A Fiscal Framework for Slovenia: Policy Considerations

Anita TuladharEuropean Department

International Monetary Fund2007 Article IV Consultation

Overview

1. Fiscal policy developments and challenges

2. The current fiscal framework in Slovenia

3. Experience with Fiscal Rules in the EU

4. Policy issues for Slovenia

1. Fiscal Policy Developments and Challenges

A history of sound fiscal policy with relatively low deficits and debt

NMS-8: General Government Deficit and Gross Debt, 2005(Percent of GDP)

-3.6-6.5

-2.5 -3.1-1.4

2.30.1

-0.5

30.4

57.7

42.0

34.5

28.0

4.5

12.1

18.7

-10

0

10

20

30

40

50

60

Czech Hungary Poland Slovakia Slovenia Estonia Latvia Lithuania-10

0

10

20

30

40

50

60

Net lending (+) /net borrowing (-)

Government consolidated gross debt

Source: Eurostat.

Tax burden has been relatively high

NMS-8: General Government Revenue and Tax Receipts, 2005(Percent of GDP)

20.9

24.6

20.618.8

25.6

20.2 20.6 20.3

40.4

43.4

40.9

33.9

45.8

35.5 36.2

33.0

0

5

10

15

20

25

30

35

40

45

50

Czech Hungary Poland Slovakia Slovenia Estonia Latvia Lithuania0

5

10

15

20

25

30

35

40

45

50Total tax receipts

Total generalgovernment revenue

Source: Eurostat.

So is the size of governmentNMS-8: General Government Expenditure, 2005

(Percent of GDP)

44.1

49.9

43.3

37.1

47.2

33.236.0

33.6

0

10

20

30

40

50

60

Czech Hungary Poland Slovakia Slovenia Estonia Latvia Lithuania0

10

20

30

40

50

60

Source: Eurostat.

Deficits have been gradually declining due to rising tax collections and gradually declining expenditures

48.1

48.9

48.0 48.0

47.447.2

44.3

44.8

45.545.3 45.2

45.8

40

42

44

46

48

50

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009-6

-4

-2

0

2Total general government expenditure

Total general government revenue

Deficit, RHS

Source: Ministry of Finance, Republic of Slovenia.

Slovenia: General Government Total Expenditure, Total Revenue, and Deficit, 2000-09(Percent of GDP)

Looking ahead, strong expenditure restraint will be needed to

accommodate a lower tax burden.

48.1

48.9

48.0 48.0

47.447.2

46.6

45.1

44.4

42.6

44.3

44.8

45.545.3 45.2

45.8

45.1

43.6

42.7

41.7

40

42

44

46

48

50

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009-6

-4

-2

0

2Total general government expenditure

Total general government revenue

Deficit, RHS

Source: Ministry of Finance, Republic of Slovenia.

Slovenia: General Government Total Expenditure, Total Revenue, and Deficit, 2000-09(Percent of GDP)

Expenditure restructuring is also needed to increase budgetary flexibility

to allow for countercyclical policy...

25

45

65

85

NMS EU 15 SI

Social benefits Wage bill Other non-discretionary

Share of Total Spending, 2000-05(In percent)

...not evident thus far.Slovenia: Indicators of Fiscal Stance, 2001-06

Output Gap and Cyclically Adjusted Deficit

-5

-4

-3

-2

-1

0

1

2

2000 2001 2002 2003 2004 2005 2006-5

-4

-3

-2

-1

0

1

2

Output Gap

Cyclically Adjusted Balance

Cyclically Adjusted Balance versus Net Lending (In percent of Potential GDP)

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

-5.0 -4.0 -3.0 -2.0 -1.0 0.0

Cyclically Adjusted Balance

Out

put G

ap

Procyclical tightening in earlier years were led by revenue measures. More recently, fiscal stance was acyclical.

Source: AMECO and staff calculations.

Decomposition of the Change in Deficit (In percent of GDP)

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

2001 2002 2003 2004 2005 2006

Discretionary componentCyclical ComponentChange in Deficit

Decomposition of Changes in Cyclically Adjusted Balance (In percent of GDP)

-2

-1

-1

0

1

1

2001 2002 2003 2004 2005 2006

Change in Cyclically Adjusted RevenueChange in Cyclically Adjusted Expenditures

Implementation has lagged behind initial policy intentions. Furthermore,

risk of fiscal relaxation after EMU entry.

