Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
If You Want to Cut, Cut, Don't Talk: The Role of Formal Targets in Israel's Fiscal Consolidation Efforts 1985-2008 Adi Brender Research Department, Bank of Israel IMF Conference: Fiscal Rules for Israel Background Since the 1985 stabilization, governments repeatedly stated a commitment to fiscal consolidation. Since 1992 Israel’s fiscal policy is formally guided by multiyear deficit targets. • Performance with respect to the targets and the actual fiscal position varied over time. • This paper focuses on the contribution of formal targets and policy design to performance. The Logic of Multiyear Targets • The original decision-maker takes most of the political “heat” for constraining the “deficit bias”. • Subsequent governments tend to adhere to the predetermined rule: – the “price” has already been paid – abandoning it could get the government blamed for hurting macroeconomic performance. • Market participants understand the “game”; Hence, the policy is credible from the outset. Underlying Questions • Does the public really like deficits? – No such evidence in the literature – Doesn’t really make sense (rationality). • Can macro-fiscal targets be met without external constraints (SGP, US guarantees). • More reasonable to think of the “Deficit bias” as a micro phenomenon with macro consequences. Pre-Specified Measures or Macro Targets? Policy-makers need to confront interest groups on specific budget items. Setting macro-fiscal targets leaves the “real battle” - approving and implementing the required measures - to future policy-makers. • The micro component is a key difference between monetary and fiscal targets. Israel’s Experience 1985-2008 Examine 4 sub-periods separately: : • Post 1985 consolidation: no quantitative macro-fiscal targets. • Early 1990s: Mass immigration, adoption of formal targets. • 1993-2003: Fiscal targets and strong expenditure dynamics. • 2003-2008: Expenditure restraint and formal expenditure ceiling. The 1985 Stabilization • • • • Following repeated failures of government programs and intensifying crises. No quantitative medium-term targets. Substantial Immediate one-off measures. Pre-specified medium-term programs to cut expenditures: 1. Defense 2. Product subsidies 3. Producer subsidies • Legislated tax-rate reductions after the initial phase. Components of the Decline in General Government Deficit: 1980-1990 1980-1984 Average 1985 57.4 1989 1990 65.5 1986 1987 1988 (Percent of GDP) 63.4 57.5 54.0 50.4 50.3 39.3 40.9 43.8 42.7 40.6 37.0 36.4 69.2 64.5 59.7 57.3 56.3 55.6 54.8 o/w Defense 19.5 18.5 15.9 14.5 12.9 12.1 12.4 Subsidies 8.9 6.2 4.2 4.2 4.1 3.4 2.7 Investment 2.3 1.8 2.0 2.4 2.6 2.5 2.7 Interest 10.9 12.6 11.6 10.3 9.3 9.1 8.7 Other 27.6 25.5 26.1 26.1 27.5 28.4 28.4 -11.8 1.0 3.7 0.1 -2.3 -5.2 -4.6 Total Revenue o/w taxes Total Expenditure General government balance 1991: Introduction of Deficit Targets • In 1990 and 1991 Israel absorbed 380,000 immigrants (8% of the population). • The direct annual fiscal cost of absorption in these two years amounted to 3.5% of GDP. • The underlying surplus in 1991 – excluding one-off absorption costs - was 0.8% of GDP. • To show that once absorption expenses phase-out other expenditures will not rise, a balanced budget target was adopted for 1995. Why Multiyear Targets • To persuade the markets that the large deficit in 1991 and 1992 is temporary. • Insufficient track record of commitment to long-term fiscal consolidation. • The target was written into a law –to overcome time inconsistency before the scheduled elections in 1992. • Consistent with the emerging international norm of the time. First Government Change - 1992 • The new government, elected in 1992, immediately raised the target. • Also: adopted expansionary medium-term policies: raised wages, transfer payments, road infrastructure and public consumption. • Policy costs were not fully visible until 199596 due to faster-than-expected decline in immigration. Key Components of the Change in the General Government Balance 19901994 1991 1992 1993 1994 50.4 49.7 49.2 48.2 36.1 36.6 36.9 37.7 7.4 6.3 5.9 4.7 53.4 54.3 53.5 51.3 11.4 10.3 10.4 9.1 Interest 7.9 7.2 6.9 6.4 absoption related1 3.8 3.4 1.6 0.5 30.3 33.3 34.6 35.3 General government balance -3.0 -4.6 -4.3 -3.1 General government balance excluding absortion costs 0.8 -1.2 -2.8 -2.6 Total Revenue o/w taxes bilateral transfers Total Expenditure o/w Defense Primary Civilian exp. The Era of Revised and Missed Targets: 1995-2003 • Following the first change subsequent governments kept changing the targets almost every year. • The targets were almost always missed. • Nevertheless, all the governments insisted on presenting multiyear targets with a low deficit (1-1.5 percent of GDP) at the final year – usually after the next scheduled elections. Table 3: Budget Rules and Targets 1991-2003 Decision year Deficit Target (in percent of GDP) 1992 – 6.2% 1991 1993 – 3.2% Notes Adoption of declining deficit law. The deficit was specified in term of the domestic balance. 