal risk prudently
– Recognizes the need to treat contingent liabilities in a
prudent way
• Pursuing policies that are consistent with a
reasonable degree of predictability about the level
and stability of tax rates
New Zealand: Principles of responsible fiscal
management
• Who defines what is a “prudent” level of debt, or
a “reasonable” period of time over which the
budget should be balanced?
• The government of the time
• However, the government must justify its
interpretation of what is prudent and reasonable in
parliament, as well as to the general public
In addition:
• A lot of emphasis on “disclosure”
• The government must present a Budget Policy
Statement well before the beginning of the budget
year, which should include:
– their strategic priorities for the next budget
– their short-term fiscal intentions
– their long-term fiscal objectives
• Three year horizon
• Regularly present updates of impact of fiscal
decisions.
Venezuela: Congressional Budget Office
(1998)
• Created through an IDB program
• Deals with the problem of lack of technical
capacity in Congress to discuss budget issues
• Responsible for macro forecasts
• Provided reports of fiscal impact of laws and
budget decisions, as well as technical studies
requested by the legislature.
• Gained ample prestige in a short period of time
• Recently dissolved by the government of Chavez
Perú: Fiscal transparency law
• Deficit rule: Déficit/GDP<1%
• Expenditure rule: increase in spending cannot
exceed the rate of inflation plus 2 percentage
points.
– Controversial: It implies a decreasing trend for
expenditures/GDP, if GDP growth is greater than 2%
• Electoral years: Special rules to avoid acceleration
of budget execution
• Exceptions:
– National emergency or international crises (not clear
how these are defined)
– Recessions: deficit/GDP cannot exceed 2%
Perú: Stabilization fund
• It is integrated with the following resources:
– current revenues, when these exceed the trend
– receipts from asset sales and concessions
– up to a maximum of 3% of GDP
• Resources are used when:
– current revenues fall below their trend (there are limits
regarding how much may be used in a single year)
– in emergency situations (not clearly defined)
In addition:
• Multi-annual (three years) macro-fiscal program,
including:
– exposition of principles of fiscal policy
– fiscal targets for the next three years
– macroeconomic assumptions, and projections for
revenues and expenditures
• Regular budget execution reports
• Declaration of compliance with fiscal
responsibility by the Finance Minister
– needs to justify any deviations, and announce measures
to correct them (in May)
Argentina: Fiscal Responsibility Law
• Deficit rule: declining over time until balance is achieved in
2003 (as in GRH)
• Expenditure rule: real rate of growth of expenditures cannot
exceed real rate of growth of GDP, “except if other
expenditure authorizations, financed with specific or
properly identified revenues, are added to the budget”
– with this addition, the rule loses its “teeth”
– cyclical problems: should be defined on the basis of trend
GDP
• If real growth is negative, primary expenditures may at most
remain constant, in current pesos
– Would generate serious problems if inflation is high.
Argentina: stabilization fund
• It is integrated with the following resources:
– predetermined shares of current revenues
– privatization receipts
– up to 3% of GDP
• Resources are used during recessions
– so as to cover, at most, budgeted revenues
– no more than 50% of what is left may be used within one year
In addition:
•
•
•
•
Multi-annual budget (three years)
no off-budget items may be created
includes programs to increase spending efficiency
transparency and disclosure