Fiscal Deficit Targets(In percent of GDP)

PEP 2001

PEP 2002

PEP 2003

PEP 2004 CP2005

CP2006

Actual-3.0-2.5-2.0-1.5-1.0-0.50.00.51.01.52.0

2001 2002 2003 2004 2005 2006 2007 2008 2009Source: Pre-Accession Economic Programs (PEP) and Convergence Programs (CP)

Need for a stronger expenditure-based fiscal framework?

Stronger commitment device for fiscal discipline

Lend credibility to the tax reform program as being permanent allowing

gains from less distortionary policy

2. Current Fiscal Framework in Slovenia

• Subject to EU rules under Stability and Growth Pact (EDP), but well within the margins.

• No national rules at the general government level.

• Budget process centralized with strong role for finance minister during budget formulation stage. High ranking for transparency (Open Budget Initiative, 2006)

• Four year budgetary projections are prepared with macroeconomic input from IMAD.

To what extent is the medium term strategy adhered to in annual budgeting?

• Two-year rolling budgetary framework which imposes expenditure ceilings, but these are revised for the second year depending upon macroeconomic developments and policy priorities.

Key difference with expenditure rule: Does not preserve automatic stabilizer property

3. Experience with Fiscal Rules (Deficit rule, expenditure rule)

Table 1. Deficit Target Rules in Select EU Countries.Fiscal objective Planning horizon

Denmark Medium term fiscal strategy, 2001

Average structural budget surplus of 1.5-2.5 percent of GDP from 2003 to 2010.

Multiannual (till 2010)

Finland Medium term objectives, 2004 Reach balanced structural deficit by 2007 for central government, cap on central government primary expenditure excluding unemployment benefits; decline in debt ratio

Four years on a rolling basis

Germany Domestic Stability Pact, 2002, Constitution

Golden rule for the federal government under the Constitution. Federal and subnational governments should aim for a balanced budget

Permanent

Netherlands Below 3 percent of GDP under normal economic fluctuations

Four years at beginning of coalition period

Spain Budget Stability Law, 2003 Balance budget or surplus at all levels of government. Temporary deviations allowed with plans to restore balance within two to three years.

Multiannual (3 years)

Sweden Fiscal Budget Act, 1997 Surplus of 2 percent of GDP over the business cycle

Three years

Switzerland Constitution Balanced structural budget PermanentUnited Kingdom

Finance Act, 1998 Golden Rule: balanced current account over the cycle

Three years on a two year rolling basis

Source: IMF (2006), European Commission (2006).

Considerations for a deficit rule• In the EU, the restrictiveness and coverage national fiscal rules

have increased (EC, 2006). Stricter fiscal rules in case of coalition governments (Hallerberg, Strauch and von Hagen, 2004).

• Arguments for a numerical budget balance rule in the form of a permanent target:– To directly address deficit bias arising from ‘common pool’

problem. – This problem more acute during cyclical upswings, in fragmented

political systems with a ‘commitment’ approach of budgeting, and when governments face electoral uncertainty.

– Empirical evidence in favor of deficit reduction following introduction of rule, although this may be subject to endogeneitybias, i.e. enactment of fiscal rule already reflects political will to consolidate (Debrun, 2007).

• Arguments against a numerical budget balance rule:– Rigid annual deficit stance can lead to a procyclical stance ->

deficit targets in structural terms or averages over a medium term horizon. But this is difficult to calculate for a transition economy and there are also difficulties in interpretation for setting expenditure ceilings.

– Poor quality of fiscal adjustment -> ‘golden rule’ that excludes investment spending and targets current balance

– Creative accounting and circumventions through off-budget activity, cash/accrual classification, etc.

– Lack of enforceability at central and general government level. Main incentive for compliance is through reputational costs.

