Posted by Bill Dorotinsky
In the current economic climate, many countries are not focused on budget consolidation, but on spending to stimulate economic growth. But many countries are also engaged in budget consolidation exercises to find fiscal space for new investment. As the global economy recovers, all countries will be focusing on budget consolidation. Both the current crisis and likely future pressure for fiscal retrenchment present opportunities for tackling inefficient public spending and pursuing reforms which calmer economic circumstances would not permit. So it is timely to consider lessons of successful fiscal consolidation, to maximize the potential for countries to make the most of their efforts.
A December 2008 Journal of Public Policy paper, “Roads to Success: Budget Consolidation in OECD Countries,” (Jrnl Publ. Pol. 28, 3, 309-339) by Uwe Wagschal and Georg Wenzelburger, provides just such a consideration of lessons from OECD country budget consolidation exercises. The paper looks at 23 OECD countries over the period 1980 to 2005, and looks for periods of budget consolidation, success of the consolidation, and sustainability of consolidation, and tries to tease out common patterns.
Definitions
One can always quibble with definitions, but the paper employs the following defensible criteria:
• Budget consolidation – a negative primary balance improves over two change periods by at least one percent per year and public debt ratio remains constant, or the average primary surplus of at least two percent of GDP over two change periods and the public debt ration falls. The non-cyclically adjusted primary balance to measure deficits.
• Sustainable consolidation - the public debt ratio in the third year after consolidation is no higher than in the final year of consolidation.
Applied to OECD countries, the researchers found 26 periods of consolidation in 17 countries over 1980-2005, of which 15 were found sustainable, 10 unsustainable, and one uncertain.
More interesting, the paper selected nine case studies to examine in more details the nature of consolidation in terms of
• expenditure measures,
• revenue measures, and
• institutional reforms to support budget balance
The nine countries selected were Austria, Belgium, Canada, Denmark, Italy, Netherlands, New Zealand, Sweden, and the United States. To help tease out some institutional dimensions, these countries were classified by ‘world of welfare groupings:’ social democratic (Denmark, Netherlands, Sweden); conservative (Austria, Belgium, Italy); and, liberal (Canada, United States, New Zealand).
Expenditure Findings
• In most countries, health expenditures continued to rise, hampering budget consolidation
• Most countries reduced spending on general public service (especially debt servicing), defense, and public safety
• Conservative welfare states did not manage to reduce social security expenditures much, while social democratic and liberal welfare states managed deeper reductions
• Liberal welfare states made deeper cuts in defense and public safety (peace dividend)
• Social security expenditures tended to be reduced through tighter benefit entitlement criteria, shorter payment periods (helped by declining unemployment), and eliminating benefit indexation, rather than direct cuts in payment rates
• General public service expenditure reduction was primarily due to declining debt service payments, but some personnel expenditure reductions did occur, more among liberal welfare states than others. Measures used to reduce personnel costs included freezing salaries and cutting benefits and supplemental pay
• Education spending tended to be protected, while economic affairs function expenditures were reduced, mainly cutting subsidies
Revenue Findings
The study found that increasing revenues did contribute to consolidation, but the degree of contribution varied considerably.
• Income and profit tax load increased for countries in the sample, except for the Netherlands and Denmark, where they fell. A few countries introduced special taxes explicitly for budget consolidation (Belgium, Italy, and Sweden).
• Other sources of revenue followed no discernable path, with increases in some countries and reductions in others (goods and services taxes, social contributions and payroll taxes, property taxes).
• Where revenues increased, three policy instruments were identified: de-indexation of income tax brackets; additional taxes on higher income groups, and green taxes.
• One-off revenues from asset sales and privatizations did support budget consolidation in some countries (Italy, Belgium, Denmark, Sweden, Canada, and Austria), but lack of reliable data prevented more general analysis.
Institutional Reforms
The paper argues that expenditure and revenue measures are not enough, and that “key factors influencing the sustainability of fiscal policy also include the structure of the budget process and other institutional arrangements.” The paper examined institutional reforms the authors deemed to be directly linked to fiscal policy performance, including budget process reform, public service reform, constitutional changes, and changes in forms of financing or organizing benefits.
Three countries are singled out for having made the most substantial institutional reforms:
• Belgium – strengthened the role of the non-partisan Superior Finance Council in budgeting, and established a medium-term fiscal framework for communities and regions (with penalties)
• Sweden - focused on executive-legislative budgeting processes, and established a spring fiscal policy discussion that fixed aggregate and sector expenditure ceilings six months before the actual budget
• Italy – strengthened the role of the Minister of Finance (implemented a year before budget consolidation, but regarded as essential to success)
Austria, Canada and New Zealand were regarded as undertaking more moderate process reforms.
