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April 16, 2012

Is Fiscal Transparency at Risk? Ten Questions for FAD’s Tim Irwin

Posted by Marco Cangiano

Tim_marco
Tim Irwin is headquarter-based consultant in the Public Financial Management 1 Division of the Fiscal Affairs Department, headed by Marco Cangiano. He’s recently published a Staff Discussion Note on accounting devices and fiscal illusions and has several papers on fiscal transparency under development, including one on the history of the subject. Tim has worked on issues such as fiscal reporting, fiscal risks, and the governance of state-owned enterprises and public-private partnerships, in Iceland, Jordan, Mexico, and Portugal. Before joining the Fund, he worked at the World Bank, the New Zealand Treasury, and an economic consultancy.

Is fiscal transparency at risk now that fiscal consolidation and monetary stimulus are the primary policy tools being used to resuscitate European economies? Are countries less interested in fiscal transparency in the aftermath of the financial crisis, i.e. more motivated to hide the real goings on in the kitchen of government?

1. Tim, why another piece on accounting tricks and stratagems? What’s new under the sun? Is this a follow up to the Fiscal Monitor appendix (2) you wrote last year?

Yes, it’s a follow-up. Like the appendix in the Fiscal Monitor, it shows how governments can manipulate their accounts to make the deficit look smaller than it really is. This note goes into the subject in more depth. Some of the stories in it are old, but others are new: even though Greece’s problems led to calls for better government accounting, the crisis hasn’t put an end to the use of accounting devices. Indeed, the need for governments to show they have their deficits under control may have increased the temptation to use them.

2. In your work you’ve used the term fiscal illusion? Is this a new concept?

Discussion of fiscal illusion goes back quite a while. Bill Easterly, who used to be at the World Bank, published a piece in 1999 asking “When is fiscal adjustment an illusion?” And Vito Tanzi, the former director of our department, traced the concept back to the work of Amilcare Puviani, an Italian economist who wrote about fiscal illusionsat the turn of the nineteenth century.

3. It sounds like you enjoy diving into the history of things, even of a dry topic like PFM. Tell us a bit more about transparency and how the concept has evolved over the centuries.

If you think about the use of accounting devices, you can get the impression that government accounting is in a very bad state, and in some ways it is. Yet government accounts used to be state secrets almost everywhere, and fiscal transparency is now one of those things that almost all governments accept in principle, even if they disagree about what it means in practice. The French Revolution of 1789 was one of the turning points: the Declaration of the Rights of Man said that citizens had the right to know how the government spent their taxes.

4. Are all the instruments and transactions entertained by government that you mention in your note always a bad idea?

No, some of them might be good ideas. I got interested in the subject when I was working at the World Bank on public-private partnerships. PPPs are an interesting way of financing and maintaining public assets, and are potentially more efficient than traditional public investments. However, when I went to countries that were interested in them, I found that there was surprisingly little talk about whether PPPs were in fact better than public investments, all things considered. Instead, it usually turned out that the government had set itself a deficit or debt target and was now looking for ways of getting around that target. It’s only when PPPs are treated as public projects for accounting purposes—as happens in a few countries now—that it’s clear that the government’s motivation isn’t masking the size of the deficit.

5. One of the issues in your work is the so-called disappearing government? While some may cheer at the news, what do you mean by this, and is it really happening?

The idea, which I first heard from our colleague Adrienne Cheasty, is that things that used to be done by departments or ministries are now more likely to be done by other, partly independent public bodies—state-owned businesses, independent regulatory agencies, and so on. Sometimes this means that the costs of the activities don’t show up in the government’s accounts. In the end, though, the government is still usually on the hook when things go wrong. For example, if the government repeatedly asks a state-owned business to make unprofitable investment on its behalf, sooner or later, it will have to bail the business out.

6. Your earlier piece launched a sort of alarm that fiscal transparency may be at risk. Why, in the end, should we be bothered about fiscal transparency?

Fiscal transparency is about ensuring that the public, and the government itself, has good information about public finances—on what has happened to them in the past and on how they can be expected to develop in the future. The hope is that better information leads to better public debate and better decisions—for example about whether or not the government should spend more to stimulate the economy or, take another example, whether current pension policies should be changed to try to save money in the long term.

7. Many would argue that lack of fiscal transparency is one of the key fiscal risks. Let’s define fiscal risk first and then let’s see how this relates to fiscal transparency as you defined it.

One definition of fiscal risk is unpredictable change in public finances. Tax revenue can fall suddenly when the economy unexpectedly goes into recession, for example, and every now and then a natural disaster or financial crisis can require the government to spend much more than it had planned. All this is true whatever the state of fiscal transparency, but bad accounting can conceal predictable problems, while good accounting can prompt action to solve those problems before it’s too late.

8. Most of the bad behavior by government you warn about has happened before. Why should this time be different? If it is true that a crisis focuses the mind, how have countries responded to this?

It’s hard to know what effect the crisis will have on transparency. As I mentioned earlier, it may have increased the temptation to conceal bad news. But new doubts about governments’ creditworthiness might lead to more transparency. For example, a government that thinks its finances are in better shape than the market gives it credit for might want to commit itself to following tough accounting rules, to demonstrate to the world that its finances are not that bad and to distinguish itself from governments that follow looser standards. And there are some signs of improvements. The EU is adopting new rules to improve fiscal information. Britain recently published its first set of modern accounts for the whole government (according to a modified version of the standards followed by big companies around the world), and it created a new agency to give an independent opinion on the state of public finances. The U.S. government’s recent accounts include an innovative new presentation of information on the fiscal sustainability of current government policies.

One really important question raised by the crisis is what government accounts should say about the fiscal risks of dealing with the financial crisis—not just about the risks caused by explicit guarantees, but about the risk of having to bail out banks to stop a financial panic. Before the crisis, the consensus seemed to be that governments shouldn’t publicly discuss the fiscal risks of bail outs for fear that this would worsen “moral hazard.” But after the crisis it’s not so clear that silence helped. Perhaps it would be better to be draw attention to the problem and explain what was being done to solve it.

9. Are there any quick fixes? Your note seems to suggest adopting better reporting and accounting based on international standards would suffice? Or is there more?

Full compliance by more governments with existing international standards—including the IMF’s Government Finance Statistics Manual—would help a lot. There are still many governments in rich and middle-income countries with substandard accounting and fiscal statistics.

But there is more to it than that, I think: there’s a need to improve forecasts of taxes and spending, and to ensure frank discussions of fiscal risks in cabinet, parliament, and society—current standards don’t say much about forecasts or reporting risks. There is also a need to make accounts and budget documents easier for people to understand and to promote more informed debate about public finances.

10. Finally, your thoughts on accounting, statistical reporting, and economics—but we have only 100 words left.

Perhaps we should give the last word to Jeremy Bentham, the great English philosopher and social reformer, who actually took a keen interest in government accounting and said, around the time of the French Revolution, that it was the “eye of the public” that “makes the statesman virtuous.” One of the tasks of government accounting is to help focus the eye of the public and—to return to the subject of accounting devices—to minimize optical illusions.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

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Comments

Issue of great importance. In a time of great bailouts and rapid money creation, transparency is key role. Recent fiscal and monetary policy created tool for financing gov. spending without visible limits. Public should be able to learn how the great amount of money is spend and transparency and clear budgeting rules should apply more than ever.

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