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April 11, 2014

Formal vs. Informal Fiscal Rules: Lessons from Sweden

Posted by Ingvar Mattsoni

An unusual political conflict occurred in Sweden in the autumn of 2013. The conflict triggered a fierce debate on fiscal rules between the political parties in the Swedish Parliament, the Riksdag. This is unusual because consensus on fiscal rules has prevailed since the fiscal policy framework was reformed after the economic crisis in the 1990s.

The conflict was sparked off by an amendment of the income tax law. The minority government proposed a tax reduction for high income earners in its budget bill. According to the parliamentary rules of procedure (the Riksdag Act), this proposal had already been approved by the parliament in a package of measures that included aggregate expenditure ceilings, revenue projections as well as amendments of tax laws. All four opposition parties disliked the government’s proposal to cut taxes for high-income earners, but since they could not agree on other parts of the package, the government was successful in passing the law.

This was all in accordance with the Riksdag Act and with precedent. Parliament was now expected to deal with appropriations within the framework of the approved budget law. When the opposition parties in the finance committee proposed a new amendment to the income tax law, reversing the reduction for high-income earners, however, the speaker of the parliament refused to put it to the vote. In his opinion, the proposal violated the rules of procedure that provide for one omnibus decision on the budget, including tax amendments. The chamber disagreed with the speaker and the matter was sent to the committee on the constitution for settlement. This committee ruled that the initiative was legal, thus agreeing with the finance committee (the opposition parties), and disagreeing with the speaker (and the governing parties). The reason stated by the committee was a formal one: there is no definite, explicit ban on committee initiatives on tax laws after the budget has been approved. The bill was subsequently put to a vote and approved, thus inflicting on the government a defeat in parliament on a major tax issue. The defeat also had symbolic importance due to the upcoming elections in September 2014.

In essence, the conflict was a matter of diverging interpretations of the rules of procedure in parliament. The case unveiled a fundamental difference between the parties about the purpose of the budget reform in the 1990s. They did not agree on the spirit of the rules. Two lines of argument were pursued:

- The aim of the reform was to protect public finances and thus it must be possible to raise taxes because it improves the budget balance. (Cutting expenditure is allowed according to the Riksdag Act.)

- The aim of the reform was to emphasise the importance of controlling the overall fiscal aggregates―spending and the budget balance―hence the top-down budgeting process that was introduced in the 1990s. Votes are not taken individually on every line in the budget, but only as packages of alternatives. Thus, the argument runs, it is wrong to pick out one item from the overall budget and reverse it after the omnibus vote has been taken, even if it increases revenue. The reform aimed to help minority governments get their budget bills through parliament.

The conflict may sound like a storm in a Swedish fiscal tea cup. Nevertheless, it created a huge impact when it broke out, because it challenged the fiscal consensus and the fact that the fiscal policy framework mainly relies on informal rules. The reversed tax law was important but not itself the source of the crisis. The real concern was whether the events signalled a breakdown of the fiscal consensus in Sweden that has lasted for nearly 20 years.

  Image1

Debate on the budget in the Riksdag, autumn 2013. Deputy Chair of the Finance Committee and opposition spokesperson Fredrik Olovsson (Social Democratic Party) on the left and Minister of Finance Anders Borg (Moderate Party) on the right. Photographer: Dahlstrand, Melker

The statutory base for fiscal rules varies around the world. Both informal and formal rules exist. Formal rules can be stated in law or in the rules of procedure of the government and parliament. In some cases they may even be included in the constitutionii or, as in the EU, in international treaties. Fiscal rules also vary between detailed rules and more generally stated goals, objectives and targets.

Sweden has, like most countries, a mixture of formal and informal fiscal rules, but depends most heavily on informal rules, comprising unwritten agreements and understandings between and within members of parliament and the government. The formal rules are also comparatively general; not very detailed. Nevertheless, they have proved to be remarkably durable due to the strength of the political commitment from both governing and opposition parties.

There are pros and cons for formalised rules. As for instance Ana Corbacho and Teresa Ter-Minassian emphasise “… a robust legal foundation for a fiscal rule can significantly enhance the prospects for its effective observance and credibility, given higher costs of non-enforcement.”iii It is reasonable to expect that formal rules also improve transparency as well as predictability. Another advantage is that formal rules are easier to transfer between generations of decision-makers. Few of the MPs in the Riksdag were members during the financial crisis of the 1990s and can recall these hard times from their own experience. They have not needed to face up to the consequences of weak budget discipline and deteriorating public finances.

There are, however, also disadvantages to formal rules, which cannot cover all possible situations. Rules often include loopholes and open the way for fiscal gimmicks. If too complex they may lead to sub-optimal decisions on the allocation of public expenditure. Formal rules require sanctions to be applied if they are breached, but sanctions―for example, for breaches of the EU fiscal compact―can be two-edged and counterproductive. Politicians may manipulate formal rules for their short-term electoral gains (e.g., chasing pork barrels). It is thus important that decision-makers act in accordance with the spirit of the formal rules: political understandings and other informal rules can help to make this happen.

In reflecting on the lessons of last year’s crisis, it is desirable in my view that, after the 2014 elections, the Swedish parliament should explicitly clarify in the Riksdag Act whether committee initiatives of the kind that occurred last autumn should be allowed or not. This does not imply, however, that it is either necessary or desirable in Sweden to replace the existing formal rules with a new set covering all conceivable situations. There remains a strong consensus among all parties in Sweden on the necessity of sound public finances, budget discipline, and fiscal rules. This consensus needs to be reasserted. There is no better buttress for sound public finances than a political conviction for the fulfilment of the fiscal rules, whether in Sweden or in other countries.

iHead of Secretariat, Finance Committee, Swedish Parliament.

iiFor the American discussion about a constitutional amendment for a balanced budget see e.g., Aaron Wildavsky (1980) How to Limit Government Spending. Bekeley: University of California Press or David Dreier and William Craig Stubblebine (1983) “The Balanced Budget/Tax Limitation Amendment” in Hastings Constitutional Law Quarterly Vol. 10.

iiiAna Corbacho and Teresa Ter-Minassian (2013) “Public Financial Management Requirements for Effective Implementation of Fiscal Rules” in Richard Allen et al (eds.) The International Handbook of Public Financial Management. New York: Palgrave Handbooks.

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

Thank you for an excellent update on Sweden's fiscal rules, which leads me to two observations. First, this is arguably the first major legislative challenge to the straightjacket imposed by the budget process reforms of the 1990s. Perhaps the time has come to rebalance legislative-executive relations. If the Riksdag finds a way to reconcile greater activism with budget discipline, it could - yet again - be a model for legislative bodies in other countries. Second, the analysis does a fine job highlighting the importance of the political consensus underpinning Sweden's fiscal rules. Simply put, first came the consensus, then the rules. Efforts in Europe to impose constitutionally-grounded balanced budget rules on EU countries via the Fiscal Treaty appear to assume the opposite: that externally-imposed (and very complex) rules will somehow engender greater commitment to fiscal discipline. This blank-slate approach ignores the domestic origins of successful budget reforms in countries such as Sweden.

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