• Austria changed its process from a bottom-up to top-down budget, and improved the ministry of finance monitoring of expenditure to enable quicker responses to expenditure pressures with retrenchment measures; also, modified relations between the federal level and states provided additional funds for subnational budget consolidation
• Canada - the medium-term framework was made two-year, and external research institutes provided macroeconomic forecasts to make the foundations of the budget more secure. Related to this was deliberate, systematic conservative forecasts and a safety reserve in the budget. Ministry of Finance specified performance targets and an new expenditure management system also were introduced.
• New Zealand adopted its Fiscal Responsibility Act, “obliging governments to pursue a sustainable budget course.”
Only minor reforms were noted for Denmark, the Netherlands and the US, which the authors note have stronger budget processes already.
• U.S. – the authors note the reforms undertaken before the ‘consolidation period,’ including Gramm-Rudman-Hollings and the Budget Enforcement Act set fiscal limits. The one reform occurring during the consolidation phase, the Line Item Veto Act, might be seen as illustrating some consensus towards deficit reduction, but itself made no impact on fiscal consolidation.
• Denmark – reformed the budget process in the 1980’s, and during consolidation, the medium-term fiscal framework was reinforced and local authority budget cooperation was improved.
• Netherlands – improved its budgeting process in the 1980’s with fiscal targets in coalition agreements, and only minor changes were made during the consolidation.
Public Service Reforms
Outside the budgeting process, the authors noted that broader public service reforms “helped exploit potential savings and … facilitated budget consolidation.” Measures they cite include:
• New Zealand’s State Sector Act and New Public Management reforms, shifting control form inputs to outputs – which the authors suggest preceded budget consolidation and was essential for its success
• Denmark – performance contracts were introduced in public service areas
• U.S. – improved performance information for budgeting (Government Performance and Results Act)
• Austria – improved performance and personnel monitoring
• Belgium – public sector wage structure modifications
Constitutional Reforms
The authors cite three country constitutional changes as being implemented to improve budget discipline:
• Sweden – extended the legislative period from three to four years
• Italy – reorganization of the subnatonal state structure and fiscal decentralization, and electoral reform (1994) that strengthened majority democratic features and reduced fragmentation
• Belgium – fiscal decentralization, with more authority to the regions, but also less recourse for regions to seek additional funding from the central government
Benefit Financing
The authors note that during budget consolidation, some countries changed the way some benefit programs were financed, such as Canada’s modifications to calculation of transfers to provinces, Belgium shifting social security contributions to other financing sources, and Sweden adopting a new social security contribution for employees
Labor Market and Pension Reforms were also briefly reviewed, and the authors suggest active labor market policies in Denmark, the Netherlands, and the US, and pension reforms in Sweden, Italy, Canada, Belgium, accompanied the budget consolidation, and may have reduced future fiscal pressures.
Institutional Reform Index – the authors construct an index of budget reforms and willingness to reform based on their review of the institutional changes adopted by countries. The assignment of weights to the reforms seems somewhat arbitrary, but using the index, the authors conclude
• “The extent to which institutions were changed depended on the problem pressure and the initial level of the stringency of the budget process”
• “ a more stringent budget process and large scale institutional reforms facilitate budget consolidations”
• “such a reform climate is a window of opportunity that can be sued in order to implement far-reaching institutional reforms”
Consolidation Patterns
The authors briefly try to explain consolidation patterns, and attempt to identify causal patterns.
• Liberal and social democratic states succeeded most in reducing social expenditure than more conservative welfare states, where the authors suggest that the form of social insurance conveys ‘social rights’ to beneficiaries that are difficult to change. Among social democratic welfare states, politicians linked social expenditure reductions to the financial crisis, and that such reductions were necessary to save the social welfare system in the long-run.
• The veto player theory did not seem to play a key role, as successful budget consolidations occurred in countries with many veto players (Belgium, Italy). The authors suggest that if the fiscal deficit or debt reaches high enough proportions, reforms can be implemented in any environment.
• Blame avoidance policies were identified across all countries, with either social expenditure reductions linked as essential to the fiscal situation, or use of ‘hidden cuts” by adjusting indices to achieve future savings. For countries in the EU, formal Maastricht criteria were also used as ‘scapegoats for the adjustment policy”
