In Chapter 5, Gerd Schwartz and Ana Corbacho discuss the main characteristics of fiscal responsibility laws (FRL) implemented in some developed and developing countries. It presents an evaluation of its effectiveness based on 13 country case study (Argentina, Australia, Brazil, Colombia, Ecuador, India, New Zealand, Panama, Pakistan, Peru, Spain, Sri Lanka, and The United Kingdom).
Fiscal Responsibility Laws
In 1994 New Zealand approved a Fiscal Responsibility Act in order to strengthen fiscal discipline and improve transparency and accountability. Then, many other countries followed the example by passing fiscal responsibility laws (FRL). But emphasis in terms of the measures implemented varied in two basic approaches: one focused on procedural rules and the other in numerical rules.
According to the study, the main reason to have a FRL was the perception that fiscal discipline was not been maintained voluntarily and that it was necessary to introduce additional legislation in order to guarantee compliance. Many factors can explain the misuse of discretion: short-term horizon of politicians, political and distributive conflicts in budgetary allocation, and time inconsistency in relation to fiscal policy.
The chapter recognizes that procedural and transparency rules in and by themselves may be insufficient to strengthen fiscal policies; however, they may help by making the budget process more hierarchical. On the other hand, numerical fiscal rules may help to contain a deficit bias and address problems of time inconsistency, address the expenditure bias, and target pro-cyclical expenditure.
The potential disadvantages of numerical rules include lack of flexibility in fiscal policy and incentives to rely on low-quality measures to meet the targets.
The scope of FRL varies from country to country, but the FRL have some remarkable features that can explain their different levels of success:
- coverage and jurisdiction (could be applied to central and/or subnational governments – larger coverage seems to be better);
- sanctions (can be institutional, personal, or not be contemplated – LRFs with sanctions are more effective);
- escape clauses (provisions to limit or suspend the rule if special circumstances happen, such as natural disasters, war, and calamities – too generous escape clauses can undermine its credibility); and,
- cyclical considerations (creation of funds to support anti-cyclical expenditure – existence of funds add a long-term perspective that strengthen credibility).
But FRL by itself is not enough to guarantee fiscal discipline. Other factors such as existence of sound budget institutions, political consensus for prudent fiscal policy, political commitment to observe the rules, existence of a sound public financial management system, quality of fiscal information, adequate coverage of the budget, and overall transparency of budget execution and reporting are essential elements to fiscal discipline.
The paper also provides a summary of the main fiscal rules applied in 13 countries (Argentina, Australia, Brazil, Colombia, Ecuador, India, New Zealand, Panama, Pakistan, Peru, Spain, Sri Lanka, and The United Kingdom).