– More common at local level governments

Table 2. Key features of Expenditure Rules in Select CountriesType of expenditure Definition of target Level of

governmentBelgium Primary expenditure Annual medium term

growth rate of 1.5 percent

Federal government

Denmark Public consumption Real expenditure growth rate in accrual

terms

General government

Finland Total expenditure Freezing of real expenditure at 1999

levels

Central government

Ireland Total expenditure Annual nominal growth of 4 percent over 1998-

2002

Central government

Netherlands Expenditures as defined by ceilings (central government

expenditures less non-tax revenues and infrastructure

funds, ceilings for social security, health care and

general government

Medium term real expenditure ceilings

translated into annual nominal amounts

General government

Sweden Primary expenditure plus old age pension expenditure

outside budget

Annual nominal expenditure ceiling: annual expenditure

should not rise faster than projected nominal

GDP

Central government

excluding extrabudgetary fund

Switzerland Central government expenditures including

investments

Annual nomial expenditure ceiling equal to one-year reveue forecasts

adjusted for cyclical position of economy

Central government

United Kingdom Departmental Expenditure Limits (DEL)

Nominal expenditure Government departments

Considerations for a MT budgetary framework with binding expenditure

ceilings• Introduces a countercyclical feature to the

budgeting system as it allows the automatic stabilizers to operate fully on the revenue side

• Theoretically consistent with cyclically adjusted deficit rule, but more practical and transparent

• Preconditions for successful implementation• Political commitment• Underlying structural reforms need to be well identified• Integration with the annual budgeting process and deviations

need to be offset in subsequent years• Exclusion of hard to control items• Regular reviews of budget programs and projections• Realistic macroeconomic projections

Table 3. Key features of Independent Fiscal Institutions in Select CountriesInstitution Forecasts and

Projections of Independent Analysis of Fiscal Policy Developments

Normative Reports/Recommendations on

Belgium National Account Institute, High Council of Finance

Macroeconomic forecasts

Monitoring of budget implementation, analysis of whether budgetary plans and outcomes are in line with fiscal rules

Proposals for changes in budget plans, normative statement on respect of fiscal rules, recommendations in case of slippages

Denmark Danish Economic Council

Forecasts (macroeconomic, revenue, expenditure, balance, debt, long-term)

Monitoring and analysis of budget

Proposals for changes in budget plans, normative statement on respect of fiscal rules, recommendations in case of slippages

Netherlands Bureau of Economic Policy Analysis

Forecasts (macroeconomic, revenue, expenditure, balance, debt, long-term)

Budget analysis, monitoring of budget implementation, analysis of whether budgetary plans and outcomes are in line with fiscal rules, estimates of impact of policy measures

Spain Court of Auditors Monitoring of budget implementation, analysis of whether budgetary plans and outcomes are in line with fiscal rules

Normative statement on respect of fiscal rules, recommendations in case of slippages (ex-post basis)

Sweden National Institute of Economic Research

Forecasts (macroeconomic, revenue, expenditure, balance, debt, long-term)

Monitoring and analysis of budget

Normative statement on respect of fiscal rules

United Kingdom National Audit Office Analysis of budget assumptions

Normative statement on respect of fiscal rules in budget plans

Source: EC (2006).

Considerations for an Independent Fiscal Institutions

• Guardian of fiscal objectives set ex-ante by Parliament• Limits time-inconsistent behavior of policymakers by

making fiscal policy more transparent and increasing reputational cost of deviations from fiscal objectives

• Led to more transparency and public debate• Roles:

– (i) Preparations of macroeconomic forecasts and assumptions; – (ii) monitoring and analysis of fiscal policy developments,

including normative statements on adherence to fiscal rules; – (iii) enforcement of sanctions on a non-discretionary basis

• Impact of on fiscal performance subject to simultaneity bias

• A signalling device for commitment to fiscal discipline

4. Policy Issues for Slovenia

Policy considerations• Rule targeting cyclically adjusted deficit• Long term fiscal sustainability considerations for determining deficit

target• Improvements in the medium term budgeting framework through an

explicit expenditure rule– Specific reform measures underlying deficit targets and estimates of

savings– Extending time horizon of the MTBF unerpinned by spending ceilings.

• Independent assessment of fiscal policy plans and implementation– Produce baseline fiscal projections based on unchanged policies– Normative assessment of fiscal policy implementation including on

adherence of fiscal strategy and rules– Review reasons for deviations from targets

• Thank you.