1994 – 2.2% 1995 – 0.0% 1994 – 3.0% Upward revision of the annual and medium-term deficit targets. 1993 Will be reduced each year over the next 3 years. 1994 1995 – 2.75% - 1995 1996 – 2.5% - 1997 – 2.8% Moving from domestic deficit to overall deficit, including Bank of Israel's "realized profits". 1998 – 2.4% 1996 1999 – 2.0% 2000 – 1.75% 2001 – 1.5% 1999 2000 – 2.5% 2001 – 2.25% 2002 – 2.0% 2003 – 1.5% 2000 2001 – 1.75% 2002 – 1.5% 2003 – 1.25% Downward revision. The deficit was redefined during the fiscal year to exclude the Bank of Israel’s "profits". 2002 – 2.4% 2003 – 2.0% Upward revision. The target for 2002 was increased to 3.0% before the budget was approved. 2001 2002 2004 – 1.5% 2005 – 1.0% 2003 – 3.0% 2004 – 2.5% 2005 – 2.0% 2006 - 1.5% 2007 – 1.0% From 2007 onwards 1%. Central Government Performance With Respect to the Offcial Deficit Targets 7 percent of GDP 6 5 4 3 2 1 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Years Actual Modified Actual Target Despite a decade of declining deficit targets, the target for 2003 was similar to that of 1993. The 2003 Consolidation Program Background • Deep recession, military conflict, surging yields on government debt. • Failed stabilization in the preceding year. • A decade of missed fiscal targets. Consequently – to gain market confidence: • Need for a front-loaded program. • Need measures to sustain the consolidation over the medium-term. Projected Budget Balance Before and After the 2003 Adjustment Program 2003 2004 2005 (in percent of GDP) 1 2006 Before the program: no adjustment Central government balance -6.0 -7.0 -7.1 -7.2 After the adjustment program Central government balance -5.4 -5.1 -4.4 -3.7 -5.4 -4.1 -3.7 -3.2 … -3.5 -2.4 -1.5 -5.3 -3.6 -1.8 -0.9 2 After the 2004 budget Central government balance Ex-post balance projection in early 2004 Actual balance 1All 3 the scenarios assumed the same interest rate and 4 percent annual growth. All figures are adjusted to the current GDP definition. 2 Based on specific measures adopted with the 2004 budget. 3 An estimate based on the measures adopted until early 2004 and actual growth for 2004-2006. The Role of Targets: 2003 Consolidation • In 2003 the deficit target was abandoned. • Expenditure ceiling: introduced in 2005 but was changed several times. In no year was the budget in accordance with the ceiling. • Actual expenditure was well below the budget due to administrative measures affected since 2003. • Since 2006: tax cuts offset expenditure cuts. Performance:1985-2008 • Targets can be effective even if they are missed, by setting a guideline to policy. • However, the dismal performance between 1993 and 2003 shows that missing the targets was not just a technicality. • The key to that failure was the inability, or unwillingness, to tackle the expenditure dynamics set by previous governments. 20 09 20 07 20 05 20 03 20 01 19 99 19 97 19 95 19 93 19 91 19 89 19 87 70 65 60 55 50 45 40 35 30 25 20 19 85 percent of GDP General Government Expenditure and Taxes Years Taxes Excl. one-off absorption cost Overall expenditure Lessons from 23 Years of Attempted Consolidation • The key to success: tackling expenditure dynamics. • Pre-specified medium-term measures to cut expenditures succeeded in reducing the deficit. • Announcing macro targets without specifying the measures did not work. They were changed by each new cabinet and sometimes also within cabinets’ term-in-office. • Good news: Once specific measures were introduced, they survived government changes Lessons (Cont.) • Bad News: successful programs were implemented in times of crisis and after failed attempts with less comprehensive ones. (consistent with OECD experience) Paraphrasing Winston Churchill: "You can trust the government to do the right thing, after exhausting every other possibility“ • Role of external constraint: US aid in 1985 and loan guarantees in 2003. Conclusion • Policy credibility and sustainability should be evaluated based on the expected impact of its specific measures – not stated macro targets. • Macro-fiscal targets may help coordination – but alone, they are not building credibility. Looking forward: Need for clear long-term target and multiyear budget framework: - Bypassing the target with long-term programs. - An expenditure ceiling without a long-term target, makes tax cuts a “free-play”. Share of Central Government Expenditure in GDP- Alternative Scenarios: 2008-2013 40.0 (Percent of GDP) 38.0 36.0 34.0 32.0 30.0 2008 2009 1.7% annual increase in exp. ceiling 2010 2011 2012 2013 Exp. growth in line with specific decisions